Treasury metrics

Published: Sep 2016

Treasury metrics should link up to the departments overall goal, which will be some form of cost effective risk reduction. However, performance can only be properly defined in terms of parameters that are in practice subjective, and therefore must be set by the board of directors. In this article I explore the various metrics that treasury may wish to employ.

Corporate treasury has an incredibly diverse set of responsibilities and consequently varied goals. However, for most departments their objectives are likely to be some form of cost effective risk reduction (CERR). After all, non-financial corporates want to reduce financial risk so that more of the firm’s resources can be devoted to the core business.

But each firm will have a different view on what cost effectiveness means, and the same can be said for their risk tolerance. As a result, it is the board that has to decide on the parameters within which treasury has to work.

Capital structure

Capital structure is probably the core treasury related decision that the board has to answer, and its results ripple through the entire treasury operation.

At its simplest, treasurers need to know how much leverage to have and how much cash to hold. An important follow on detail is how much long tenor debt to issue – from a CERR perspective, long tenor debt is less risky but more expensive.

The target duration is, of course, closely related but I will cover that under interest rate risk.

From a CERR perspective, the optimal capital structure gives the lowest sustainable weighted average cost of capital (WACC). The strategic variables include leverage, tenor and cash. High leverage reduces cost and sustainability, and low leverage increases cost and sustainability (because equity is more expensive than debt but does not have to be repaid). Equally, short tenor reduces cost and sustainability, and long tenor increases cost and sustainability (because long tenor debt is more expensive than short tenor debt but reduces liquidity risk). And low cash balances reduce cost and sustainability, large cash balances increase cost and sustainability (because cash yields much less than WACC but reduces liquidity risk).

A quick scan of current corporate practice – especially with approximately $5trn of corporate cash – shows that boards seem to be leaning heavily in favour of sustainability, presumably fearing macro-economic uncertainty may increase both financial and commercial risk.

Although there are mathematical models, such as the capital asset pricing model (CAPM), which help to optimise WACC – they assume that the markets provide valid input about the riskiness of the firm. Certainly market inputs require consideration, but having lived through at least a decade of distorted markets, they cannot be the only input. Ultimately this decision is a key management responsibility, and from a governance perspective that means a board decision.

There are a number of methodologies the board can use to define capital structure, including:

  • Fixed numbers and ratios.
  • Following peers.
  • Operational metrics (ie keep six months operating expenses in cash).
  • Target rating.

In all cases, there has to be some range that allows treasury operational flexibility.

My favourite is the target rating. This gives the treasurer (and CFO) more flexibility to optimise WACC, and provides an easy to understand metric for investor and customer relations. A common strategy is to target one level above “junk” to give some room to weather adversity. Again there is no one right answer – it depends on financial and commercial market constraints (for example, customers often worry about financial solidity of their suppliers).

Cash management

Cash management can be broken down into balance management and flow management, and each require relevant metrics.

For balance management, the key issue is cash concentration – how much of total cash is available for corporate needs such as paying down debt, business development, etc? We want to minimise cash leakage in the form of trapped cash or simply lazy cash that we have not concentrated. The cost of concentrating cash is a material but secondary metric (depending on how critical cash is for each corporate).

Flow management is basically a cost game. It is important to realise that cost reduction in this context is more about eliminating bank fees (by taking flows out of the banking system with payment aggregation and netting) rather than haggling down bank fees. In this respect, in-house banks (IHB), on-behalf of structures (OBO), netting et al are all very helpful.

In case you think I am missing some important credit and operational risk metrics, consider that for balance management concentration maximises cash in treasury’s hands which implies that treasury will rigorously apply the group credit risk policy. And for flow management, cost reduction must measure all in cost, including in house FTEs and cost of errors, not just bank fees.

Foreign exchange risk

Foreign exchange risk policy and metrics is another somewhat subjective area – which means board level decision making. For example, some groups forego hedging altogether for more or less philosophical reasons, others hedge only balance sheet exposures to avoid the hassle of hedge accounting, while others try to hedge the entire business cycle. Like capital structure, there is no Excel model that will give you the ineluctable answer, so it has to be a board decision.

The first decision is what to hedge – nothing, balance sheet (whatever causes FX revaluations in the accounts), or cash flow/margins (normally balance sheet plus orders and some forecasts). In the last case, we also need to decide what tenor to hedge (commonly six to 18 months, depending on the pricing cycle). Additionally, we need to know the hedge ratio – what percentage of the measured exposure should we hedge, and what variation around that target is permissible.

With those decisions put in place by the board, operational metrics for treasury are quite simple – basically have we followed the board policy and how cost effectively? To the extent that the board allows some discretion to treasury (small over and under hedging, use of options rather than forwards), then we can measure the risk adjusted cost compared to a benchmark (exactly following the policy using market forward rates).

The big benefits will come less from fancy hedging strategies and more from rigorous netting of exposures and even adjusting business models to reduce what has to be hedged in the market.

It is easy enough to play around with swaps and swaptions to try to beat the market – though actually beating the market can be hard absent central bank distortions. But what surprises me is how few corporates are clear about their benchmark duration.

In my experience, duration is hard to pin down in the real economy. Even long-term plant with thirty or more years payback tends to have revenues that follow business cycles, implying a relatively short duration – a big exception again is government distortions such as electricity off take agreements.

So once again, benchmark or neutral duration is a matter for the board to decide (because it cannot be calculated quantitatively) and of course they have to fix risk limits in terms of permissible deviation from neutral.

Once the benchmark or neutral duration is fixed, treasury can get on with trying to beat it – ie to achieve a lower than benchmark cost of debt within the board determined capital structure and duration constraints.

Other Metrics

The metrics described above are “strategic” for treasury in the sense that they come from the board. Metrics for forecasting and for front- middle- and back office are operational – treasury can decide how best to execute within the parameters set by the board (within the policy and cultural constraints of the firm, of course).

Once the board has set the parameters, treasury must set performance metrics on an ‘all in’ basis. This ensures that secondary issues such as internal control and process efficiency will be covered and built into the overall metrics framework. For example, outstanding reconciling items typically take expensive time to resolve and may incur overdraft and other fees, so metrics about outstanding reconciling items go beyond internal control (which is also important) and address all in cost.

Of course, there will often be control metrics around corporate Sarbanes-Oxley (and equivalents) compliance. The important thing is that treasury specific metrics should have clear causal links into treasury’s overall goal of cost effective risk reduction (CERR).


Treasury metrics can only be set in the context of risk parameters that are company specific and somewhat subjective. Such parameters have to be set by the board of directors, because they affect the company as a whole and because they cannot be determined with empirical quantitative methods.

With the parameters established by the board, treasury can build a coherent framework of metrics to help them manage treasury towards the overall goal of CERR.

David Blair, Managing Director

Acarate logoDavid Blair, Managing Director, Acarate

Twenty-five years of management and treasury experience in global companies. David Blair has extensive experience managing global and diverse treasury teams, as well as playing a leading role in eCommerce standard development and in professional associations. He has counselled corporations and banks as well as governments. He trains treasury teams around the world and serves as a preferred tutor to the EuroFinance treasury and risk management training curriculum.

Clients located all over the world rely on the advice and expertise of Acarate to help improve corporate treasury performance. Acarate offers consultancy on all aspects of treasury from policy and practice to cash, risk and liquidity, and technology management. The company also provides leadership and team coaching as well as treasury training to make your organisation stronger and better performance oriented. |

The views and opinions expressed in this article are those of the authors

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