By Joseph Neu
The underlying goal of any enterprise’s strategic functions is twofold: support overall growth and enhance the profitability of the firm’s lines of business. Hence it follows that for treasury to be recognized as a strategic function it must make these goals its own.
Redefining TVA®
For several decades, treasuries have tried to promote the value they add to their firms in order to be considered more than a cost center. One approach has been to try to generate profits, at least enough to cover their costs. However, most efforts to become a profit center—contributing significantly to the bottom line consistently— prove hard to maintain over time.
Thus, in most cases (see IT, December 2004), a service center orientation has taken hold—i.e., treasury provides financing and related advisory services to the firm’s business units (and even third parties).
Yet, this service role is not without its drawbacks. Merely being a “valued” resource to the firm makes it hard to build a case for a meaningful strategic role (IT, December 30, 2002); and often, it’s difficult to quantify the value treasury brings to the table, making it doubly hard to claim a growing relevance to the operations.
This is why more and more strategic-oriented treasurers are latching onto growth and profitability initiatives.
The timing is right. Established companies are devoting increasing bandwidth to questions about the sources of future growth, particularly against the backdrop of shrinking demographics in the developed world. And given how difficult it is to continue to grow at high levels, companies are looking for ways to make existing businesses more profitable.
As more firms confront these questions, treasurers are considering stepping away from dealing with the excess cash piling up (in the absence of desirable investment opportunities) and buying back shares (to counter declining valuation expectations) to see what they can do to help.
The ERM tangent
To influence growth and profitability, treasury needs to interact more directly with the lines of business. Some treasuries have successfully employed risk management activities to build a bridge to business units, helping them to manage their foreign exchange risk in particular. Many of them are now looking at ways to strengthen this bridge by expanding their scope to enterprise-risk management (ERM).
Few inside or outside the firm care as much about risk as they do about growth and profitability. To get business managers to focus on risk, treasury often has to couch ERM messages in terms of how risk mitigation can enhance growth and profitability.
So unless and until valuation gets driven by a company’s risk-mitigation quotient, ERM will likely remain a tangential strategy driver; it follows that it should not be the treasurer’s primary focus. And, to the extent that it is a focus, treasurers should make the links between risk management and growth and profitability more explicit.
Measuring treasury’s contribution
Making an explicit link between treasury activities and growth/profitability goals is a challenge, since much of what determines growth and profitability (as with enterprise risk) lies outside of treasury’s scope. But this is nothing new. It is no different than the challenge confronting treasury anyway: coming up with an appropriate and objective measure to indicate its value to the firm.
If the challenge is the same, why not seek to measure the impact treasury actions have on growth and profitability in the first instance? Such a measure likely starts with the cost of capital and treasury’s analysis and execution of funding decisions to drive capital costs down from some benchmark. (Note: the real gains are likely found in structural changes, not grubbing for basis points.)
Then it should incorporate treasury efforts to mitigate risk—e.g., improve the risk adjusted cost of sales, including capital, supply chain on the one hand, and the risk-adjusted return on sales on the other. Next, treasury can measure improvements on profitability generated by the elimination of frictional costs on cash flows due to fees, spreads, taxes, etc.
But it is the impact of advisory work with business units, the hardest to map to treasury contribution elements, that adds the most to growth and profitability. In the end, attempts to measure treasury’s marginal contribution may never be an exact science, but they only need to be convincing enough to shift perceptions of treasury as a cost center, permanently, to that of a profitability center with a real seat at the strategic decision-making table.