ELEC 4 Flashcards
What are the types of debt
Commercial Paper
Factoring
Field Warehouse Financing
Floor Planning
Lease
Line of credit
Loans
Receivable securitization
Sales and leaseback
The treasurer is usually called upon to either manage a company’ s existing debt or procure new debt.
In either case, this calls for a knowledge of the broad variety of debt instruments available, as well as dealing with credit rating agencies.
It may also be necessary to have a working knowledge of the accounting, controls, policies, and procedures used to manage debt.
DEBT MANAGEMENT
unsecured debt that is issued by a company and has a fixed maturity ranging from 1 to 270 days.
A company uses commercial paper to meet its short- term working capital obligations.
It is commonly sold at a discount from face value, with the discount (and therefore the
interest rate) being higher if the term is longer.
A company can sell its commercial paper directly to
investors, such as money market funds, or through a dealer in exchange for a small commission.
COMMERCIAL PAPER
is a financial transaction in which a company sells its accounts receivable to a finance company that specializes in buying receivables at a discount called
FACTOR
Accounts receivable factoring is also known as
invoice factoring or accounts receivable financing.
It uses a company’s inventory as collateral for a loan. The inventory to be used as collateral is segregated from the rest of the inventory by a fence, and all inventory movements into and out of this area are tightly controlled.
Alternatively, the inventory may be stored
in a public warehouse. State lien laws typically require that signs around the segregated area clearly
state that there is a lien on the inventory stored inside.
It is highly transaction intensive and
recommended only for those companies that have exhausted all other less expensive forms of
financing.
FIELD WAREHOUSE FINANCING
is a method of financing inventory purchases, where a lender pays for assets that
have been ordered by a distributor or retailer, and is paid back from the proceeds from the sale of
these items.
The arrangement is most commonly used when large assets, such as automobiles or
household appliances, are involved.
The entity at risk in this arrangement is the lender, which is relying
upon the sale of the underlying assets in order to be repaid.
Floor planning
Accordingly, the lender may demand the
following:
o That all assets acquired under the floor planning arrangement be sold at a price that is no
lower than its original purchase price.
o That the inventory of assets in stock is regularly counted and matched against the records of
the lender.
o That the loan be paid back no later than a certain date, thereby avoiding the risk of product
obsolescence.
covers the purchase of a specific asset, which is paid for by the lease provider on the company’s behalf. In exchange, the company pays a fixed rate, which includes interest and principal,
to the leasing company
It may also be charged for personal property taxes on the asset purchased.
LEASE
is a lease in which the lessor only finances the lease, and all other rights of ownership transfer to the lessee, resulting in the recording of the underlying asset as the lessee’s property in its general ledger.
The lessee can only record the interest portion of a capital lease payment as expense, as opposed to the amount of the entire lease payment in the case of a normal lease
CAPITAL LEASE
under the terms of which the
lessor carries the asset on its books and records a depreciation expense,
while the lessee records the lease payments as an expense on its books.
This type of lease typically does not cover the full life of the asset, nor does the buyer have a small - dollar buyout option at the end of the lease
OPERATING LEASE
a commitment from a lender to pay a company whenever it needs cash, up to a preset maximum level.
It is generally secured by company assets, and for that reason bears an interest rate not far above the prime rate.
It is a flexible loan from a bank or financial institution and a defined amount of money that you can access as needed and then repay immediately or over a pre specified period of time.
It will charge interest as soon as money is borrowed, and borrowers must
be approved by the bank.
LINE OF CREDIT
is a loan that uses fixed assets or inventory as its collateral is a common form of financing by banks.
Loans may also be issued that are based on other forms of collateral, such as the cash surrender value of life insurance, securities, or real estate.
Asset Based Loans
is a fixed-income instrument since bonds traditionally paid a fixed interest rate (coupon) to debtholders. Variable or floating interest rates are also now quite common.
It is also referred to as a certificate of indebtedness.
Bonds
a bond that uses collateral a company’s security investments.
Collateral trust bond
a bond that can be converted to stock using a predetermined conversion ratio.
The presence of conversion rights typically reduces the interest cost of these bonds, since investors assign some value to the conversion privilege.
Convertible bond
a bond issued with no collateral.
A subordinated debenture is one that specifies debt that is senior to it.
Debenture
a bond that provides for either reduced or no interest in the beginning years of the bond term, and compensates for it with increased interest later in the bond term.
Since this type of bond is associated with firms having short - term cash flow problems, the full-term interest rate can be high.
Deferred interest bond
a bond whose terms allow purchasers to convert them to common
stock, as well as any accrued interest.
The reason for its “death spiral” nickname is that bondholders can convert some shares and sell them on the open market, thereby supposedly driving down the price and allowing them to buy more shares, and so on.
Floorless bond
a bond whose payments are guaranteed by another party.
Corporate parents will sometimes issue this guarantee for bonds issued by subsidiaries in order to obtain a lower effective interest rate.
Guaranteed bond
a bond that pays interest only if income has been earned.
The income can be tied to total corporate earnings or to specific projects
If the bond terms indicate that interest is cumulative, then interest will accumulate during nonpayment periods and be paid at a later date when income is available for doing so.
