Chapter Eight

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Liquidity Management Introduction and Float

IN THIS CHAPTER, WE INTRODUCE the concept of liquidity management and pooling and go into detail on one of its main areas of focus: reducing float. Part Three provides further discussions on liquidity and its management.

INTRODUCING LIQUIDITY MANAGEMENT

Managing liquidity involves increasing cash visibility, efficiency, and usage; extracting value from cash; and reducing the level of working capital or external debt required for the firm. Using the firm’s own cash dramatically enhances financial ratios and return on capital (see Figure 8.1).

FIGURE 8.1 Liquidity Management

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There are many areas that the Treasurer can look at to proactively manage the firm’s liquidity and improve its cash efficiency. Earlier we discussed different account structures. Concentration and pooling structures work on top of account structures and are used to consolidate cash positions around the world and distribute liquidity where needed across a regional or global network. Managing working capital and reducing the requirement of working capital is a core area of focus. Structuring the financial supply chain and utilising opportunities in the supply chain are areas where Treasury is increasingly becoming involved as a trusted advisor. Finally, finding diverse, deep, and reliable funding sources at an optimal cost that can tide the firm through times of liquidity shortage (management of liquidity risk) is one of the key challenges faced by treasurers today. All of these areas are covered in later chapters.

This chapter focuses on float and achieving cash flow–related efficiencies. Efficient liquidity management and the leveraging the power of a centralised Treasury structure minimises idle balances and liquidity, enables the company to pay outstanding debt and lower its interest expense, using intercompany funding where possible, and increases yield through centralising all cash for scale and efficiencies.

POOLING AS A CONCEPT

Pooling can be defined as the reduction in a company’s operating cash by combining its various fungible cash resources and thereby lowering collective volatility of its operations. The benefits of pooling come through (1) lower cash required to run the business and correspondingly (2) increased profitability through reduced borrowing costs or higher returns on larger pools of cash.

Pooling is sometimes perceived to provide benefits primarily by diverting funds from surplus locations to borrowing ones, thereby saving overdraft or interest expense. This is one reason why Treasurers of largely surplus organisations do not explore pooling more seriously.

However, one of the core benefits of pooling that can be applicable to net surplus or borrowing groups is that it creates less cash volatility at a firm level and hence higher visibility and the ability to plan for liquidity. Most important, it reduces the overall cash required to run operations.

FLOAT AND ITS CAUSES

Float can be defined as the nonavailability of funds for use to a firm owing to transit, systemic, or procedural delays (either intentional or unintentional). Float typically reduces available liquidity and interest earnings or savings owing to the use of the company’s own money. There could also be an opportunity loss of the funds. Float is a common problem for companies across their various operations and has been an increasing area of focus since the liquidity issues of 2008.

An important aspect to consider, given the zero-sum nature of interest, is that someone in the system could be earning the interest on the monies that should, in ideal circumstances, be with the firm. Float loss is one of the reasons for tight liquidity situations for companies around the world. Some of the causes are depicted in Figure 8.2.

FIGURE 8.2 Causes of Float

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Various Kinds of Float Across the Supply Chain

Figure 8.2 provides a snapshot of the various kinds of float through the supply chain.

Float Across the Order-to-Cash Cycle

The order-to-cash cycle (see Figure 8.3), as the name suggests, is the set of activities and time taken for the money payable by a client or customer to be available to the company from the time the order actually is placed. This cycle is further elucidated as we explore the financial supply chain in subsequent chapters.

FIGURE 8.3 Float Across Different Points in the Order-to-Cash Cycle

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Table 8.1 depicts the various legs and the float times across each leg.

TABLE 8.1 Different Points of Float

Float Start Point End Point
Order float Order Approval of order
Pre-delivery Approval of order Warehouse
Inventory float Order Shipping
Invoicing float Shipping Invoicing
Credit terms Invoicing Payment due date
Late payment float Payment due date Actual payment date
Bank credit float Actual payment date Money in account

Ways to Reduce Float (Cash Flow and Process Efficiencies)

Treasury can add value in reducing float by using more efficient collection methods and more efficient balance sheet methods. We discuss balance sheet methods in Part Three. Methods to reduce float through cash flows and process efficiencies are discussed here.

Where Treasury Can Influence Float Times

Treasury influences some of the decisions on process and financing efficiency; these elements are circled in Figure 8.3 and have a shaded background in Table 8.1.

