What is a Corporate Treasury in Finance? 3 Goals, 7 Functions

Most professionals first hear of treasury departments as a branch of government, but it’s equally important in the financial operations of large companies.

In fact, companies generating more than $10 million in revenue (SMBs) build Corporate Finance Departments that are typically split into into three areas: accounting, finance, and treasury.

While most people understand the importance of accounting and finance, few realize what a treasury does and how important its functions are to the company’s success.

In short, the treasury department is responsible for managing a company’s cash: ensuring liquidity with working capital management, establishing controls for accounts payable, limiting risk exposure in fund-raising, setting payout strategies, and investing excess cash in capital markets to generate financing income.

Treasury in the Corporate Finance Department: What Does it Do?

The company treasury manages cash, but it is not the business decision maker. This means that one of its core challenges is working with company leaders to organize cash flows around business objectives.

In other words, in addition to controlling day-to-day cash inflows and outflows, the treasury must have a long-term vision to make strategic investments that generate financing income all while maintaining short-term flexibility to fund operations as needed.

Treasury Goals

We can thus divide a treasury’s goals into three:

1. Short-term liquidity and cash flow management
2. Mid-term fund-raising as needed
3. Long-term capital market income

Treasury: 7 Core Functions

To achieve these goals, treasury’s have special functions. This article investigates how a company treasury achieves its 3 goals with 7 key functions:

1. Accounts payable management
2. Working capital management
3. Fund-raising
4. Cash forecasting
5. Payout strategies
6. Financial risk management
7. Capital structure & cost of capital

Difference Between Government Treasury and Corporate Treasury

Before we look at each of these functions, it’s important to understand the difference between a government treasury and a corporate treasury.

In a sentence, government treasury departments have a wider scope than corporate treasuries. Like corporate treasuries, government treasuries manage their country’s liquidity, fund-raising, and capital investment activities, but they also monitor macroeconomic trends, propose economic legislature, advise political leaders on economic and financial issues, collect taxes (the IRS, for example, is a bureau of the US Treasury), and prosecute financial evaders.

Perhaps the most important difference is that corporate treasuries ultimately aim to generate as much value for investors as possible, whereas government treasuries aim to improve the lives of their citizens. The former often indicates dividends, whereas the latter indicates profit reinvestment.

Let’s now look at the 7 core functions corporate treasuries use to achieve their goals. I’ll use “description,” “challenge,” and “solution” as separators to break down each of these function.

Accounts Payable Management

Description. Accounts payable management consists of controls put in place to ensure the company pays invoices as late as possible and in the correct amounts.

It’s a fundamental of cash flow management to pay invoices as late as possible, thereby maximizing the amount of excess cash available to fund operations and to invest in markets (we’ll discuss this thoroughly under the working capital management function).

So what happens? Companies must purchase goods and services from suppliers in order to operate, and these goods and services are either regular or one-offs.

The company treasury has to pay these suppliers either at the time of delivery, or on credit at a later date.

In addition, the company has financing payments (such as loans) to pay on a regular basis. But there is little-to-no flexibility on timing it comes to these payments.

Challenge. The challenge arises when have 100s or 1000s of monthly invoices and loan payments that fall into the laps of 3 to 5 accounts payable specialists. The risk for human error is high.

Especially when payments must be made in different forms. Most payments today are digital, but some suppliers or special servicing fees must be done through legacy secure portals… or worse, manually.

Moreover, companies with operations internationally, or in different fiscal regions domestically, must navigate from which bank account they should pay in order to avoid additional processing fees.

In addition, these usually companies have many different loans, each with its own maturity date and interest. Keeping track of those is a challenge in itself, not to mention paying on time.

To add another level of complexity, public companies (those that are listed on stock exchanges) must comply with regulations and laws that vary across fiscal regions.

Solution. The ways in which company treasuries manage accounts payable vary widely, but common techniques include account signatories, payable tranches, loan registers, manual payment controls, and consolidated vendor bank registers.

In addition, a common HR technique is the separation of source documentation, cash reconciliation, and bank account management responsibilities.