Income bond
a bond offering can be backed by any real estate owned by the company called a
real property mortgage bond
by company - owned equipment called an
Equipment bond
By all assets
General mortgage bond
a bond issuance where a portion of the total number of bonds are paid off each year, resulting in a gradual decline in the total amount of debt outstanding.
Serial bond
a bond whose stated interest rate varies as a percentage of a baseline indicators, such as the prime rate.
Treasurers should be wary of this bond type because jumps in the baseline indicator can lead to substantial increases in interest costs.
Variable rate bond
a bond with no stated interest rate. Investors purchase these
bonds at a considerable discount to their face value in order to earn an effective interest rate.
Zero coupon bond
a bond that offers no interest rate on its face but allows
investors to convert to stock if the stock price reaches a level higher than its current
price on the open market.
The attraction to investors is that, even if the conversion price to stock is marked up to a substantial premium over the current market price of the stock, a high level of volatility in the stock price gives investors some hope of a
profitable conversion to equity.
The attraction to a company is that the expectation of conversion to stock presents enough value to investors that they require no interest rate on the bond at all, or at least will only purchase the bond at a slight discount from
its face value, resulting in a small effective interest rate.
Zero coupon convertible bond
is a form of short - term loan that is granted by a lending institution on the condition that the company will obtain longer-term financing shortly that will pay off the bridge loan.
This option is commonly used when a company is seeking to replace a construction loan with a long-term note that it expects to gradually pay down over many years.
This type of loan is usually secured by facilities or fixtures in order to obtain a lower interest rate
Bridge loans
usually extended by governments to guarantee
bank loans to finance a company’s working capital needs in geographic areas to attain social
improvement.
Economic Development Authority Loans
are highly desirable forms of financing, since a company can lock in a favorable interest rate for a long time, and keeps it from having to repeatedly apply for shorter
- term loans during the intervening years, when business conditions may result in less
favorable debt terms.
Long term loans
a well-established funding method whereby assets such as trade receivables, credit card receivables, or other financial assets are packaged, underwritten and sold in the capital markets in the form of asset-backed securities
Receivables Securitization
an arrangement in which the company that sells an asset can lease back that
same asset from the purchaser.
With a leaseback—also called a sale leaseback—the details of the arrangements, such as the lease payments and lease duration, are made immediately after the sale of the asset
In a sale-leaseback transaction, the seller of the asset becomes the lessee and the purchaser becomes the lessor.
Sale and leaseback
is a company that assigns credit ratings, which rate a debtor’s ability to pay back
debt by making timely principal and interest payments and the likelihood of default.
An agency may rate the creditworthiness of issuers of debt obligations, of debt instruments, and in some cases, of the
servicers of the underlying debt, but not of individual consumers.
A debt rating results in a credit score that indicates the perceived risk of default on the underlying debt, which in turn impacts the price of the debt on the open market.
Having a credit score is essentially mandatory, since most funds are prohibited by their internal
investment rules from buying debt that does not have a specific level of credit rating assigned to it.
Credit rating agencies
These are the three top – tier credit - rating agencies that the Securities and Exchange
The Commission SEC allows to issue debt ratings.
Moody’s, Standard & Poor’s, or Fitch.
The recordation of debt - related transactions is somewhat technical, and therefore subject to some degree of calculation error.
Several of the following controls are designed to verify that the correct interest rates and calculation dates are used. In addition, there is some possibility that the deliberate timing of gain and loss recognition related to debt transactions can be used to manipulate reported earnings.
Several of the following controls are used to detect such issues. Finally, controls over the approval of debt terms, borrowings, and repayments are also described.
Debt related controls
General Debt Transaction Controls
•Require approval of the terms of all new borrowing agreements
• Require supervisory approval of all borrowings and repayments
• Investigate the reasoning for revenue recognition related to attached rights that is not recognized ratably
General Debt Transaction Controls
• Require written and approved justification for the interest rate used to value debt
• Include in the month - end closing procedure a task to record interest expense on any bonds for
which interest payments do not correspond to the closing date
Interest Rate Calculations
The policies set forth in this section define the issuance and buyback of debt, control the timing of expense recognition, the setting of interest rates used for expense calculations, and similar issues.
The intent of
the bulk of these policies is to issue and buy back debt only when it is in the best business interest of the company to do so, as well as to ensure that debt – related transactions are recorded fairly.
DEBT-RELATED POLICIES
All notes and bonds shall only be issued subsequent to approval by the board of directors
• Debt sinking funds shall be fully funded on scheduled dates
• Recognition of unearned revenue for attached rights shall match offsetting discount amortization as closely as possible
General debt transaction control (debt related policies)
• Debt shall not be extinguished early if the primary aim is to report a gain or loss on the
extinguishment.
• When interest rates allow, the company shall repurchase its debt with less expensive debt.
Extinguishment of debt (debt related policies)
• Debt shall not be extinguished early if the primary aim is to report a gain or loss on the
extinguishment.
• When interest rates allow, the company shall repurchase its debt with less expensive debt.
Extinguishment of debt (debt related policies)
Debt conversions to equity shall always be recorded using the book value method
Convertible debt (debt related policies)
is the process of registering a company’s stock for sale to the public.
