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Managing cash in a capital drought. (Cover Story).

Weak earnings, tight credit and poor investment results have put cash at a premium. Treasury experts offer suggestions on what companies can do to make the best of a bad situation

It's no fun being a corporate treasurer these days. The double whammy of a weak economy and tight credit are placing maximum pressure on cash flow, forcing treasurers to take a hard look at how their organizations use working capital. It's a time for tightening up -- and in some instances, changing how their companies operate internally.

"Treasurers today have a tough job," says Jim Sagner, senior managing partner at Sagner/Marks, a White Plains, N.Y.-based consulting firm that works closely with corporate treasurers. "It's much tougher than it was 15 years ago."

Most U.S. companies have seen their earnings whacked by a schizophrenic economy that seems to be growing modestly one moment, and then tottering on the edge of a double-dip recession the next. And, the decline in corporate earnings has shriveled corporate cash flow with the fierceness of a Death Valley sun at high noon.

Worse yet, many U.S. banks have retreated from the commercial lending market -- depriving treasurers of a key source of capital just when they need it most. Technology companies that rely on venture capital firms to help finance their operations have seen those funds evaporate as well. And the commercial paper market, long an important short-term capital source for big companies, has become harder and more costly to access -- sometimes almost prohibitively so.

"Capital is the driest I've seen in years," says Dan Jones, area managing partner for Dallas/Fort Worth for Tatum CFO Partners, a consortium of chief financial officers that provide consulting services to middle market companies. "Banks don't have an appetite for lending right now."

While companies will always be subject to the ups and downs of the business cycle, the reluctance of large commercial banks to make unsecured loans at favorable rates and terms may be a more permanent change. To be sure, asset quality problems throughout the industry are a big reason why banks have turned off the credit spigot. When banks get into trouble by lending too aggressively -- as they did in the late 1990s, during the waning days of the previous economic expansion -- their first reaction is often to rein in their lending officers.

But there are systemic factors that also explain why banks are more reluctant to provide thinly priced working capital loans to corporations, beginning with their recognition that credit-only relationships don't provide the kind of financial returns that are apt to make Wall Street happy.

Many banks are now insisting upon an extensive relationship that not only includes credit, but other services as well, including such things as cash management, merchant processing and 401(k) administration. "They almost look at the loan as a loss leader," explains Ken Parkinson, a managing director at Treasury Information Services in Hopewell, N.J. "Unless you're willing to give them some additional business, they're going to take another look at the relationship."

Adding to the current credit crunch is the simple fact that there are far fewer banks today than just 15 years ago, the result of regulatory repeal and a merger mania that swept through the industry. The passage of the Gramm-Leach-Bliley Act three years ago tore down the historic separation of commercial and investment banking, codifying a further concentration of economic power in the hands of commercial banks. "Things are more different today than they've ever been in the U.S.," says Sagner, referring to changes in the country's banking system.

And for corporate borrowers, these changes have added up to one thing: fewer banks competing for their business. "It has been very interesting watching treasurers going around begging for credit," says Sagner. "They can't live off cheap credit anymore. Those days are like the buffalo -- they aren't coming back."

While the market for bank credit is likely to remain a seller's market for years to come, that doesn't mean lenders won't ease their underwriting standards somewhat as the economy improves and their asset quality problems are finally resolved. But until then, the scarcity of working capital is something corporate treasurers will have to solve largely on their own.

Sagner believes the ready availability of bank funding in years past allowed many treasurers to get slack in the way they managed their company's cash flow. "There are a lot inefficiencies out there," he says. "Working capital is often where the big savings are, and many treasurers don't want to deal with this." Companies often tie up too much money in current assets, which Sagner says is anything that can be turned into cash within a year. Inventory can account for a significant percentage of current assets, and it's not unusual for some companies to keep too much inventory on hand. "It's like they've never heard of just-in-time inventory management," he says.

Other sloppy practices include the failure of companies to aggressively collect their receivables -- which obviously gets cash in the door quicker. And they frequently fail to pay quicker in those instances where vendors offer a 1-2 percent discount on invoices paid in 10 days or less.

"Look inside the company for where cash is trapped in the system," advises Robert Hamilton, a senior vice president in Wachovia Corp.'s treasury consulting group. For example, companies with a number of widely scattered field offices that collect payments of various sorts need to get those funds into a centralized account as quickly as possible so the treasurer has a clearer picture of the company's cash flow situation, and also so that any excess funds can be invested.

Hamilton also advises tighter management over disbursements. If a company over-funded its various disbursement accounts by, say, $5 million a year and had to replace that funding through a bank loan costing approximately 4 percent of the borrowed amount, carrying that much excess cash would actually cost the company about $200,000 annually. "There aren't a lot of tricks here," says Hamilton. "A lot of this is common sense."

Companies may also want to consider making larger structural changes in their operations that can have a positive impact on the treasury function. One approach is to automate the invoicing and payment process so treasurers can make more accurate cash flow forecasts and optimize working capital, while also capturing early payment discounts (see "The Promise of Automated Invoice Payment" on the previous page).

Another approach would be to cut costs by outsourcing certain "non-core" treasury functions. Greg Saxer, a senior vice president in treasury management services at PNC Financial Corp., says that an increasing number of companies are asking themselves whether they really need to own the processes that do the billing or make disbursements. "This is a trend that is gaining notoriety," he says.