• Account signatories. Each bank account has a list of signatories. Signatories are the authorized personal who can validate payments from those accounts. The use of signatories ensures several pairs of eyes examine payments before the cash flows out. It also ensures no accounts payable specialist is tempted to divert funds.
  
• Payable tranches. You might be thinking, “how could you ever get 1000 invoices paid if multiple signatories must examine each payment?” It’s a good question, and it’s why there are payable tranches. Payable tranches are just amounts at which accounts payable specialists need signatories for approval. Logically, the higher the amount, the more signatories are needed. For example, a company generating $10M in revenue does not need signatories to review $500 in office supplies. The AP specialist can pay that him/herself. However, a supplier payable of $100,000 might be the first tranche, at which level the AP specialist needs approval by 1 signatory.
  
• Loan registers. Loan registers are documents that list each loan, its type, the interest rate, monthly payment, and the maturity date. Banks will issue loan invoices to the company, so there is no need to calculate the payment yourself. However, cross-referencing the invoice with this register provides a sanity-check for AP specialists. More often than not, loan registers are saved in a secured cloud database.
  
• Manual payment controls. Most AP payments happen through a host-to-host digital payment process wherein payment information uploads automatically after the initial clearance. However, there are inevitably some payments that must be performed manually. To be clear, manual payments are not “in person.” The term indicates that the AP specialist must input all of the necessary information at each payment. The control process here is usually two signatories that both approve AND review the inputs.
  
• Consolidated vendor bank registers. As part of the automatic payment process, most treasury AP teams have a database of the bank accounts that autofill. But in order to make that happen, the AP team must meticulously monitor and update its consolidated vendor bank register. This register MUST have the bank account number, the bank name, and the routing number (US only), the name of the company, and the account owner. The register MAY include additional details on the company’s relationship with the target bank and target company.
  
• Separation of responsibilities: 1. source documentation, 2. cash reconciliation, & 3. bank account management. Any time there’s money involved, there’s a risk for conflict of interest. This risk particularly applies to accounts payable. On a day-to-day basis, the AP team must manage source documentation (invoices in most cases), make payments from bank accounts, then reconcile cash with those documents. This reconciliation happens on a biweekly or monthly basis. However, the person managing the invoices can also perform reconciliation. There would be no control to catch him/her stealing. Moreover, the person managing cash reconciliation cannot manage the bank accounts. There would be no control to catch him/her stealing. BUT, the person managing records could also manage the bank accounts. The control to catch him/her stealing is another person doing cash reconciliation.

Working Capital Management

Description. Working capital management (WC management) is tracking current assets and current liabilities to ensure short-term liquidity and to invest excess in capital markets.

To be clear, the treasury’s view on WC management is different than an investor’s perspective. Whereas the investor is interested on seeing [current assets/current liabilities] (the ratio) over a period of time, the treasury is interested in seeing [current assets – current liabilities] (the difference) in the immediate future.

In other words, the treasury wants to make sure that in the following days, weeks, and months, the company will have enough cash to pay for its obligations. It also wants to use any surplus to invest and generate additional income.

Working capital management is different from accounts payable. Accounts payable focuses on controls to ensure timely and correct payments of current liabilities, whereas WC management focuses on how these current liabilities interact with current assets.

As a reminder, current assets include cash, inventory, and accounts receivable (among others). And current liabilities include loan payments and accounts payable (among others).

Challenge. The challenge arises when time enters the equation. As mentioned, an investor is only concerned with WC at the end of a period, but the treasury must ensure enough of inventory and accounts receivable will become cash before liabilities become payable.

It helps to remember that current liabilities are always cash items, and current assets are either cash OR non-cash items.

For example, when a company has $400,000 in current assets and $200,000 in current liabilities, the ratio looks good (2:1). However, if $100,00 of those current assets are cash and $300,000 are accounts receivable due in 30 days, they would not be enough to pay all $200,000 current liabilities if due in 15 days.

