Cash & Liquidity Management

Treasury reporting

Published: Jul 2014
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If there is one unifying theme running through nearly all the changes seen in the world of corporate treasury since the crisis it is that of transparency. For evidence of this trend, one needs to look no further than the growing reporting burden. Boards and senior corporate management, concerned about their companies’ financial health, have begun to demand increasingly accurate and timely data on their companies’ financial health. But that is not the only driver. Reporting requirements have also been at the centre of a number of the regulatory changes introduced in recent years. In this article, we return to the fundamentals of treasury reporting and look at the ways in which the practise has changed.

Nobody likes nasty surprises, least of all corporate treasurers. That is why, for the treasurer, having the proper data and intelligence is vital. Treasurers need to be able to view and report on a wide range of business intelligence data including exposures, hedging positions, cash forecasts and debts. The board demand it, external regulators demand it and, increasingly, treasurers themselves are demanding it.

Of course, without the help of a TMS, making sense of the data can be hard work – but any treasurer would agree that’s more preferable to the shock of discovering a financial exposure after it is too late to doing anything about it. With an effective, cohesive reporting framework in place the treasury team should be able to quickly identify, quantify and manage the various financial risks that their companies face.

Opinions often differ on precisely what should be reported and in what way, but there are some basic elements to consider. In this article, we will return to these basics, outlining the fundamental areas that should be reported and how they should be reported.

How to report

Each company is unique in its structure, size and nature of operations. While all these factors influence the format and scope of treasury reports and result in a variety of potential reporting styles, several features and guidelines are applicable to all treasury reports. Perhaps the most important aspect to remember is that any report produced, must be used – whether internally, or as part of an external management process. In order to be used, it needs to be usable. This means producing a report to the required timeline. The report should also be in a user-friendly format, so the relevant information is easily accessible.

The format of management reports

Information should be supplied in a clear, concise and reliable format. Certain features help to achieve this:

  • Reliability

    Senior management must be able to rely on the accuracy of the information given.

  • Brevity

    The level of detail needs to guarantee that all relevant information has been given, but details are only important to senior management if they are crucial to general decision-making. Whenever possible, the focus should be on key issues, presented in the form of rules and principles, rather than a list of details. A summary of the key points can help to focus on the relevant information.

  • Language

    It is vital to present key information using clear and understandable language. Whenever possible, the use of mathematics and calculations should be avoided and their meaning and effects should be expressed in plain words. Management commentary is an essential element of reporting and increases the accessibility and usability of management reports.

  • Illustration

    Showing is often more convincing than merely telling. Therefore reports can often benefit from graphs and illustrations to emphasise or explain important points.

Expert opinion on what items should be reported, and in what level of detail, will often vary to a certain extent. However, there are a number of fundamental areas for reporting that are common to most treasuries.

Cash flow forecast

Cash flow forecasting aims to increase the visibility of cash and liquidity positions of a firm. By predicting future cash surpluses or deficits, cash flow forecasts enable treasurers to gain a picture of investment options or borrowing requirements in advance. For a comprehensive picture a range of timescales – yearly, quarterly, monthly, weekly – should be covered. Longer-term forecasts are most useful for acquiring notice of potential financing requirements so that the extension or renewal of debt facilities can be coordinated in a timely manner. Short-term forecasts, on the other hand, tend to be used more for managing day-to-day liquidity.

The first step, logically, is to collect the required data – recurring outflows and inflows and accounts payable (AP) and accounts receivable (AR) – usually via a TMS, ERP, or bank feed. Once these figures have been collected the next job is to analyse and make sense of it. Analysis can take various forms. It might be simply moving averages – the identification of future cash flow positions through historical data – or exponential smoothing, which is a similar process but with a variety of weightings added to the data, and finally, distribution modelling, which uses previous data patterns to extrapolate future trends. Technology such as a TMS can do a lot to simplify this stage of the forecast through the conversion of data into easy-to-read graphical forms such as charts and graphs. However, for a majority of treasuries manual input through Excel spreadsheets continues to be the main tool for executing such tasks.

Foreign currency transaction exposure reports

Reports that combine currency cash flow forecasts with an analysis of hedging transactions should be compiled for each country where the company has significant exposure. This can help to identify the firm’s net outstanding exposure over the relevant time period. For each period, the maximum expected loss from adverse currency movements should be estimated using a calculation of the level of net exposure, the duration for which the position is open and, lastly, the historical volatility of the currency pair in question.

Of course, when it comes to foreign exchange exposures it is the net gain or loss that really matters to the corporate treasurer. This is why more sophisticated treasury operations will often apply what is called a portfolio approach when calculating currency risk. The rationale of a portfolio approach is that while exchange rates can move in different directions on a daily basis, some currencies move in one direction and others in the opposite, thereby altering the cumulative level of risk. This is called ‘portfolio effect.’ In order to quantify and reveal the net exposure of a portfolio of foreign currency denominated assets and liabilities, an analysis of statistical correlations between changes in one rate and that of another using historical data needs to be performed. For the purpose of reporting, the results are usually set out in a correlation matrix displaying the correlation between all the exchange rates within the portfolio.