While sales owns the process to negotiate credit terms, and collections and the accounts receivable (AR) management team own the rest of the collections process, Treasurers are playing an increasingly important role in managing the entire float process.

Figure 8.4 shows some of the various methods on reduction of float through increased efficiencies in cash flow and processes.

FIGURE 8.4 Reduced Float Through Increased Efficiency of Cash Flow and Process Efficiency

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Collections Side

The search for an efficient collections solution has been an eternal one, especially in economies that are geographically dispersed and use physical paper. The challenge is compounded by the need to have information immediately into systems and cash soonest into accounts.

Lockboxes

The lockbox concept works on outsourcing the activity of cheque collection or pickup, processing, and reconciliation to an external agency, especially in remote locations. The agency or vendor collects the cheques or paper instruments, either from a customer site or from predesignated collection points/courier centres. The items are then pre-processed—sorted by bank and entity and recorded through coding their magnetic ink character recognition (MICR) bands—and images are recorded.

Data entry, if not automated, is done, and the files are processed for uploading into the firm’s system.

In many cases, the vendor also provides clearing support—ensuring that the items are sent for clearing and tracking for returns and credits. Reconciliation reports with adequate controls are also built in, as are processes for exception resolution.

Lockboxes generally cut down transit (mail) time and collection float. AR collections and clearing time is also cut down, and there is quicker information flow and reconciliation. Image scanning and storage also provides for stronger data backup and matching. Lockboxes also increase visibility of cash flows by providing, in many cases, same-day collection information. Savings may also be generated through imaging, reducing transit costs of instruments as well as ease of access for other functions (see Figure 8.5).

FIGURE 8.5 Lockbox Mechanism

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Sweeps and Account Structures

Other facilities, such as auto-sweep facilities (described in the section on pooling in Chapter 9), and account structures such as intervention accounts may be used to reduce float times.

Any incoming credits through electronic means, such as card payments, can be reconciled on a daily basis (and sometimes many times a day). Using a single banking corporation for easier access to funds across accounts is also one way to reduce float.

Integration

The use of paperless receivables through an integrated system increases efficiency of collection and posting entries. The concept of against-the-sun sweeps (see the next note) enables movement of funds across time zones.

Finally, negotiating better pricing and turnaround times with the banks and integrating with banking systems reduces cost and processing time respectively, and hence directly provides savings for the firm.

Against-the-Sun Sweeps: West to East
Some global banks provide an against-the-sun sweep facility (see Figure 8.6) that moves cash balances from the United States into Europe and then into Asia, a practice hitherto thought impossible. When an Asian regional Treasury of a global firm located in Singapore requires funds, it calls for the same from the global account in Europe or the United States, at the end of the business day in Asia, with funds value-dated on the same day. This provides a just-in-time equivalent of managing cash and liquidity and optimises the firm’s use of borrowing.

FIGURE 8.6 Against-the-Sun Sweep

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Payments Side

On the payments side, interesting developments have increased efficiency to reduce float on the processing side.

Disbursement Strategies

Disbursement processes must be designed carefully to delay the debit and value date on which the firm’s money leaves the account as much as possible, while still ensuring timely payment to beneficiaries. Various disbursement strategies are discussed next.

Controlled disbursement (banker’s cheques). Drafts issued by a bank are usually prefunded (i.e., the bank debits the account at the time of issuance). Presentation for payment can happen many days later. Controlled disbursement or banker’s cheques are akin to drafts except, like cheques, the debit happens only on presentation.
Positive pay. This method is used especially in environments prone to fraud or for cheques above a threshold. It provides cheque imaging with the customer’s cheque issued file to allow the clearing process to go through. The firm itself can override exceptions or discrepancies.
Corporate cards. These cards, which work off the corporate account, eliminate the need for paper, especially for reimbursement claims. Controls, limits, preapprovals, and dates can be built in, hence using automatic verification and checks that save human resources and lower cost dramatically.
Payroll or salary disbursements. Moving all employee accounts to one bank enables the firm to fund accounts for salary payments only on the due date, since transactions within the same bank can be automated easily. The banks can provide incentives for employees to move their accounts, such as add-on facilities, waiver of charges on certain transactions, loans, and electronic banking, that make it easier for individuals to use the bank and allow the company to reduce its funding float. Of course, this process must be implemented with the full support and cooperation of the partners in the human resources team, and Treasury would add value only in negotiating the best deals for employees.