If a treasurer wants to sell stock to investors that in turn can be immediately traded by the investors, then it is necessary to file a registration statement with the Securities and Exchange Commission (SEC).
Stock registration
Primary Registration of Stock Corporations:
Schedule of Availability of Service
Mondays to Fridays, 8:00am-5:00pm without noon break
Who may avail of the service?
All applicant corporations thru their representative
What are the basic requirement
- Cover Sheet
- Reservation Payment Confirmation
- Articles of Incorporation (AI)
- By-laws (BL)
- Treasurer`s Affidavit (for stock)
- Joint Undertaking to Change Name
What are the additional requirements
- Endorsement/clearance from other government agencies, if applicable.
- Clearance from other Department of the Commission.
- For Corporations with more than 40% foreign equity: Application Form for registration under the
Foreign Investments Act of 1991 (R.A. 7042, as amended). - Endorsement/clearance from: (a) Philippine Economic Zone Authority (PEZA) for applicant under
R.A. 7916,
(b) Subic Bay Metropolitan Authority (SBMA) or Clark Development Corporation (CDC)
for applicant under R.A. 7227 and
(c) Cagayan Economic Zone Authority (CEZA) for applicant
under R.A. 7922
EQUITY RELATED POLICIES
Regulation D Exemption
Securities can only be sold under Regulation D to an accredited investor.
An accredited investor is one whom the issuing company reasonably believes falls within any of these categories at the time of the securities sale:
- A bank, broker - dealer, insurance company, investment company, or employee benefit plan;
- A director, executive officer, or general partner of the issuing company;
- A person whose individual net worth (or joint net worth with a spouse) exceeds $1 million;
- A person having individual income exceeding $200,000 or joint income with a spouse exceeding $300,000 in each of the last two years, with a reasonable expectation for reaching the same income level in the current year; and
- Any trust with total assets exceeding $5 million.
Equity Policies
The policies described below apply to a company’s use of the Regulation A or D exemptions,
All unregistered securities issued by the company must carry a restrictive legend, specifying that they cannot
be traded. The following policy enumerates the precise restrictive language:
Policy: All unregistered securities issued by the Company shall contain the following restrictive legend:
“These securities have not been registered under the Securities Act of 1933, as amended. They may not be
sold, offered for sale, pledged or hypothecated in the absence of a registration statement in effect with respect
to the securities under such Act or an exemption from such registration requirements. ”This legend may only
be modified following the recommendation of corporate counsel.
(Under equity policy)
General solicitation of investors is not allowed under Regulation D, so a policy should note that prohibition.
An example follows:
Policy: The Company shall not use any form of general solicitation to potential investors for the sale of
unregistered securities Better yet, require the advance approval of corporate counsel for all contemplated
securities solicitations. Given the presumed expertise of counsel, it is most unlikely that a general solicitation would be approved.
An example follows:
Policy: All securities solicitations must be approved in advance and in writing by corporate counsel. This
approval shall include a description of the solicitation and sample marketing materials.
(Under equity policy)
General solicitation of investors is not allowed under Regulation D, so a policy should note that prohibition.
An example follows:
Policy: The Company shall not use any form of general solicitation to potential investors for the sale of
unregistered securities Better yet, require the advance approval of corporate counsel for all contemplated
securities solicitations. Given the presumed expertise of counsel, it is most unlikely that a general solicitation would be approved.
An example follows:
Policy: All securities solicitations must be approved in advance and in writing by corporate counsel. This
approval shall include a description of the solicitation and sample marketing materials.
(Under equity policies)
Regulation A allows for the use of “test the waters ”documents, as well as advertising. Given that the stock
restricts the content of these issuances, the company should channel them all past corporate counsel, who
is required to review and approve them prior to issuance.
A sample policy follows:
Policy: All securities solicitations must be approved in advance and in writing by corporate counsel. This approval shall include a description of the solicitation and sample marketing materials.
EQUITY RELATED CONTROLS
General Stock Sale Control
Verify available authorized shares
Verify board authorization
Have due diligence officer review all SEC filing
Verify contents of security authorization letter
Determine a sufficient number of authorized and unused shares
available for distribution by comparing the authorized number of shares listed in the articles of incorporation
to the share total reported by the company’s stock transfer agent.
Verify available authorize shares
The board minutes should reflect the approval of a stock offering that includes the minimum and maximum allowed amounts of funding, and the approximate terms of the offering.
Verify board authorization
The SEC can and will reject any registration documents if information is not presented exactly in accordance with its instructions.
Have due diligence officer review all sec filinga
The treasurer authorizes the issuance of shares to new
investors by completing a form letter to the company ’ s stock transfer agent, itemizing the number of shares
to be issued to each investor, and noting addresses and tax identification numbers.
Verify contents of security authorization letter
are the defined set of parameters used by financial and strategic buyers to assess an acquisition target.
When considering various forms of cash investment, the treasurer should first consider the safety of the principal being invested.
It would not do to invest company funds in a risky investment in order
to earn extraordinarily high returns if there is a chance that any portion of the principal will be lost.
Investment criteria
look for teams with great entrepreneurial potential as shown by prior business,
academic or entrepreneurial ventures. Also, a team with passion for and commitment to the new
business idea, and ability to inspire confidence among future stakeholders, including employees,
potential customers, and investors.
