Chapter Twenty Seven

Key Performance Metrics for a Treasury

A SCORECARD FOR TREASURY PERFORMANCE needs a balanced combination of objective and subjective elements. Various firms use different methods to evaluate the performance of their Treasury. Some firms use just one method. Some firms do not find the need to have an objective evaluation of the performance of the Treasury function; we do hope that the reading of this book will encourage them to develop metrics for their Treasury.

INTRODUCING PERFORMANCE METRICS

For a global Treasury that works as a cost centre, Figure 27.1 provides a simple summary of the key organisation and financial goals.

FIGURE 27.1 Key Metrics

How these are achieved and how the many elements that contribute to the success of a global Treasury are captured form the core of this chapter. All activities involve people, and without extensive interaction and teamwork among people of the Treasury function and the rest of the organisation, no success would be possible. Some of these subjective performance elements should be captured in metric form. Performance metrics and benchmarks have to be comprehensive in coverage and simple in design and execution.

In this chapter, we provide just one of the many scorecards that can be used. The performance evaluation for a Treasury can be divided into three steps:

A sample performance evaluation process is depicted in Figure 27.2.

FIGURE 27.2 Scope of Metrics and Measurement

SOME CRITERIA FOR DECIDING PERFORMANCE METRICS

Next we turn to some of the criteria for deciding which performance metrics to use.

• Profit centre versus cost centre. If the Treasury is a profit centre, the metrics would be more oriented towards financial profits and less on volatility and visibility of cash flows. For purposes of the sample metrics in this book, we have assumed the more conservative approach of Treasury as a support function and cost centre focused on reducing volatility.
• Geographic spread of operations. As the locations in which the group is present grows in number, there is an increase in complexity of operations and management. Metrics should reflect that fact, with different countries having appropriate benchmarks depending on their development and stage in the life cycle.
• Nature of markets where the group is present. Different markets have different regulations on the movement of money and market factors. For example, Singapore-based operations would be different from Kenya markets in terms of liquidity, market forces, benchmarks, capital movement, and regulations. Hence, the two country operations would have different benchmarks to reflect the nature of their respective markets.
• Outsourced activities. The degree of outsourcing could have an impact on the metrics—the outsourced operations might have a different (usually tighter) metric and benchmark depending on the terms of the service agreement.
• Degree of centralisation. Presence of centralised activities, such as centralised treasuries, in-house banks, shared service centres, and the like could change the benchmarks as compared to those of firms with more distributed and on-site activities.
• Competition and industry practices. What competition and industry peers practices could impact the setting of benchmarks for evaluation?
• Organisational culture. Many cultures encourage predominantly objective management, and the metrics for Treasury would help in delivering such measures. However, there are a number of subjective evaluation aspects to be factored in, and attempts must be made to make these as quantifiable as possible (through formal interviews, surveys, etc.).
• Direct dependence on Treasury function. Some of the metrics would be a combination of the performance of other functions. Hence, importance and thus weight for Treasury’s contribution towards those metrics should be adjusted accordingly. Care should be taken to highlight those aspects that Treasury is directly responsible for.
• Availability of data, frequency of measurement, and ease of the performance measurement process. It is important to have good measures of Treasury performance. However, the collation of data should not be so onerous as to make performance measurement itself a full-time activity. Increasing automation and recording of data makes it easier to retrieve numbers and report them in the required formats, but the reporting frequency and intensity has to be a meaningful exercise that the Treasury management committee must review thoroughly before making recommendations to the chief executive officer and to the board. The use of each metric must also be reviewed during the annual review process of the Treasury policy.

PERFORMANCE METRICS

We now discuss the metrics themselves.

Themes of Performance Metrics

Performance metrics can be divided into these themes:

• Financial performance based. These metrics have a direct impact on the financials of the group. They include operating cash flow (increase is better), cost of capital, and cash position.
• Activity or project based. These metrics are based on a certain activity or project, such as stability of cash flows because of hedging, cost of hedging, and cost save because of outsourcing.
• Process based. These metrics are tracked at an individual process level and are the most micro-level of all metrics. Examples are: turnaround time for data entry, invoice float, and employees directly involved in foreign exchange settlements.
• Human feedback based. These metrics are direct responses to the overall impact of the Treasury team on the organisation. Part of the Treasury team’s responsibility is internal customer service and supporting the businesses and country operations; hence, internal customer and employee satisfaction surveys are important metrics to consider.

The importance of the themes is to ensure that the material universe of Treasury performance is captured. To do this, the Treasurer must go through financials impacted by Treasury, activities, and projects in which Treasury plays a key role or is the owner, and processes that Treasury runs or plays a key role in. This bottoms-up approach ensures a comprehensive scope of metrics used.

Measurement Units of Performance Metrics

The use of various metrics entails the use of various measures. We group these measures by units of measurement, which would enable users to ascertain the benchmarks and a score for each metric.

Dollars or Value

The value, usually the currency value of any metric, provides an absolute numeric measure of performance. Many measures, such as cash flows, costs, and gains, are measured as values. Some items, such as bank credit limits, are dependent on external entities.

Since most other measures finally show up in some form on the enterprise value (a form of discounted value of future cash flows), it is important to consider the various forms of dollars of value depicted. Table 27.1 shows some measurement units.

TABLE 27.1 Measurement Units

It is important to remember to compare like numbers with similar ones—for example, a discounted cash flow adjusted from tax but not risk must be compared with an equivalent cash flow and benchmark.

Market Rates

Market rates could be percentages for cost of capital, targeted share price for buybacks, budgeted or meaningful target rates for foreign exchange and commodities, and so on. Selection of the benchmark is especially important for evaluation, especially because market rates seldom remain static, and the benchmark market rate at the end of the financial year could be very different from that at the beginning.