Electronic Invoice and Bill Payment

Electronic invoice and bill payment (EIBP) is an emerging concept of combining suppliers and customers in the same marketplace for sourcing, invoicing, and payments. It is offered as an outsourced service by banks and other providers like Ariba, Alibaba, and I2. Similar services are also offered by large companies on their own using in-house solutions. The basic EIBP process is shown in Figure 8.7.

FIGURE 8.7 EIBP Process

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The increased efficiency allows for less wastage or float in the system, paving the way for potentially larger discounts and more efficient liquidity for all parties. In many cases, the use of EIBP has reduced the float time from over two weeks to under a week.

Automation

Using more electronic payments and reducing paper instruments increases the efficiency of cash flows and days that funds can remain within the corporation.

We now move to a case study that discusses an improvement of the cash management at a global firm.

CASE STUDY: OPTIMISING CASH MANAGEMENT IN A GLOBAL FIRM
Cash management is comprised of the policy, processes and practices involved in dealing with cash within an organisation. It starts with realising customer collections and other receipts, moves to making payments to vendors, employees and other stakeholders and ends with using the cash held by the business productively.
Wipro Limited is a company listed in the New York Stock Exchange, USA and the National Stock Exchange and Mumbai Stock Exchange in India. It operates through 80 subsidiary companies in four distinct lines of businesses—IT Services, IT Products, Consumer Care & Lighting and Infrastructure Engineering. All the four businesses have a multi-country presence and are among the leading global players in their industry segment.
The First Challenge
“How do we get global customer collections from their bank accounts to ours at the least cost and in the shortest possible time?”
This in brief is the first of the cash management challenges addressed by the Wipro Treasury team. Conceptually, a simple task of transferring money from point A to point B in the least possible time, incurring the least cost, is complicated by four hurdles—different countries with their unique regulatory environments, multiple currencies involving currency conversion cost, multiple subsidiaries restricting free transferability of funds and the challenge of a large, widely dispersed customer base. Table 8.2 details the magnitude of this challenge.

TABLE 8.2 Magnitude of the Cash Management Challenge

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Wipro’s global cash management system is built on three basic principles described here.
  • First, regulatory compliance and simplicity is accorded the highest priority by ensuring that intercompany transactions are kept to the minimum.
  • Subject to this hygiene standard, cash management is optimised for cost-benefit analysis. In this analysis potential investment returns obtained from holding cash is set-off against transaction and currency conversion costs to compute net benefit. While optimising sterile cash holdings, the limitations of using cash across countries and subsidiaries are factored in. The objective of minimising intercompany and trans-national fund flows is to reduce inter-company interest payments and currency conversion costs.
  • The final factor targets transactional efficiency by limiting the number of banks involved in the cash management operations.
Based on the above set of principles, cash management is organised into geographical clusters for each of the four businesses. These clusters are formed considering the organisational structures, regulatory feasibility and ease of feasibility of fund transfers. The grouping of clusters is described in Table 8.3.