Management Team
must demonstrate a strategy to claim significant market share or revenue.
Market opportunity
funds must be used to accelerate the company’s achievement of key milestones that increase the company’s value.
Activities such as research and product development, building a sales
and marketing infrastructure and hiring key executives.
Use of proceeds
must demonstrate a plan to generate significant profits beyond the initial product idea and can grow quickly and manage the scale necessary to succeed.
Growth potential
must have some proprietary features that distinguish you from potential competitors or provide barriers to entry that prevent other companies from capturing customers with a similar offering.
Attributes that convey competitive advantage include intellectual property protection, key know-how, and scarce human resources (i.e. knowledge and skills)
Competitive advantage
this includes significant executive experience in a variety of fields. A company should at least be composed of a pool of professionals in allied fields.
Strategic fit
invest in first-of-a-kind new ideas, rather than incremental enhancements to common
products and services.
Technology
a clearly articulated exit strategy is essential. It is not just interested in the strategy
you select, but more importantly in the how - the operational strategy that shows specific steps you will take to achieve the exit
Exit strategy
What are the investment options
BANKERS ACCEPTANCE
BONDS NEAR MATURITY DATE
Certificate of deposit
Commercial paper
Money market fund
Repurchase agreement
Us treasury issuances
Banks sometimes guarantee (or accept) corporate debt, usually when they issue a loan to a corporate customer, and then sell the debt to investors. Because of the bank guarantee, they are viewed as obligations of the bank.
BANKERS ACCEPTANCES
A corporate bond may not mature for many years, but one can always purchase a bond that is close to its maturity date. There tends to be a minimal risk of loss (or gain)
on the principal amount of this investment, since there is a low risk that interest rates will change so much in the short time period left before the maturity date of the bond that it will impact its value
BOND NEAR MATURITY DATES
These certificates are essentially term bank deposits, typically having durations of up to two years. They usually pay a fixed interest rate upon maturity, though some variable – rate CDs are available.
CERTIFICATE Of DEPOSIT
Larger corporations issue short - term notes that carry higher yields than on government debt issuances. Most commercial paper matures in 30 days or less, and rarely matures in greater than 270 days,
in order to avoid the registration requirements of the Securities and Exchange Commission (SEC). Commercial paper is issued at a discount, with the face value being paid at maturity.
COMMERCIAL PAPER
This is a package of government instruments, usually composed of Treasury bills, notes, and bonds, that is assembled by a fund management company.
The investment is highly liquid, with many investors putting in funds for as little as a day.
MONEY MARKET FUND
This is a package of securities (frequently government debt) that an investor buys from a financial institution, under the agreement that the institution will buy it back at a specific price on a specific date.
REPURCHASE AGREEMENT
The United States government issues a variety of notes with maturity dates that range from less than a year (U.S. Treasury certificates) through several years (notes) to more than five years (bonds).
US TREASURY ISSUANCES
INVESTMENT STRATEGIES
The treasurer should develop a standard methodology for investing funds. This goes beyond the selection of a type of investment, and enters the ream of strategies that can range from being passive (and requiring no attention) to those that are quite active and call for continuing decision making.
This section describes a range of possible investment strategies
Earning credit strategy
Matching strategy
Laddering strategy
Tranched cash flow strategy
Riding the yield curve strategy
Credit rating strategy
the bank uses the earnings from idle balances to offset its service fees. If a company has minimal cash balances, then this is not an entirely bad strategy — the earnings credit can be the equivalent of a modest rate of return, and if there is not enough cash to plan for more
substantive investments, leaving the cash alone is a reasonable alternative.
EARNING CREDIT STRATEGY
matches the maturity date of an investment to the cash flow availability dates listed on the cash forecast. For example, ABC Company’s cash forecast indicates that $80,000 will be available for investment immediately, but must be used in two months for a capital project.
A treasurer can invest the funds in a two-month instrument, such that its maturity date is just prior to when the funds will be needed.
This is a very simple investment strategy that is more concerned with short term liquidity than return on investment, and is most commonly used by firms having minimal excess cash.
MATCHING STRATEGY
involves creating a set of investments that have a series of consecutive maturity dates.
TRANCHED CASH FLOW STRATEGY
a strategy of buying longer - term securities and selling them prior
to their maturity dates. This strategy works when interest rates on short - term securities are lower
than the rates on longer - term securities.
RIDING THE YIELDING CURVE STRATEGY
the treasurer buys the debt of a company that may be on the verge of
having its credit rating upgraded.
By doing so, the investment ends up earning a higher interest rate
than would other investments with a comparable credit rating. This strategy works best when the
The treasurer is very familiar with the debt issuer and has some confidence in his credit assessment.
CREDIT RATING STRATEGY
is a key part of the risk management lifecycle. After identifying risks and assessing the likelihood of them happening, as well as the impact they could have, you will need to decide how to treat them.
The approach you decide to take is your risk management strategy. This is also sometimes referred to as risk treatment and one of which is.
Risk reduction strategy
is to avoid investments in the securities of any single entity, in favor of investments solely in one or more money market funds.
These funds provide instant diversification across a multitude of issuers, with the attendant risk being constantly reviewed by a staff of risk management
professionals.
