Peter Warmerdam describes how Philips centralised its treasury operations and how this process has allowed the treasury function to focus more on creating shareholder value, through Asset and Liability Management, Financial Risk Management, Working Capital Management, Operational Risk Management, Sales Financing and Cost Management.

Why did you decide to restructure the Philips treasury?

Philips is a very complex multinational corporation, with over 1100 subsidiaries in 150 countries. When I joined Philips in 1998, the treasury function was partly decentralised with some decisions still taken at a country level. As a result we had over 300 banking partners.

In order to reduce costs and free working capital, we decided it was in the company’s best interest to centralise processing to get greater visibility of and control over cash flows and risks throughout the group.

In a first phase we concentrated our treasury activities into four regional finance centres, before consolidating them in a second phase into a single enterprise-wide structure.

What were your objectives when you decided to restructure the treasury?

We needed to develop a structure, which would give us as much visibility over the cash flows and risks as possible. The selected structure needed to be sophisticated enough to cope with the flows generated by all our subsidiaries. If we could not identify the cash within the group in an automated manner, it would be impossible to use that cash more efficiently.

We also wanted to be able to automate as many processes as possible. In order to do this, we needed to standardise the processes across the group as far as technology and regulations would allow. Despite having so many different ERP systems, we recognised it was important to reduce the number of interfaces between systems as much as possible. Automation and standardisation of interfaces would allow us to reduce the number of personnel both within Treasury and Finance and Accounting in general.

Our decentralised structure also meant that we made a large number of intra-group cross-border transactions in order to make best use of our cash. By introducing a centralised Cash Management structure, we substantially reduced the number of external bank relationships across the group. In turn this allowed us to reduce the level of idle cash and to vastly improve the management of our available cash.

Finally, we wanted to improve controls within the more automated treasury, to be able to create clear audit trails and comply with different regulatory requirements.

How is the Philips treasury structured today?

The core elements are a centralised Treasury Management System, a Payment Factory, an In-house Bank, a Deal Station and more recently a Loan Station.

The treasury management system was key to our centralisation strategy. This needed to be sophisticated enough to connect all our subsidiaries and to track all of our cash flows. One of the core components was the ability of the system to transfer information automatically to both our in-house bank and to external banks.

During this period we implemented a centralised Liquidity Management process using a series of currency cash pools, thus reducing both idle cash balances and the need for local overdrafts.

The next part of the process was to create a Payment Factory, which would be able to process all our outgoing payments, internal as well as external. This was a crucial part of the consolidation, as it allowed us to reduce our banking partners. We now only use two banks to make commercial payments on our behalf.

By using the Payment Factory we reduced external crossborder payment processing costs. To complement it, we have also developed an In-house Bank to manage intercompany payments and accounts.

What difference has this structure made to the business units?

The subsidiaries are still responsible for managing their own payments, although they are made through the Payment Factory. The Payment Factory allows the business units to manage all of their payments through a single, secure interface. By centralising the processing of outgoing payments, treasury is able to ensure that cash is used within the group as efficiently as possible and all FX exposures created are captured and laid off by our central dealing room.

Whenever a subsidiary wants to make a payment, it will submit a payment file to the Payment Factory, rather than issuing an instruction directly to a bank. Once the Payment Factory has ensured the authenticity of the payment file, it will make the payment either through the In-house Bank or using an external bank. Through our structure most external payments can be made as cheaper domestic payments rather than as cross-border as used to be the case. Once the payments have been executed the subsidiary will receive a file in return for automatic reconciliation of their Accounts Payable. To complete the information flow we also provide the suppliers with an automated Remittance Advice.

What other processes have you developed?

One of the ways we have standardised the relationship with our subsidiaries is by creating the Deal Station, which allows our subsidiaries to communicate their foreign exchange exposures through a web browser directly into the treasury management system.

Every business unit has its own functional currency and has its own hedging policy. This is based on the corporate policy, but allows the business unit to vary its hedging strategy by setting a hedge ratio for anticipated cash flows and the tenor of the outstanding hedges. These decisions are incorporated into the algorithm calculating the matching hedge. The optimal hedge ratio and tenor are the result of the analyses of our inhouse Financial Risk Consultants, who take into consideration a number of factors such as, for example, the price elasticity of the product, flexibility in the sourcing and competition.

These hedge requests are then executed in the market using a web-based bank-independent bidding platform.

Once the deal has been executed, hedge documentation can be generated matching each exposure to the external foreign exchange transaction. This system creates a clear and transparent audit trail, from the input of the exposure and the calculation of the matching hedge, to the final deal between corporate treasury and an external counterparty. Further, the requirements of IAS 39 and FAS 138 are satisfied, allowing our business units to apply hedge accounting for the hedges of their exposures ensuring the result of the hedge affects the income statement when the underlying transaction affects the income statement.

How has this system helped you to achieve your objectives?

There are a number of important benefits:

• Control is deeply embedded in the process.
• It meets the needs of the business units. This process is easy for the business units to use and standard across all businesses.
• It is a standard, straight-through process. All foreign exchange deals for all our entities around the world, except for China, are executed in Amsterdam. In China, local deals are concentrated in Shanghai.
• It is efficient. This process has eliminated all the communications by fax and phone between the business units and treasury. It has also automated foreign exchange dealing through the treasury management system. Through standardisation, processing headcount has been reduced by 70%.
• Our hedging process is fully compliant with US GAAP.

How do you measure the success of this process?

There are three main ways:

1. We issue Annual Customer Satisfaction Surveys.
2. We conduct regular benchmarking exercises with multinationals.
3. We have reduced the costs of our global Treasury organisation by over 40%, which includes the costs of building up a consulting focussed organisation.

What are the next steps?

We are currently in the process of rolling out our Loan Station. It builds on the Deal Station concept for intercompany and external financing of the countries worldwide, with instruments and country limits setting capabilities. Loan Station will give us the possibility to handle the loans in the most efficient manner, to provide a complete overview and to control all debt of Philips country entities worldwide.

Finally, a bigger challenge will be to implement a collections factory. Introducing a Payment Factory is easier, because we have control over the payments we want to make. Introducing a collections factory will be more difficult, as we are dependent on the methods our customers want to use. This is an area in which we still have a multitude of bank relationships. Although it will be very difficult to achieve, any progress we make will add to the efficiency of our operation.