Time

The time taken for a cycle, processing, cash realisation, or any other activity is a good indication of process efficiency or liquidity. In many cases, such as the cash conversion cycle, an equivalent dollar value (working capital requirement) could be used as well.

Numbers or Volume

Numbers, such as number of employees for an activity or a full-time employee headcount reduction, are useful big-picture metrics. As a process, these typically get converted to value and reflect as a benefit or concern in the financial statements.

Volumes, such as the throughput of hedging transactions or cash collections by cheque, indicate scale of operations and sometimes help in redirecting focus to high-sensitivity, low-spotlight areas. Also, volumes provide a good estimate of the impact of automation and scalability of Treasury operations.

Statistical Measures (Percentages, Ratios, Variances)

Financial ratios form a core component of any Treasury performance measurement. Other measures, such as percentages (which show process improvements or loads, or balance sheet strengths and areas of concern) and variances, are brought in as required to supplement more standard measures and to delve deeper into some numbers or to throw more light on policy/practices. Risk limit utilisation, for example, is a good indication of how stretched the limits are and provide feedback to the Treasury management committee for the next review.

Rating or Survey Results (Ratings/Rankings)

Credit rating exercises, industry surveys, employee surveys, and other exercises provide different elements that indicate performance on various grounds.

Benchmarks

The role of benchmarks in the evaluation process is critical. Once the metrics have been collated, it is important to determine what to evaluate them against since inappropriately chosen benchmarks or levels tend to distort the performance. Each organisation would have to do its own assessment of the benchmarks and values to use.

Internal Benchmarks

Historical Numbers

Historical numbers, past performance, or metrics are some internal benchmarks. These are useful to look at performance relative to previous years or quarters and good indications of performance over time. Growth numbers and process improvement are well measured with historical numbers. Remember to compare similar values with the same basis.

Targets/Budgets/Forecasts

Targets are set internally, and most firms have a well-managed process to set them. Budgeted rates, especially for market factors that are beyond the firm’s control, are trickier to handle, especially when the firm’s risk management policy does not lay down a long-term perspective for carrying out such transactions. The importance of forecasts, especially for near-term ones, is highlighted when they are used for performance evaluation.

External Benchmarks

Market Benchmarks/Indices

Benchmark rates or index values from market sources are an independent verifiable parameter to use. However, many of these are variable. For that reason, the equivalent current level at any point of time must be considered.

Market Surveys/Industry Best Practices

Market surveys and peer reviews could provide good feedback on the benchmark to be used with respect to the outside world. This method can be reliable, especially for process times and operations and control environments, where firms are more willing to disclose their own numbers to obtain a market benchmark. It is important also to select the right candidates for benchmarking—select peers and industries that have similar elements to yours. For a conglomerate with diversified interests, each company within the group should be benchmarked, and groups with similar interests should be picked for a consolidated comparison.

SOME CAVEATS ON METRICS AND EVALUATION

There is never a perfect method for performance evaluation, especially for a unit such as Treasury, which has multiple interfaces with other entities.

Many Metrics Are Not Directly Governed by Treasury

Treasury is only partially responsible for some of the metrics—for example, increased base currency value of sales. Hence, the metric should be weighted adequately to accommodate this aspect. Also, subjectivity or choice regarding metrics to be used is required if the accuracy of the inputs is not consistent.

An example is the hedging of sales or revenue cash flows in the longer term. Based on forecast inputs from sales and business lines, Treasury undertakes some hedges. These forecasts will change over time, and Treasury will keep making adjustments to the hedges. For a specific evaluation metric, both the final financial result and the efficacy of the original hedge must be considered for fair evaluation.

Many Factors Are Market Based

While Treasury may be the only entity in the firm that is managing market-related risk, some moves may be beyond envisioned levels. In these situations, care must be taken to value the restorative action that Treasury would have done in adverse situations. If the market has gone through a crisis of liquidity or volatile moves, how well Treasury has managed the situations should be considered.

Information Availability

Treasury’s performance is only as good as the information it works with. Hence, the quality of inputs coming in from business and countries on which Treasury relies for accurate information and meaningful forecasts should be considered.

Accounting versus Economic Value

It can be tempting and sometimes simpler to use accounting value of transactions and activities, especially risk management products. However, especially for longer-tenor transactions, economic value of the transaction over the life of the deal should be considered as a fair measure of performance. Similarly, while up-front carry or profits could be recognised from a swap or option, the entire life of the transaction and possible reversals should be kept in mind. An alternative in these cases is to create a virtual escrow into which the large gains from these transactions are deposited, with the money used to provide for any adverse payouts, should market situations reverse. The performance evaluation for Treasury in this case should be over a reasonable time period, with the credit or points for benefits accruing over time.

SAMPLE TREASURY PERFORMANCE METRICS

Table 27.2 shows a sample set of performance metrics for an organisation. Each firm must determine its own set of metrics and assign and evaluate them accordingly.

TABLE 27.2 Performance Metrics

TREASURY FITNESS

Treasury Fitness, introduced in Chapter 1, is a concept developed by the author and Aktrea Capital Pte Ltd, that serves as a diagnostic tool for a Treasury much in the same way that a fitness test indicates any potential points of stress or problem for a human body. The mobile App that is being developed for this book will allow first-time buyers of the book limited access to a free diagnostic fitness test for their Treasury. This feature is expected to be available from April 2013.

SUMMARY

Designing a scorecard that objectivises the entire performance gamut of an operation with the width and depth of a global corporate Treasury is a challenge for chief executive officers and chief financial officers. As in all true appraisals, having a set of balanced measures and reviewing the measures themselves periodically over time will help the firm arrive at a steady-state set of performance metrics.