Three weeks ago, Martin Bellin wrote an article on how the trend of centralization of treasury infrastructure has ebbed, but in its place has come a flow of attention toward centralizing information and function. I want to go into a little more depth on one aspect of this – paying attention to your global operations – and why this is so important.
Centralized or decentralized, you often see the same problem occurring in treasuries: they overfocus on the largest segments of the business, placing less emphasis on their global operations. For example, it’s very tempting for companies in large markets – especially the US – to eat up most of their available manpower managing their massive local market. This leaves subsidiaries ignored unless they are actively losing money. Their excess cash is ignored, their FX risk is ignored – they even get left out of forecasting. Uninvolved in the main treasury operations, subsidiaries are left to provide quarterly – or worse, yearly – roll up reports detailing their status to head office.
Let’s use a fictional, but illustrative example: Franklin F. Sadler bicycle components (FFS). It’s 2004, and let’s say that FFS manufactures aluminum hubs for race bikes. In the last few years they’ve expanded across the aftermarket sector and are now making a lot of their profits from long-term deals with high end bicycle manufacturers. They are taking pre-orders at a fixed price, manufacturing and delivering by a set date, usually a year down the road. Their largest market has always been Europe, but with renewed American interest in cycling., the American market is booming.
FFS, like many companies, splits their regional sales off to subsidiaries in local markets, while their main operations like manufacturing are still centrally located near HQ, in this case the UK. Treasury is focusing on cash flow for manufacturing and on local European sales and integration with the North American arm of the business is limited to quarterly cash forecasts. Everything is going great and they don’t see a reason to pay attention to their global operations. Then, 2005 hits.
The Commodities Supercycle
From 2004 to 2005, the cost of aluminum rose 12.5%, – an effect of the global commodity supercycle. From January to July it wavered and then jumped upward 30%, ending the year higher than it had been in over 15 years. Over the next two and a half years, it would rise and fall between $2400 and $3000 per ton, averaging 45% higher than it had been at the start of 2005.
For a company reliant on aluminum this would certainly be a challenge. For FFS, with limited intel insight into their global subsidiaries, they’ve only hedged aluminum based on the needs of their European business.
The problem is that the UK Treasury can’t see the full picture. Without forecasting the needs of their American offices, they’re not accurately forecasting what they will need to spend on aluminum in the future. This creates a situation where the Americans are under contractual obligation to sell bicycle hubs at a loss in the future.
Suppose a deal is signed between the US subsidiary and Trek to provide hubs for their line of Tour De France bikes. Prices are fixed and the delivery happens in a year. The UK Treasury has no visibility into the quantity of aluminum required to fill this order and the manufacturers find themselves short, meaning they have to buy aluminum at the current market rate – now 30% higher than when they had started the year. Suddenly the hubs they’re selling for $30 to Trek are costing them $35 to make, and they’re in the red.
Since manufacturing is having trouble keeping up, the American office finds itself in a deal going sour as their ability to fulfill their agreements falters. Without up to date forecasting information from the US side of the business, the group is now short on cash and they’re stuck. If they haven’t arranged good financing beforehand, they may have difficulty financing this shortfall or even worse, have one of their key banks drop out, leaving them with limited financing options. And so the death knell begins.
This might sound like a contrived scenario, but this is almost exactly what happened to a number of companies from 2004 to 2009. Automotive companies, manufacturing companies, all found themselves in highly volatile markets with few safeguards to ensure that the company as a whole is taken care of.
These situations are not that hard to avoid, as long as the information is available. Once you have centralization of information, you can instate a system for providing global forecasting to your central treasury. This gives them the foreknowledge to finance and hedge in scenarios like the above. Then, they’d be able to see early signs and perhaps find financing. In the end a company’s death knell would sound more like a battle march.
Without centralizing information, allowing you to pay attention to your global operations, you’re playing a risky game. You don’t know what’s going to happen mid period, especially in a volatile market – and that can freeze the liquidity of even the most successful company.