Treasurers work as financial risk managers, attempting to protect a company’s value from the financial hazards associated with its business operations. Because these risks can originate from a variety of sources, the role necessitates knowledge of many areas of business as well as the ability to connect with a wide range of financial professionals. Corporate treasury management, once an extension of the accounting department, has now evolved into its own company department and professional body.
Managing Different Risks
Treasurers are responsible for managing a number of critical risks associated with changes in interest rates, credit, currency, commodities, and operations. To varying degrees, businesses face any or all of these risks. The most frequent are:
The most critical risk a treasurer must manage is liquidity risk, which occurs when a firm runs out of cash due to insufficient revenue, excessive spending, or an inability to get funds from banks and other external sources. Inability to meet payment obligations on time can lead to the demise of a business if creditors sell off its assets to pay its debts.
Surplus funds can be invested to earn interest, and the treasurer must ensure that entities issuing or insuring securities are financially stable and creditworthy. Checking an issuer’s credit rating, which gives an impartial assessment of the chance that a third party will pay on time and in full as planned, is one way to accomplish this. The treasurer must also have confidence in the counterparties to financial instruments used to control risks (such as interest rate swaps) will perform as expected.
Exporting enterprises incur currency transaction risk in addition to credit risk when they convert proceeds from foreign sales into their local currencies. When the values of their foreign subsidiaries’ assets and liabilities are converted to a single home currency, multinational corporations suffer translation risk in financial reporting. Currency movements that produce a decline in the value of consolidated overseas assets and profits may be viewed as an issue by investors and analysts, potentially causing the company’s share price to collapse.
Another sort of currency risk that treasurers may find more difficult to control occurs when a competitor from another country benefits from a more favourable currency translation. Tactical efforts to be competitive, such as relocating production units to match a competitor’s currency cost base, can have significant consequences. Senior management would only implement such a move after thorough deliberation, with input from the treasurer.
Interest Rate Risk
Most companies need to borrow to finance operations, such as buying raw materials, machinery or premises. Borrowing at variable interest rates allows businesses to pay less if market interest rates decrease, but raises their costs if rates rise. If a corporation fails to pay the interest due to a lack of funds, it may face a liquidity crisis, undermining its ability to borrow in the future, or raising it only at higher interest rates that represent its increased credit risk to lenders.
The financial hazards mentioned above are examples of external risks. Operational risk is an internal treasury risk that stems from insufficient operational controls, which could result in a loss of company value. Inadequate controls might exist if a treasury dealer borrows money under a company loan agreement, ostensibly for a commercial purpose, but transfers the proceeds to his or her own bank account because the treasurer can engage in both trading and funds transfer activities. Such functions would be divided in a well-controlled treasury, and attempts to perform both by the same individual would be promptly discovered.
The Bottom Line
Treasurers are progressively taking on greater strategic roles in businesses. They have progressed from managing working capital to collaborating with a company’s top management to control risk and improve the bottom line.