Let’s look at this on a timeline to visualize the challenge in a working capital schedule:

As you can see, we start with $100,00 in the bank. Although receivables are $200,000 higher than current liabilities, the cash outflow to occurs before the receivables. This means the company would not be able to pay them. In finance talk, the company would be cash negative, illiquid, insolvent — that’s a big no no.

Solution. Treasuries use working capital cash schedules to monitor their cash levels and ensure they are never at risk of being cash negative. These schedules look much like the chart shown above. In fact, if a treasury’s WC cash schedule looked like the above chart, it would need to engage in fund-raising, which we will cover next.

But there are preemptive means to protect against becoming cash negative. They’re policies that the company puts in place to get money faster than it must pay. They include credit policies and payout timeline policies.

• Credit policy. Credit policy is another term for accounts receivables policy. When a customer purchases on credit, he or she receives the good or service and pays for it at a later date. This is most common in B2B companies and B2C companies selling big-ticket items that cost more than a few hundred dollars. From a marketing perspective, it’s brilliant. Instead of the customer having to use her credit card and pay interest, she simply pays in multiple installments. However, from an accounts receivable perspective, it’s not favorable to wait for cash. A company’s credit policy, thus, states how long and in what installments payments must be made by customers. It maximizes the duration allowed using limitations from working working capital. Those who work in treasury know that this is a constant battle with sales and marketing teams.
  
• Payout timeline policy. On flip side of credit policies are payout timelines. Payout timelines show how long the company has to pay for the goods and services it has received. In other words, payout timelines are the same thing as accounts payable. While the company cannot set a policy for the duration and installments on its payouts, it can set an acceptable range. The payout timeline policy states how quickly each type of service and good may be paid for. If not, the company will not accept the contract. This policy is different for Cost of Sales (costs that are directly linked to production of the company product, such as metal for watches) and for operating expenses (expenses such as professional services and office supplies that aren’t necessary to production). In most cases, the company has less flexibility with CoS suppliers since they are essential to the business.

Fund-raising

Description. Fund-raising is the use of either capital injections or debt to fund assets. In plain English, it’s when treasury works with the legal department to issue new shares and get cash inflow, or when it goes to the bank to get a loan.

There are two reasons why treasury would need to raise funds: 1. WC management, or 2. funding expansion. The first is a short-term activity and the second is a long-term activity.

While issuing shares only comes in one form, there are many types of loans. The choice of which loan to use depends on whether it’s for WC management (small amounts) or funding expansion (large amounts).

For example, remember the chart above showing how a company can become cash negative? If it were a real-world scenario, the treasury would need to request a revolving credit facility (RCF) — a type of loan that allows the company to borrow a small amount, pay it back, then borrow again. It’s just like a credit card (NOTE: RCFs stand in opposition to a mortgage-type loans, which do not revolve and therefore only provide cash once at the initial date).

On a long-term basis, when the company plans to invest in a new business line, buy a large amount of land, or engage in any other kind of large expenditure, it would use a long term, mortgage-style loan. These loans almost never revolve.

Speaking of long-term funding, issuing shares to get capital is exclusively a long-term activity.

Challenge. Remember what I said about the need for a loan register? Most big companies have many loans, which makes managing them very complicated. The reason big companies end up with many loans is poor fund management.

So what happens? Long-term loans are easy because they fund a specific large purchase and have a regular payment schedule. RCFs, on the other hand, are easy to loose track of.

For example, imagine the treasury needs $200,000 to fulfill upcoming payables, so the treasury requests an RCF at a local bank. The company has a good reputation, so an RCF of maximum $500,000 is granted. The treasury withdraws the needed $200,000.

Once the payable is taken care of, business decision-makers decide they need to purchase $400,000 in CoS to quickly build products for a new market in which a competitor declared bankruptcy.

Since the company only has $300,000 left in the first RCF, AND she needs to pay interest on the first withdraw, the treasury needs to take on another RCF to fund these activities. This is called borrowing on margin — using one loan to fund another.

To make matters even more challenging, companies that borrow on margin will find it harder to get additional RCFs and long-term loans at affordable rates. This is because borrowing on margin is risky, and banks see the company as more likely to default on its loans.

