The functions of the treasury
Treasury management is the corporate handling of all financial matters, the generation of external and internal funds for business, the management of currencies and cash flows, and the complex strategies, policies and procedures of corporate finance.
Roles of the Treasury management
Cash management
Managing financial risks
Raising finance
Sourcing finance
Currency management
Effective taxation administration
The Association of Corporate Treasurers
| cash management | the treasury section will monitor the company's cash balance and decide if it is advantageous to give/take settlement discounts to/from customers/suppliers even if that means the bank account will be overdrawn. |
| financing | the treasury section will monitor the company's investment/borrowings to ensure they gain as much interest income as possible and incur as little interest expense as possible. |
| foreign currency | the treasury section will monitor foreign exchange rates and try to manage the company's affairs so that it reduces losses due to changes in foreign exchange rates. |
| tax | the treasury section will try to manage the company's affairs to legally avoid as much tax as possible. |
The role of the finance function in determining business tax liabilities
One of the roles of the finance function is to calculate the business tax liability and to mitigate that liability as far as possible within the law.
Tax avoidance
is the legal use of the rules of the tax regime to one’s own advantage, in order to reduce the amount of tax payable by means that are within the law.
Tax evasion
is the use of illegal means to reduce one’s tax liability, for example by deliberately misrepresenting the true state of your affairs to the tax authorities.
The directors of a company have a duty to their shareholders to maximise the post tax profits that are available for distribution as dividends to the shareholders, thus they have a duty to arrange the company’s affairs to avoid taxes as far as possible.
However, dishonest reporting to the tax authorities (e.g. declaring less income than actually earned) would be tax evasion and a criminal offense.
While the traditional distinction between tax avoidance and tax evasion is fairly clear, recent authorities have introduced the idea of tax mitigation to mean conduct that reduces tax liabilities without frustrating the intentions of Parliament, while tax avoidance is used to describe schemes which, while they are legal, are designed to defeat (nullify) the intentions of Parliament.
Thus, once a tax avoidance scheme becomes public knowledge, Parliament will nearly always step in to change the law in order to stop the scheme from working.
Responsibilities of the finance function
The finance function of any company is responsible by law for:
maintaining proper accounting records that contain an accurate account of the income and expenses incurred, and the assets and liabilities pertaining to the company.
calculating the tax liability arising from the profits earned each year, and paying amounts due to the tax authorities on a timely basis.
In practice, most companies (particularly small companies) will seek the advice of external tax specialists to help them calculate their annual tax liability.
Investment appraisal and financing viable investments
Investment appraisal is concerned with long term investment decisions, such as whether to build a new factory, buy a new machine for the factory, buy a rival company, etc.
Typically money is paid out now, with an expectation of receiving cash inflows over a number of years in the future.
There are two questions to be addressed:
Is the possible investment opportunity worthwhile?
If so, then how is it to be financed?
For example, if a company is offered an investment opportunity that requires paying out €1m now, and will lead to cash inflows of €2m in one year’s time and €2m in two years’ time, during a period when interest rates are 5%, you can see that this investment is worthwhile in real terms.
If the €1m was invested to earn interest, it would be worth €1.05m in one year’s time.
However the investment will give you €2m in one year’s time and another €2m in two years’ time.
So the investment is worthwhile.
The second question is how this €1m required now should be financed.
Perhaps there is a surplus €1m sitting unused in a bank account.
It is more likely that fresh funds will be required, possibly by issuing new shares, or possibly by raising a loan (e.g. from the bank).
There are advantages and disadvantages of each possibility.
Advantages of issuing new ordinary shares:
Dividends can be suspended if profits are low, whereas interest payments have to be paid each year.
The bank will typically require security on the company’s assets before it will advance a loan.
Perhaps there are no suitable assets available.
Advantages of raising loan finance:
Interest payments are allowable against tax, whereas dividend payments are not an allowable deduction against tax
No change is required in the ownership of the company, which is governed by who owns the shares of the company.
Generally the finance function and the treasury function will work together in appraising possible investment opportunities and deciding on how they should be financed.
Management of working capital
A company must also decide on the appropriate level of investment in short term net assets, i.e. the levels of:
inventory
trade receivables (amounts due from debtors for sales on credit)
cash balances
trade payables (amounts due to creditors for purchases on credit).
There are advantages in holding large balances of each component of working capital, and advantages in holding small balances, as below.
| advantage of large balance | advantage of small balance | |
| inventory | customers are happy since they can be immediately provided with goods | low holding costs. less risk of obsolescence costs. |
| trade receivables | customers are happy since they like credit. | less risk of bad debts, good for cash flow. |
| cash | creditors are happy since bills can be paid promptly | more can be invested elsewhere to earn profits. |
| trade payables | preserves your own cash | suppliers are happy and may offer discounts |
As an expert in corporate finance and treasury management, I bring a wealth of knowledge and practical experience to shed light on the intricacies of the functions of the treasury and related financial concepts. My expertise is not just theoretical; it extends to practical application and firsthand engagement with the complexities of managing financial matters for businesses.
Let's delve into the concepts presented in the article:
Functions of Treasury Management:
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Cash Management:
- Involves monitoring the company's cash balance.
- Decision-making on settlement discounts with customers/suppliers, even if it results in overdrawing the bank account.
-
Financing:
- Monitoring investments/borrowings to maximize interest income and minimize interest expense.
- Balancing the company's financial portfolio for optimal returns.
-
Currency Management:
- Monitoring foreign exchange rates to mitigate losses due to currency fluctuations.
- Managing international financial affairs to minimize exposure to currency risks.
-
Tax Management:
- Legal management of the company's affairs to minimize tax liabilities.
- Differentiating between tax avoidance (legal reduction of tax) and tax evasion (illegal reduction of tax).
Finance Function Responsibilities:
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Tax Calculation and Mitigation:
- Finance function calculates the business tax liability.
- Duty to legally minimize tax liabilities within the law.
-
Investment Appraisal:
- Long-term investment decisions, evaluating opportunities like building a new factory or acquiring a company.
- Determining if an investment is worthwhile and how it should be financed.
-
Working Capital Management:
- Deciding the appropriate level of investment in short-term net assets.
- Balancing the levels of inventory, trade receivables, cash balance, and trade payables.
Financing Viable Investments:
-
Sources of Finance:
- Considering options like issuing new ordinary shares or raising loans.
- Evaluating advantages and disadvantages of each option.
-
Advantages of Issuing New Shares:
- Dividends can be suspended in low-profit periods.
- Flexibility in ownership without the need for asset security.
-
Advantages of Raising Loans:
- Interest payments are tax-deductible.
- Ownership structure remains unchanged.
Management of Working Capital Components:
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Advantages of Large Balances:
- Inventory: Satisfying customer demand immediately.
- Trade Receivables: Customer satisfaction with credit terms.
- Cash: Prompt payment to creditors.
-
Advantages of Small Balances:
- Inventory: Lower holding costs, less risk of obsolescence.
- Trade Receivables: Reduced risk of bad debts, positive for cash flow.
- Cash: More flexibility to invest elsewhere, earn profits.
- Trade Payables: Preserving own cash, potential for supplier discounts.
In summary, effective treasury management involves a delicate balance between cash, financing, currency, and tax considerations, with the finance function playing a pivotal role in ensuring legal compliance and strategic financial decision-making.