The use of money market funds is especially cost - effective for smaller treasury departments
that cannot afford the services of an in - house investment manager.
Simple risk reduction strategy
The process of issuing funds for an investment is unique in that every step in the process is a control point.
Without regard to controls, the only step required to make an investment is for an authorized person to create
and sign an investment authorization form (itself a control point) and deliver it to the bank, which invests the
company’s funds in the designated investment.
INVESTMENT MANAGEMENT CONTROLS
define the level of risk that a company is willing to tolerate and defines the exact types of investment vehicles to be used (or not used). Such a policy should cover the level of allowable liquidity.
Investment policy
Many companies have decided that they are not in the business of making investments, and so they avoid all risk, even though they may be losing a significant amount of investment income by putting all excess cash in U.S. government securities.
Second policy criterion is risk
For the purposes of a company’s short-term investments,
this should be the least of the three investment criteria; it is much more important for a company to achieve
high levels of liquidity and risk minimization than it is to achieve a high rate of return.
If a company is willing
to rebalance the three criteria in favor of a greater return, then it should at least consider making return on
investment a lesser factor for its short - term investments, since they have less time to recover from the
vagaries of the financial market
Final policy criterion is return on investment
For example, if the treasurer elects to divide available cash into short - term, medium - term, and long - term tranches, then the policy should allow for long - term investments that approximate the amounts and durations to be used in the long term tranche.
Similarly, if the treasurer plans to aggressively anticipate interest rates, then the policy should allow for some degree of speculation
investment policy should be closely aligned with the investment strategy.
Conversely, if the board of directors specifically does not allow certain activities, then this limits the treasurer’s available strategies.
The following could be the possible investment:
• Funds Investment / Marketable Equity Securities Accounting
• Investment in Debt Securities Accounting
• Investment Portfolios, Transfer Between & Transfer of Debt Securities Among
Investing cash is a key role of the treasurer, and this chapter provided a great deal of guidance for doing so.
In sorting through the large number of strategies, controls, policies, and accounting issues related to investment, the treasurer should particularly keep in mind the following three items:
• Investment policy is critical;
• Return is least important; and
• Use all controls
What is the treasurer’s primary goal in investment management
to guard the principal; a respectable return
is nice, but not as critical as ensuring that no cash is lost. The investment strategy should be built around this key underlying goal
is all of the steps involved in transferring funds ownership from one party to another except for the
final step, which is settlement
CLEARING
involves the finalization of a payment, so that a new party takes
possession of transferred funds.
The treasurer should be aware of these processes in order to understand
the timing of payment transfers.
SETTLEMENT
In clearing and settlement systems, the banks of the payer and beneficiary exchange information regarding
monetary transfers; the result of this exchange is payments between the banks.
Characteristics of clearing and settlement
The general concept of clearing and settlement is for the banks of the paying party
PAYER
Receiving party to exchange information regarding monetary transfer resulting in the
transfer of funds between the two banks.
Beneficiary
It is the massive volume of such a transaction, formal clearing and settlement systems have been installed to streamline the process
Debit The account of the payer and the credit the account of the beneficiary
where each bank pays the total amount owed. Payments handled through a
gross settlement system are more likely to have a requirement for immediate execution, where
payment instructions are processed separately for each individual transaction.
The cost of
gross settlement transactions are high, soindividual transactions running through these systems tend to involve larger amounts of funds or be very time sensitive.
Gross basis
where a large number of transactions are accumulated and offset against each other, with only the net differential being transferred between banks.
Payments handled
through a net settlement system usually wait until the end of the day, when all transactions between the banks are summarized and offset against each other by a clearing institution; the
clearing institution then sends the net transfer information to the settlement institution, which
executes the transfer of funds between banks.
The clearing institution normally completes its
daily summarization process and transmits net transfer information to the settlement institution
after the cut-off time of the settlement institution.
This means that the transfer of funds to the
account of the beneficiary bank will be delayed by one business day.
Net basis
payments processed through
them require greatly reduced funds transfers (and therefore considerably less liquidity) than gross settlement systems.
Net settlement systems
transactions which must be executed immediately. Because of the time constraint, high – value payments cannotwait for end - of day netting, and so are settled on a gross basis, with an immediate cash transfer between banks.
High value payment
transactions which does not require immediate execution and tends to
be for smaller amounts. Because of the reduced need for immediate execution, these
payments are handled through a net settlement system.
Low value payment
is a gross settlement system that is operated by the U.S. Federal Reserve and processes
large - value items with same - day, real – time settlement. Nearly all U.S. banks and the agencies of foreign banks participate in the Fedwire system.
If a bank is sending funds through the Fedwire system on behalf of a client company, then the deadline for initiating such transfers is 6 P. M. eastern time.
The fee for a Fedwire payment is relatively inexpensive.
Fedwire
is the net settlement system used for electronic payments in the United States, and is used
by most banks in the country.
used for large volume, low - value payments, such as
payroll direct deposits, business - to - business payments, dividends, tax payments, and Social Security
payments
The transfer of funds from the payer to the beneficiary can take several days, depending on the
payer’s payment instructions.
This system is significantly more complex than the Fedwire system, since it comprises a network of bank associations and privately owned processing entities.