In sum, the challenges with fundraising arise when companies borrow excessively. The consequences are two: 1. it’s hard to manage and track payments on a plethora of loans, and 2. the more loans you have, the harder it is to get more.

Solution. The obvious solution to having many loans is to take on fewer. However, since they are not the business decision-makers, the most they could do to this end is share the risks with decision-makers. Nevertheless, treasuries can use loan and consolidated loan payment schedules to track all of their loan obligations, and more importantly, maintain strong relationships with partner banks.

• Loan payment schedules. Loan payment schedules (LPS) track interest, principle, and total payments due withdrawn portions of and RCF or a long-term loan. They are usually a simple table showing this information. An RCF with multiple withdraws will show a line with interest, principle, and total payments due on each withdraw. The treasury can use these schedules to explain risk to business decision-makers. It also helps him/her keep track of the many loans with outstanding balances. Here’s a picture of example schedules.

• Consolidated loan payment schedules. Consolidated loan payment schedules (CLPS) show the sum of interest, principle, and total payments on all outstanding loans that the company has. In some cases, a separate consolidated schedule exists for long-term loans and short term ones, but the added value on CLPSs is the aggregate. It’s best to understand the total burden of debt on the business than individual debts. When companies borrow on margin, a treasury writes comments in the CLPS describing what portion of each withdraw is used to fund a previous withdraw. This allows the treasury to keep track of loans and to communicate the burden to management. A CLPS often has a visual counterpart, so here’s the schedule and a visualization. It should be noted that this consolidation is of two withdraws with the same interest rate. When interest rates differ from loan to loan, the consolidated view becomes less useful.

---

• Good relationships with the bank. Even at the highest levels of finance, much of today’s risk assessment is based on relationships that treasurers build with banks. Therefore, a good treasury manager takes care of his/her contacts at a host of partner banks. This means regularly visiting with the bankers, having lunches, and playing golf. By maintaining these relationships, the treasurer is more likely to secure loans, even when the company is already borrowing on margin.

Cash Forecasting

Description. We’ve talked a lot about managing cash on a short-term basis with cash schedules under WC management, but we haven’t mentioned long-term funding. Any healthy company generating more than $10 million in revenue uses cash forecasting to understand its performance over the course of a year and beyond. In a sentence, cash forecasting is the projection of cash inflows and cash outflows in the form of a Cash Flow Statement.

A cash flow statement (CFS) includes cash inflows and outflows from operations, from investing activities, and from financing activities. The CFS most people are familiar with is produced with the indirect method — starting with Net Income on the P&L and adding back non-cash expenses for operational flow, then adding or subtracting the sale or purchase of any big assets for investment flow, and finally adding or subtracting and loan activity or capital activity for financing flow. This is a retroactive methodology.

However, the treasury is more concerned with the direct method — adding and subtracting known or likely cash inflows and outflows in operations, investments, and financing. It’s a forward-looking methodology and accounts for inflows and outflows that are not recording on the books by accountants. The direct method is much more difficult to execute, but it’s faster, more accurate, and more flexible.

Challenge. The challenge with cash forecasting in the long-term with a cash flow statement is that there’s always a degree of uncertainty in the projection. Few business can accurately say what their expenses will be more than one year in the future, let alone assume revenues.

This is why a long-term cash flow forecast is considered a strategic guide to help business decision-makers consider their options, and not an official document.

Another challenge is the high number of inputs on a CFS. The number of variables involved increases the forecast’s uncertainty, which makes it less useful as a guessing tool.

For example, imagine you want to see how higher revenues will affect net profit. To find out, you would need to also consider what assets to purchase in order to generate those revenues, and perhaps what funding is needed to buy those assets. These are normal considerations, of course, but the cash forecast brings no value to the process.

Paradoxically, the cash forecast only simplifies the cash situation when the cash situation itself is simple. In the end, the CFS cash forecast is used mainly for show. In many cases, the Financial Planning & Analysis team uses it as inputs for the company business plan — far from the treasury’s functions.

But this still leaves business decision-makers without a tool to think about how strategic decisions affect the company’s cash flow.