Debt summary

Management will naturally want to be regularly updated on the total level of debt the company has on the balance sheet. A debt summary will normally be prepared monthly. Details, by currency, are provided on the split between committed and uncommitted debt facilities. Debt maturity profiles of each facility are also compiled in order to highlight significant refinancing risks that might arise in the future. Corporates who do not use derivatives to hedge interest rate risks should also detail the split between fixed and floating rate debt to show the company’s exposure to adverse changes in interest rates.

Covenant reports

Lenders will sometimes impose covenants when extending borrowing facilities to exert some control over the activities of the borrower. A covenant is essentially the setting of minimum financial performance standards that the borrower must achieve, for instance, the net worth of the company compared with its total debt. Since breaching any restrictions could result in the company being called into default, it is imperative for the corporate treasurer to frequently report on covenants internally and externally.

Interest rate gapping

An ‘interest rate gap’ report is a measurement of a company’s exposure to interest rate risks that is often used by the treasurer to help formulate hedging positions. Interest rate gap reports present an analysis of the company’s interest bearing assets and liabilities apportioned into future time bands when rates are reset.

The gap report table should be accompanied by a commentary outlining different interest rate scenarios and the various hedging strategies that could mitigate the impact of such exposures. A comparison of the company’s average weighted interest rate against current market rates or a measure of the performance of actual debt cost against current market rates or actual debt cost against a risk-neutral benchmark might also be included

Derivative reporting

Derivative products serve as useful tools for treasurers to manage their financial exposures, but can also carry significant risk if used inappropriately. It is very important, therefore, that the treasury monitors and manages not only the underlying exposure that they are hedging but also the instruments – futures, swaps, options and forwards – that they are hedging with. Regular reports should be compiled detailing all valuations, position balances and market exposures by product type, and any unhedged exposures also need to be noted. The importance of derivatives to the company should determine the frequency of this evaluation. For example, a large petrochemical multinational using a vast portfolio of different derivative products would clearly need to produce derivatives reports more frequently than a corporate that hedges less regularly. Naturally, regulation is also having a huge influence on external derivative reporting – see this month’s Insight & Analysis article for more information.

Counterparty credit report

As the financial crisis reminded everybody, counterparty credit exposures can sometimes put the financial health of a company – its survival even – in serious jeopardy. Managing this risk means applying, and regularly monitoring, limits for each counterparty. All deposits and any derivatives contracts that are in place should be included in the scope of these reports and any change to a counterparty’s credit rating should precipitate a re-evaluation of the exposure limit attributed to that particular counterparty. There are two commonly used measurements of counterparty risk, value-at-risk (VaR) and earnings-at-risk.

VaR first emerged as a distinct financial concept in the years following the ‘Black Monday’ stock market crash in 1987. In basic terms, VaR is used by some companies to measure the worst-case scenario for their assets or liabilities. Market trends and fluctuations over certain time periods are analysed and, using the data accumulated, estimates of the largest loss that could be incurred under normal market conditions – or a 95% probability – can be determined. The longer the specified period, the greater the value (or earnings) at risk will be. Since the price movements of assets and liabilities are netted, the VaR associated with a given portfolio is likely to be less than the sum of its individual constituents.

VaR is a useful concept for financial reporting since it allows the treasurer to combine a range of financial risks faced by a company into one single measurement. There are some notable drawbacks which the treasurer should keep in mind, however. Firstly, VaR only accounts for financial risks. Since operational risks such as those in the supply chain are not included in the calculation, treasurers need to be aware that the metric does not provide a complete overview of the risks that a company faces at any given moment. Nevertheless, VaR is a useful tool for treasurers, particularly when it comes to establishing hedging strategies. Once the VaR associated with each hedging strategy has been determined, the treasurer can use the data to ensure the level of risk associated with the favoured strategy is acceptable.

An alternative to measuring VaR is to measure the company’s Earnings-at-Risk. This technique will produce similar results to VaR, but in the form of corporate earnings, rather than shareholder value. This is more valuable than VaR for measuring the impact of counterparty risk arising from customers. For example, a company with a small number of large value customers will find that a higher proportion of earnings are at risk should one customer either default on their obligations or fail to pay on time.

In addition, as this measure focuses on earnings, it is potentially of more immediate use than VaR for the treasurer. This is because it can assess the inflows at risk at any particular time.

The key to effective reporting

Even now, nearly six years after the collapse of Lehman Brothers and the ensuing market chaos, the demand for enhanced reporting shows little sign of abating. In fact, given the large volume of new regulation affecting what companies need to report externally – FATCA and EMIR, for example – one could argue that the necessity for improvement is as strong as ever.

One thing that would improve the quality of most treasury reporting would be some careful consideration of what actually needs to be reported, rather than simply relying on previous formats. This will depend upon:

  • What the treasury needs to show management.
  • What the treasury needs to provide to other departments.
  • What information the treasury itself requires.
  • What analyses the treasury would like to do that have not been possible in the past.

Conducting a thorough analysis of what is required from a report and subsequently conveying those requirements to others can help reduce the reporting problems that often plague treasurers. It can also encourage a more open and effective attitude towards reporting throughout the company.

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