The cost of an ACH payment is quite low, usually just a few cents per transaction.
AUTOMATED CLEARING HOUSE SYSTEM
Foreign exchange settlement presents a risk of one party’s defaulting before a transaction has been completed because settlement takes place through accounts in the correspondent banks in the countries where the relevant currencies are issue
Because the various national payment systems are located in different time zones around the world, one side of a foreign exchange transaction will likely be settled before the other side of the transaction.
For example, dollar payments are settled later than euro payments, which in turn are settled later than yen payments. Thus, someone buying in dollars and paying in euros will have settled the euro side of the payment before receiving any dollars.
Continuous Link Settlement system
If the counterparty were to fail in the midst of this transaction, the transaction initiator would have paid dollars but lost the offsetting euros. This risk is called
Settlementbrisk
a number of major banks banded
together to create the CLS system. The system is operated by CLS Bank International, of which the founding banks are shareholders. Other banks can submit their foreign exchange transactions through these member
banks
Avoid settlement risk while also speeding up the settlement process
The following currencies can be settled in the CLS system:
Australian dollar
British pound
Canadian dollar
Danish krone
Euro
Hong Kong dollar
Israeli shekel
Japanese yen
Korean won
Mexican peso
New Zealand dollar
Norwegian krone
Singapore dollar
South African rand
Swedish krona
Swiss franc
U.S. dollar
How does CLS impact the corporation?
It gives the treasurer exact information about when settlements will occur in various currencies, which previously had been difficult to predict with precision. With better foreign exchange settlement information, the treasury staff can now optimize its short - term investment strategy.
If a treasurer’s company transacts significant business in regions outside of the United States, it may be worthwhile to research the process flows of the clearing and settlement systems used in those regions.
The treasurer requires information that is not normally available through a company’s standard accounting systems, or even from its enterprise resources planning (ERP) systems.
Even though an ERP system is designed to aggregate all of the information used in a modern corporation, the treasurer also requires information from a variety of external sources regarding investments, foreign exchange positions, interest rates, and so forth.
Consequently, treasury systems are needed that integrate information from a variety of
sources, yielding real - time information that the treasury staff can use to efficiently perform their tasks.
This chapter describes the treasurer’s technology needs, and whether to install a treasury management system.
Treasury technology
The treasurer is in the difficult position of requiring information from many sources, most of which are not required by any other company manage
Since treasury is a relatively small department that may not command the resources of larger departments, it can be difficult to collect all of the required information.
Treasurer technology need
Consequently, the treasurer must frequently prioritize information needs.
While priorities may vary by
company, the following list establishes a reasonable set of priorities, in declining order:
Cash position
Foreign exchange transaction
Hedging
What are the cash position?
o Cash book balance tracking
o Multibank reporting of balance information
o Cash pooling management
o Cash forecasting and reconciliation of actual to projected cash flows
o Funds transfer capability
o Investment management, including money market dealing
o Interest income calculation
o Debt management
o Interest expense calculation
o Payment processing
o Intercompany transaction settlement with notional accounts
What are the foreign exchange transaction
Rate feeds from Bloomberg or Reuters
Intercompany netting capability
Foreign exchange forecasting and position analysis
Foreign exchange bid summarization
Foreign exchange deal - making capability
Foreign exchange confirmation processing
What are the hedging
o Rate feeds from Bloomberg or Reuters
o Exposure modelling capability
o Hedge deal – making capability
o Hedge confirmation processing
o Hedge documentation capability for Statement of Financial Accounting Standards (SFAS) 133
requirements
The treasurer’s technology needs also extend to the efficiency of and control over treasury activities.
Thus, the following requirements should be considered:
Efficiency issues
Control issues
The system should never require the manual entry of a transaction into the
system more than once, and preferably should involve automated data collection and posting, so that
no manual entry is required at all.
Minimize data entry
If supervisory approval is required, the system should electronically route the pertinent transaction to the correct supervisor for approval.
WORK FLOW PROCESSING
All treasury transactions should result in a clearly defined audit trail that identifies who
made a transaction and the date, amount, and accounts impacted by the transaction
Audit trail
The system should limit access to certain modules and require approval of key transactions.
Segregation of duties
The system should automatically notify users if transaction confirmations have not been received, if hedging policies are being violated, if there are negative cash balances, and so on.
Warning indicators
is a software application which automates the process of managing
a company’s financial operations.
It helps companies to manage their financial activities, such as cash flow,
assets and investments, automatically.
It also helps to automate the back office of a company’s business obligations and financial operations.
This typically involves enterprise software that automates manual and repetitive financial transactions.
commonly used to maintain financial security and minimize reputational risk. It can be used by a company’s internal management, and may be purchased from a technical supplier.
TREASURY MANAGEMENT SYSTEM
A TMS can use data to analyze and report payments, cash management and flow, banking and accounting.
Its functions include the following:
• Real-time Cash Management
• Cash flow Forecasting
• Payment Reconciliation
• Debt Management
• Trade Finance
• Technology
The Key Benefits of a Treasury Management System
When it comes to financial risk management, most financial institutions have guidelines in place to determine
the types of services that will provide the most benefits for customers.