Solution. The treasury uses a mid-term projection with certain or near-certain revenues and costs called the rolling cash flow forecast. This forecast includes operational cash flows and MAY include investing and financing cash flow, depending on the availability of supporting documents.

• Rolling Cash Flow Forecast. Data that goes into the rolling cash flow forecast must meet two criteria: 1. cost inputs must have supporting documentation, and 2. revenue inputs must be certain or near-certain. By supporting documentation, I mean invoices or purchase orders; by certain or near-certain, I mean “old” revenue from regular customers and “new” revenue backed by either email confirmation or a written promise to purchase. On the surface, the rolling cash flow forecast looks like a simple Cash Flow Statement. However, it’s important to remember that it is not a traditional CFS. Because it’s inputs happen on a rolling basis — that is, as confirmed cash inflows and outflows become available — it may at times appear lopsided. In fact, because partners are usually more eager to sell their products, the rolling cash flow forecast often tends to have higher cash outflows than cash inflows. This is the price we pay for certainty. Where there is certainty of input, there is lack of coherence in the statement; where there coherence in the statement (non-rolling cash forecast), there is uncertainty of input. Business decision makers must be aware of this as they use the rolling cash flow forecast.

Payout Strategies

Description. Payout strategies, also known as payout policies, dictate whether the company pays out its profit as dividends or reinvests that money into the business. The treasury’s roll in payout strategies is to make suggestions, but it is never the treasury’s decision.

In a private company (not listed on a stock exchange), business decision-makers choose what they believe is best on a yearly basis. It’s a strategic decision. In a public company, the board of directors chooses based on what it believes best for the shareholders. Criteria the board of directors takes into consideration include need for funding, impact on public image of the company, and how dividends might impact the share price.

Challenge. The treasury always looks at payout strategies from a cash flow and funding perspective. This means it’s suggestions on payouts often clash with decision-makers and boards of directors. This difference of opinion is most tangible in companies that use a lot of debt (highly leveraged) to fund their WC and long-term capital investments.

The treasury would likely suggest that the company keep those profits to pay down debt obligations, or use them to fund capital expenditures needed to earn more revenue, or use them to purchase raw materials for attacking a new market.

In a sentence, the challenge is explaining and negotiating it’s payout strategy suggestion to decision-makers and board members. To add another degree of complexity, treasury must be able to explain the company’s ultimate decision to banking partners, who might question why the company doesn’t pay down it’s debts with excess cash.

Solution. Since the challenge is a human one, there is no clear solution. The treasury must simply use the tools at it’s disposal such as the consolidated loan payment schedule and the rolling cashflow forecast to communicate the needs of the company.

Perhaps the biggest skill for a treasury in the situation is the ability to recognize when a decision has been made, and to try to best understand it. The better the treasurer understands, the better s/he will be able to explain it to bank partners when the company needs more loans.

Financial Risk Management

Description. The treasury is responsible for minimizing risk exposure on the company’s cash holdings. Whether it’s in the bank, invested in capital markets, or held up in bonds, cash undergoes 4 main types of risk: interest rates, foreign currency holdings, commodity risk, counterparty risk, credit ratings.

As a function, financial risk management is process of limiting each of these risk types. To understand how treasury does them, you need to understand what they mean.

• Interest rate risk. Loans can have one or two types of interest rates: fixed or variable (aka floating). Fixed interests rates are the most common and the easiest. Regardless of how interest accrued, the rate is constant. Variable rates, on the other hand, change over the life of the loan based on a reference rate — most often the LIBOR rate. In other words, variable rates depend on the market. The interest rate risk arises, thus, with variable rates. This applies both to loans the company takes out, and to bonds that it issues.
• Foreign currency holdings. Foreign currency holding risk arises when a company has cash stored in different fiscal regions. When 1 USD equals 1.10 EUR, the treasury prefers to have USD. If it were to transfer EUR to USD, it would lose money on the exchange alone. This potential loss is foreign currency risk.
• Commodity risk. Commodities are raw materials used in a huge number of products and industries and are thus regulated more like a security than a product. Copper and oil are examples of commodities. Because the operate like a security, their value can drastically change from day to day. For companies working directly with commodities, commodity risk is tied to fluctuations in prices. However, many companies’ revenues strongly correlate to particular commodities, so the risks can be aligned.
• Counterparty risk. Counterparty risk arises when the company gives out loans or purchases bonds. In a sentence, counterparty risk is the chance that a debtor defaults on his obligation, meaning you loose all of the outstanding balance.
• Credit ratings. Credit rating risk is that a credit rating agency labels you as a risky debtor. This is a treasury concern because it can pinch the treasury’s ability to get cash when it’s in a bind.