Saxer cautions, however, that outsourcing is not a decision that should ever be made for the sake of short-term expediency. "If you're going to go to outsourcing, it has to be a long-term commitment," he says. "It's hard to rehire a staff and retrain them, let alone have them know the nuances of a business."

During tough economic times, it's also crucial that the treasury function doesn't acerbate the company's cash flow situation by actually taking on more risk. Greg Seibly, an executive vice president at Wells Fargo & Co., has advised his treasury clients to take a close look at their risk management practices. "What kind of exposures do you have?" he says. "Do you have currency exposures? Do you have trading exposures? Do you have interest rate exposures?" Most of these risks, he says, can be offset through hedging programs that utilize various types of derivative securities.

The persistent decline in short-term interest rates has also reduced the amount of money that treasurers can expect to earn by investing their excess cash. Seibly questions whether this is a problem for most companies today since "the typical corporation is going to be a net borrower," and the reduction in interest rates should lower their overall funding costs. Still, there's no question that treasurers won't make the same return on the investment of excess cash that they could have just a few years ago. "There's no way for us to offset the yield curve," Seibly says.

It's not uncommon for treasurers to be pressured by their superiors to push for higher returns on their short-term investments either by locking up their money for longer durations, or by purchasing riskier instruments than the highly rated and very liquid vehicles they would normally choose. "There are enough horror stories about treasury as a profit center to scare off most people," says Parkinson. "But that doesn't mean that treasurers haven't been asked to do things that didn't make complete business sense."

Treasurers need to resist this pressure at all costs, should it occur, says Tatum's Dan Jones. "In today's environment, treasurers have to take the highest return without taking the risk of losing their capital," he says. "The cost of replacement capital is too high." One way to protect the treasurer from being asked to take undue risks is to put firm policies in place. "Every company needs a formal investment policy that is approved by the board and monitored for compliance quarterly," says Hamilton. "This protects the individuals by giving them some firm guidelines."

And even though banks have a reduced appetite for credit, that doesn't mean they won't provide working capital to companies under the right circumstances. Jones says it may be necessary to put up some form of collateral, which is a significant change from just a few years ago. And companies most likely will be required to provide their banks with business opportunities beyond just the credit piece to make sure it's a profitable relationship for them. "You need to ask whether the bank is making money on your business," says Sagner. "And if they're not, how can you help them make money, because you don't want them to call you up and say they're out of there in 90 days."

Indeed, in an era of tight credit and reduced cash flow, companies may find that their bank is among the most important business partners they have. And banks will be quick to drop companies that haven't seen an interest in maintaining an equitable relationship. Says Parkinson, "You better not have a history of squeezing your bank, because now it's going to come back to haunt you."

RELATED ARTICLE: The Promise of Automated Invoice Payment

It would seem counter-intuitive that companies would want to pay their bills faster in an environment where cash flow is as tight as it is today, but many vendors offer discounts of 1 to 2 percent on payments made in 10 days or less. And for large companies that process lots of invoices in any given year, that can yield a substantial savings -- nearly $2 billion a year in the case of General Electric Co.

Electronic invoice presentment and payment, or EIPP, involves the automation of the entire invoice-to-payment process that is time-consuming, expensive and highly inefficient. Invoices are received electronically, processed electronically and paid electronically with an Automated Clearing House (ACH) transmission, thereby eliminating more expensive private electronic data interchange (EDI) networks that many large companies have established in recent years. Vendors must agree to submit their invoices in an electronic format, but the payoff for them is exactly that -- a faster payoff.

The advantages to the company come in three primary categories, beginning with the discount that many vendors offer on quick payment of their invoices. Although GE is an extreme case, given the company's size and complexity, moving to an EIPP system allowed it to save $1.8 billion in 1999 -- or 12 percent of its $14.8 billion in accounts payable that year. (This is the most recent year that data is available on GE's EIPP initiative. The company declined a request for an interview.)

Automation also reduces the costs of processing and paying invoices substantially. According to Gartner Inc., a Stamford, Conn.-based research and consulting firm, EIPP can save up to $7.25 per invoice. For companies that process lots of invoices, that can add up quickly.

Lastly, EIPP improves the ability of treasurers to more accurately forecast their company's cash flow requirements. One of the advantages of automation is that it improves data capture. Most treasurers today base their forecasts on historical information; with EIPP, they would have access to real data about invoices in the pipeline and could better anticipate cash demands.

Pleasanton, Calif.-based Xign Corp., which sells a product that automates the entire accounts payable function, says the average implementation time ranges between six to 12 weeks, depending on the size of company and the number of vendors it typically deals with. Portland, Maine-based Clareon Corp. has chosen to focus on just the remittance piece of the accounts payable process, and says implementation of its product averages about four weeks.

One financial executive -- David Horn, a partner at Tatum CFO Partners, a consortium of chief financial officers serving middle-market companies -- cautions that automating accounts payable is a complex undertaking that can take time to get right. Horn says he knows of companies that ended up making triple payments to the same vendors until they had worked out the kinks in their new systems. "I don't know if automating accounts payable is a plus for companies," he says.

But when the downside is weighed against EIPP's potential benefits -- including substantial discounts and improved forecasting during a time when cash flow is under excruciating pressure -- it may be a risk worth taking.

Jack Milligan is a freelance writer in Charlottesville, Va., who specializes in banking and finance subjects. He can be reached at
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Author:Milligan, Jack
Publication:Financial Executive
Geographic Code:1USA
Date:Sep 1, 2002
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