• Better tools to manage bank related transaction fees
• Improved productivity with enhanced efficiency
• Better bottom-line decisions
• Detailed variance analysis with forecasting tools
• Straight-through processing in a centralized hub
• More control over finances with automation
• Currency management
• Collections
• Reporting
• Disbursement
• Capital management
What is SWIFT?
Society for Worldwide Interbank Financial Telecommunication
operates a worldwide network
that banks use to exchange standardized electronic messages that are known as SWIFT MT codes.
The
SWIFT network is highly secure and is designed strictly to transport messages between participants — it
does not provide a clearing or settlement service
SWIFT
is highly secure and is designed strictly to transport messages between participants — it
does not provide a clearing or settlement service
SWIFT NETWORK
Companies are now able to access the SWIFT network by any one of four methods:
STANDARDIZED CORPORATE ENVIRONMENT (SCORE)
MEMBER ADMINISTERED CLOSER USER GROUP (MA-CUG)
ALLIANCE LITE
SWIFT BUREAUS
Under this approach, a company can
communicate with all member banks in a closed user group. Companies allowed to use this method
must be listed on selected stock exchanges in specific countries, which include most of western
Europe, North America, and some countries in eastern Europe, Latin America, and Asia.
SWIFT
invoices companies directly for their message traffic. This is the most efficient method, because users
have direct access to nearly all banks.
STANDARDIZED CORPORATE ENVIRONMENT
A company can join a separate MA - CUG
for each bank with which it wishes to communicate
is administered by a bank, rather
than SWIFT. The bank running each CUG will invoice member companies for their message traffic.
This approach may call for membership in multiple, which is less convenient than the
SCORE method. However, it is available to all types and sizes of companies.
Member - administered closed user group (MA - CUG).
SWIFT has made this method available to smaller companies having low transaction
volumes.
It allows them to use either a manual browser - based payment entry system or to integrate directly into their treasury management systems.
ALLIANCE LITE
Third - party providers have set up their own access to the SWIFT network and
allow companies access through their systems for a per - transaction fee.
This approach avoids the need for any in - house systems maintenance, but connectivity to any in – house treasury
management systems is likely to be limited.
SWIFT BUREAUS
because they can link their treasury
management systems directly into the SWIFT network.
By doing so, they avoid having to establish individual
interface business, and instead can rely on a single standard messaging format to initiate transactions with
and acquire information from bank accounts all over the world.es with the reporting systems of all the banks
with which they do business, and instead can rely on a single standard messaging format to initiate
transactions with and acquire information from bank accounts all over the world.
Access to the SWIFT network is important for larger companies,
used to send messages within the SWIFT network contains a standard set of information fields
EASY SWIFT MT CODE
different SWIFT MT code is used for each type of transaction
For example, a
company can issue an MT 101 to move funds,
MT 104 to debit a debtor’s account,
MT 300 for a foreign
exchange confirmation,
MT 320 for a loan confirmation,
MT 940 to request bank account
information.
Given the high degree of standardization, these messages can be automatically generated by a company’s treasury management system and transmitted through SWIFT, while all incoming messages can also be dealt with by the treasury management system in a highly automated manner.
In summary, there are multiple ways available for a company to gain access to the SWIFT system, which it can then integrate into
its treasury management system. Doing so streamlines a number of treasury transactions, which makes the
entire system more cost - effective to operate.
A company can subsist on spreadsheet - based systems if it engages in a trifling number of treasury
transactions. However, it will soon find with increased volume that the amount of rote data entry labor and
outright errors associated with such systems will eventually call for the implementation of formal treasury
systems. These systems operate best if the treasurer insists on a high level of staff training, as well as some
reduction in the number of external banking relationships. Also, the increased availability of the SWIFT
network to corporations makes it possible to engage in a high degree of transactional automation, thereby
giving the treasury staff more time for tasks that better utilize their skills.
There are implications of different methods of transferring cash to or from a company that a
treasurer should understand, since there are significant differences in the costs and cash
flow speed of each one. The level of manual processing and related controls is significantly
different for each kind of transfer, which has a major impact on the long - term efficiency of
the finance and accounting functions.
CASH TRANSFER METHOD
Inbound cash payments tend to be for very small transactions,
though possibly in very high volume, especially in retail
situations. However, business - to - business cash payments are
not common
• Cash is bulky, requires significant controls to maintain on - site,
and does not earn interest income until deposited. Given the
extra cost of counting it at the bank, it is also expensive to
deposit.
Consequently, companies have a strong incentive to
avoid both paying with or accepting cash
CASH PAYMENTS
It is a negotiable instrument drawn
against deposited funds, to pay the recipient a
specific amount of funds on demand.
• A check has traditionally been physically routed
from the payer to the payee, then to the payee’s
bank, which issues funds to the payee, and then by
the payee’s bank to the payer’s bank.
The vast majority of checks are issued directly by
companies.
CHECK PAYMENTS
is a payment on behalf of
the payer, which is guaranteed by the bank (and
therefore of value to the payee)
bank check or bank
draft.
WHAT ARE THE CHECK PAYMENT PROCESS?