Challenge. Each of these risks is a challenge in itself.

Solution. Interest rate risk and foreign currency risk are questions of balance. The treasury tries to be a creditor on as much cash as it is a debtor under a given variable rate. At the same time, it tries to hold equal amounts of cash in fiscal regions where the currency is strong, and only transfer money when the exchange rates are favorable.

When it comes to commodity risk, the most a treasury can do is work with FP&A teams to predict fluctuations in correlated commodities. It can then include this in its cash projections.

Counterparty risks are more a question of judgement than anything else. For example, when a company buys a bond, it must be confident that the debtor will pay them timely and in full. The treasury can use historical dat and credit ratings to help it decide on a debtor.

On the flip side, those same credit ratings are a risk. If the company’s rating drops too low, it cannot get funding. The risk is a question of borrowing habits. If business decision-makers highly leverage the company and borrow on margin, then the treasury must make them aware of the risk that their credit rating may drop.

Capital Structure & Cost of Capital

Description. Capital structure is a term used to describe how much of the company’s assets are funded by debts and how much are funded by equity. In most cases, small companies and startups are heavily funded by equity (when investors buy issued shares to have a stake in the company), whereas large companies have enough reputation and cash flow to take on debt. An Initial Public Offering (IPO) is an example of a major equity event, whereas a long-term debt to buy land is an example of a major debt event.

Cost of capital, on the other hand, is the amount the company needs to pay for its debt (interest) and the return it must earn on its equity (return). In other words, cost of capital is the money the company must generate using investor’s funds and debt funds.

The important thing to note is that the cost of debt and cost of equity are often very different. In some cases, debt is a “cheaper” option, and in others, equity is “cheaper.” More importantly, the cost of debt MUST be paid, while the cost of equity MAY be paid, depending on the investor contract.

For example, a public company (listed on stock exchange) must pay its debts, but it can choose whether to disburse dividends or to reinvest them in the company. Likewise, a private company must pay back its debts, but it only pays dividends if the investor requires it to.

The treasury must, therefore, choose how much debt and how much equity it should combine in the capital structure to minimize payout obligations. The more debt a company has in its structure, the more leveraged it is said to be.

Challenge. The challenge arises for companies that are either very small or very large. Very small companies have a hard time securing debt financing because banks do not trust them enough, and very large companies struggle to get equity since they have already sold publicly.

For small companies, it’s more than a question of trust. The amount of funding they need is usually disproportionate to their cash flows. Banks consider that combination a high risk. That’s why you often hear of angel investors, private investors, or venture capital investors contributing large amounts of cash to small companies.

On the flip side, large public companies have a hard time getting huge amounts of funding through equity because they have already sold shares to the public in an IPO. They have the option to buy back and reissue shares, or to dilute current shareholders by issuing entirely new shares, but these options come with a price. Buy backs and resales have a netting effect and generate less cash, and the public does not respond well to unplanned dilution of its shares.

Solution. This is the treasury’s monster task. The treasury must use a considerable amount of forethought based on the cash forecast, the rolling cash forecast, its WC requirements, its knowledge of bank relations to make suggestions about how to balance the company’s capital structure.

As we’ve said, the most important criteria for deciding on capital structure is the company size and the cost of capital for equity and debt. The treasury should speak with multiple banks and investors to understand what size and return expectations they have for the company. From that point, the treasury may either wait for the company to grow organically, then seek funding, or choose the best funding option available for its long term goals. As you probably guessed, most companies do not like to wait!