TABLE 8.3 Geographical Clustering Across Businesses

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India is the first cluster for all Wipro businesses. Wipro does not directly deal with any individual consumer or customer. All its customers are business entities. They range from the largest corporate to medium sized partnership firms who deal in and distribute their wide product range covering from soaps to Laptops and truck tippers spares. Geographically, Wipro’s customers are located across the length and breadth of India. Its wide distribution network ensures that its customer cheques come in from most of the 1138 Clearing Houses in the Indian banking system spread across the country. This results in Wipro offices having to deal with both the outstation cheques and local cheques.
Considering the presence of outstation cheques, Wipro has centralised all its cheque collections with a leading Indian bank that has presence in most of the locations where its customers are present, either directly or through their correspondent banks. Wipro obtain credit for all their collections on T+1 basis, i.e. money is available for use in their bank account on the next working day following the day in which they hand over the customer cheques to the bank. The bank in turn charges a fixed fee per month, which depends on the volume of transactions and other aspects of banking relationship. Wipro evaluates the bank charges based on the period for which the bank is out of funds, which is mutually agreed upon. The fixed fee ensures that the bank benefits from reducing the collection cycle as it cannot pass on additional cost due to extended collection cycles. In addition to capping the collection cost, Wipro benefits from reduced credit risk due to dishonored cheques, as the collection cycle time is minimised.
While the case and experience is India-based, the principle and execution can be practiced in many other markets where geographic spread is high and use of paper-based instruments is prevalent.
For each of the clusters outside India, Wipro has a designated pooling bank account where customer collections are consolidated. Based on the expense forecast for each of the cluster pool account, funds are retained to meet the immediate needs and the surplus transferred to a set of central pooling account in India. For almost all the accounts where money is retained for expenses, the funds are parked in overnight accounts that earn some interest.
The Second Challenge
“How do we minimise transit time and float?”
Wipro’s payment system is designed with the objective of minimising if not eliminating the transit time and costs involved in floats arising from payments. Leveraging the technology that is embedded in the Indian Banking Payment System most of the vendor payments are made using electronic fund transfer systems, where the vendor account is credited simultaneously when Wipro’s bank account is debited, thereby eliminating any manual handling of cheques and its physical movement. As soon as the payment is effected, a payment advice is generated by the bank and sent to the vendor’s registered email account. This system of electronic transfer is yet to be implemented in two businesses where the volumes are comparatively lower. In these two businesses, cheques are issued to the vendors.
A prominent feature of Wipro’s IT business is its large employee base. Wipro as of March 31, 2011 had 120,000 plus employees. A unique feature of Wipro’s payment system is in the complete elimination of all cash transactions. All employees when they join Wipro are provided with an ATM card for a specially designated bank account titled Employee Reimbursement Account or ERA account. This bank account is different from their salary account. All employee reimbursement claims are processed centrally and the authorised amount is credited to the employees ERA account. Concurrent with the credit, an email is generated to inform the employee of the credit to his bank account. The employee at his pleasure can draw the amount from the ERA account through any conveniently located ATM. The ERA account cannot be used for any other purpose. Neither can the employee make any deposits into this account nor are cheques permitted to be drawn on it. The bank for providing this service free of cost is entitled to use the float on this account. Hence, no interest is paid on the balance retained in the ERA account.
The Third Challenge
“How do we productively use surplus cash?”
The third cash management challenge addressed by Wipro Treasury is to productively use the surplus cash to enhance the organisation’s profits. Given the scale of operations, ascertaining the quantum of surplus cash in time for investments each day is itself is a challenging task. Wipro uses Treasury Vision, the web-based software that picks up the feed from all the designated bank accounts and presents a single screen view of the company position. The bank balances across banks and accounts are updated daily through an end of day SWIFT message which flows to a central SWIFT address from where balances and statements are populated into this software. Treasury Vision provides a customised view of geography level, bank level, business unit level aggregation that can be customised as per the organisation needs for optimal cash management
Wipro’s Treasury’s investment policy is based on prioritising the three competing claims in descending order of importance—Safety, liquidity and return. Wipro’s management acknowledges that Treasury operations are ancillary and complement its main business. Consequently the focus is on safety first. Subject to safety, returns are maximised by a judicious mix of investments in instruments having different tenors. Wipro invests in a range of instruments covering fixed deposits and Certificate of Deposits of banks, Money market mutual funds, Commercial Papers and Non-Convertible Debentures. Wipro evaluates its return on a post-tax basis. For instance pre-tax returns are converted to post-tax returns at the marginal tax rate and compared with investments that yield post-tax returns like dividend from the Mutual Funds.
As of March 2011, Wipro had an investment of nearly USD 2 billion. This amount excludes cash held in current accounts, cash and cheques on hand for routine operational needs.
Conclusion
For a large and growing multi-national, multi-business enterprise, cash management is a continuous challenge. Wide spread adoption of technology is the main contributor for its continuing progress. However, measures of progress in this sphere are quantifiable and reasonably constant, and include among others the number of bank accounts operated, sterile cash holding, payment float i.e. quantum of cheques issued but not presented and return on investments compared to the benchmark rate used.
Contributed by Shankar Jagannathan, Wipro Ltd

SUMMARY

Liquidity is one of the most critical elements of the Treasury manager’s domain, and ensuring liquidity through as many internal means as possible is one of the biggest challenges, and wins, for the Treasurer and chief financial officer. This chapter explored some of the tools to reduce float, which is one of the potential sources of liquidity that firms can tap without resorting to external capital sources. A case study on optimising cash in a global firm was also discussed.

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