CHECK CREATION
HOLDER ACCEPTANCE
HOLDERS LIABILITY
ENDORSEMENT
ACCEPTANCE BY DEPOSITORY
BANK OBLIGATION
PROCESSING FOR COLLECTION
DRAWEES ACTION
DATA STORAGE AND POSTING
SORTING AND FILING
CUSTOMER STATEMENTS
A drawer writes a check from their bank account.
CHECK CREATION
The person who receives the check becomes the holder.
Payee accepts the check.
HOLDER ACCEPTANCE
• Individuals, businesses, and banks can accept checks without liability if
they are holders in due course.
HOLDER’S LIABILITY
Payee endorses the check as either blank,special, or restrictive.
ENDORSEMENT
Endorsed check is accepted by a depositary bank, which also
endorses it.
ACCEPTANCE BY DEPOSITORY BANK
The bank is required to honor properly payable checks.
• Failure to do so could make the bank liable for wrongful dishonor.
BANKS OBLIGATION
• Check is proofed, encoded, captured, and sorted (on-us, local,
nonlocal).
• Batched and presented to the drawee through clearing arrangements
(direct presentment, correspondent bank, clearing house, Federal
Reserve bank).
PROCESSING FOR COLLECTION
• Drawee receives checks for in-clearing capture.
• Full MICR line is captured in preparation.
DRAWEE’S ACTION
• Data from capture runs stored and posted to accounts at the close of
business.
• Exception items (rejected checks) require special handling.
DATA STORAGE AND POSTING
• Checks sorted daily into bundles by statement cycle and filed.
SORTING AND FILING
• Customers receive monthly account statements with either paper
checks or check images.
CUSTOMER STATEMENTS
WHAT ARE THE ENDORSEMEN OF A CHECK
BLANK ENDORSEMENT
SPECIAL ENDORSEMENT
RESTRICTIVE
This type of endorsement involves simply signing the back of the
check. It turns the check into a bearer instrument, meaning it
can be redeemed by whoever holds it.
are
the most flexible but also the riskiest, as anyone who possesses
the check can cash it.
BLANK ENDORSEMENT
Also known as an “endorsement in full,” a special endorsement
specifies the person to whom the check is payable. It involves
signing the back of the check and writing “Pay to the order of
[Name]” above the signature. This restricts the check’s
negotiation to the specified person or entity.
SPECIAL ENDORSEMENT
This type of endorsement limits how the check can be used.
Common restrictions include “For Deposit Only” or “For
[specific purpose] only.”
For example, if a check is endorsed
with “For Deposit Only,” it can only be deposited into the
payee’s bank account and cannot be cashed. It provides an
additional layer of security by preventing unauthorized parties
from cashing or negotiating the check.
RESTRICTIVE ENDORSEMENT
If a company has significant cash holdings, then it may
be worthwhile to spend time investing in float -
related funds.
• However, maintaining an abnormally small cash
balance requires active float monitoring on a daily
basis.
If there is a gap of even a single day in float
monitoring, then the company will very likely not have
sufficient funds for all presented checks, and will incur
expensive account overage fees.
INVESTING FLOAT- RELATED FUNDS
• In banking, value dates refer to the date when account holders can
use funds from deposited checks that already passed through the
bank’s clearing cycle
• When an individual (payee) first deposits a check at their bank, the
bank will credit the payee’s account with the amount indicated on the
check.
• However, the money’s not actually been received by the bank since
they still need to collect the funds from the bank of the other party
(assuming that the parties involved use two separate financial
institutions).
The bank faces a risk of incurring a negative cash flow if
the payee immediately uses the cash from the check.
VALUE DATING
is a service provided by banks
to companies for the receipt of payment from
customers.
Under the service, the payments made
by customers are directed to a special post office
box instead of going to the company.
LOCKBOX BANKING
is a technology-based
method that lets banks accept checks for deposit
using electronic images instead of the original, physical,
paper versions.
It let banking customers use their
computers, tablets, or smartphones to conveniently
deposit checks.
not only more convenient
for bank customers; it also benefits the banks
themselves.
REMOTE DEPOSIT CAPTURE
involves the use of check
payments that are drawn on remote bank
locations, thereby lengthening the duration of the
disbursement float.
At its most sophisticated level
of usage, a company can have multiple remote
bank locations set up around the country, and pay
suppliers using bank accounts located the furthest
from them.
REMOTE DISBURSEMENT
which are also known as wire payments,
allow money to be moved quickly and securely without the
need to exchange cash. They allow two parties to transfer
funds even if they’re in different (geographic) locations
safely.
A transfer is usually initiated from one bank or
financial institution to another. Rather than cash, the
participating institutions share information about the
recipient, the bank receiving account number, and the
amount transferred.
WIRE TRANSFER
is a network
used for electronically moving money between
bank accounts across the United States. It’s run by
an organisation called Nacha.
AUTOMATED CLEARING HOUSE PAYMENTS
is a type of company charge card
used for smaller purchases to achieve greater cost
efficiency, control and convenience. Procurement cards are
also known as purchasing cards, P-Cards or PCards.
• It can be tied to either a credit card or a
bank account.
It will issue payments to payees within days, while providing
monthly invoicing to the client company
PROCUREMENT CARDS
one party agrees to may another. To make that happen, the partyreceiving payment sends a message to the ACH
network asking it to collect said payment and
move the funds into their account.
ACH
