Performance Management of a Centralized Cash management System in 4 non-financial multinational industrials: a multi case- study

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Performance Management of a Centralized Cash management

System in 4 non-financial multinational industrials: a multi

case-study

By:

Willem-Jan Willemsen S1615777

University of Groningen Faculty of Economics and Business

month and year of submission: July, 2013

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Abstract

This multi-case study discusses the added (strategic) value function of centralized Cash management of multinational manufacturing companies in the context of performance management. It tries to identify ways of positively influencing the performance of the Treasury department to support company performance as a whole. An holistic framework is used to assess performance management of Cash management and especially is zoomed in on strategies, measurement and actions. These aspects are found to need improvement as to optimize Treasury performance. This exploratory research gives rise to more future scientific research in Treasury management.

Keywords: Cash management; Performance management; Management control Thesis supervisor: dr. Bo Qin

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INTRODUCTION

Motive and Relevance of this Thesis

In the lasting financial crisis companies look for numerous ways to cut costs and make processes more efficient. They automate more processes, fire people and especially, they try to save extra by optimizing their working capital management. Also (financial) risk management increases in importance, while the crisis causes many firms to experience financial distress and forces them to actively manage risks in order to prevent external contingencies to negatively affect their business. A few of these contingencies are banks’ diminished readiness to finance risky projects or new investments and, partly caused by the former suppliers and paying clients who experience financial problems which has a negative effect on working capital. One function which enables a company to combine activities like financial risk management, Cash management and assets and liabilities management is the Treasury function. Treasury management or Cash management, two concepts which are used simultaneously in the literature, as well as in this thesis, express the “financial management that is related to a future financial balance and cash flows of any operation” (Klusáček and Polák, 2010 : 13).

In this thesis it will be made apparent how dynamic Cash management (CM) is used and how much it has changed and is still changing. The most important development is centralization of Cash management: “Pooling highly qualified people, their skills and knowledge into one centre which has full authority over managing a company’s short- and long-term resources to sustain its ongoing activities, mobilize funds, and optimize liquidity” (Allman-Ward and Sagner, 2003 : 7, Klusáček and Polák, 2010 : 8). Centralizing CM is seen as advantageous especially from a cost perspective and a risk management perspective (Holland et al., 1994, Miles J. 1997, Von Eije and Westerman 2005 etc.). Control over cash flows becomes better because of increasing automation of processes and centralized CM techniques like cash pooling.

The problem with CM is that control is difficult, because of the expertise needed as a Treasurer and not many people know exactly what it is that the treasurer does other than it has something to do with important financial transactions. Centralization of this function however brings opportunities to increase management control of Treasury employees, amongst others in the form of strict, centrally set, procedures and policies which are written down in a Treasury statute. Measuring performance however still is difficult.

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7 for the Treasury department, performance increases, which is interesting in the light of this thesis.

In recent years Treasury becomes even more important, because of the financial crisis and it becomes more integrated in the organization as a whole. Treasury strategies move from being a profit center (investing excess cash to get extra profit) to a cost/risk center. More interestingly for this thesis, Treasury simultaneously becomes a service center and in some organizations the focus lies on Treasury being a strategic business unit. The employees working in the Treasury department have a lot of expertise and they produce financial information which is also important for other business units/departments and even for external stakeholders like suppliers. As such it can be seen as a service center. The strategic business unit function is also derived from the fact that with Treasury expertise and Treasury information systems, it can contribute to strategic decision making on an organizational level.

The debate going on right now is how to measure the value that Treasury adds, every company knows that the Treasury function is important and that it does add value in multiple ways, but how can this added value be described and measured (Andersson, Bergström and Lind, 2007)? Also Mulligan (2000) emphasizes the need to think of measures for Treasury performance and she looks at different CM structures.

By looking at the literature about Treasury management subjects an important observation can be made. Most literature written on this subject is of quantitative nature, meaning studies almost exclusively try to answer questions like “what?” and “how much?”. They try to find out if there are causal relationships between financial management aspects and company performance (however which way they define this performance). One stream of studies in this area is: corporate cash holdings. How much cash should a certain company hold on to and what should it do with excess cash in order to enhance performance? There is a lack of scientific in-depth research asking question like “how?” and “why?”. There are however many articles about Treasury cases, about specific companies and practice in general and articles connected to change management as well. This thesis tries to address this “issue” and handles the topic with a performance management/management control perspective. In this literature stream case studies are numerous and more and more researchers emphasize the need for more in-depth research under specific operating circumstances and the need for research of autonomous functions and departments (Langfield-Smith, 1997: 229, Goddard and Smith, 2002: 248). This thesis has the ambition to fill in the gap somewhat looking at a Treasury setting.

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8 More and more researchers however agree that a company should not only look at performance measurement. A company should look at the impact performance management has on the organization as a whole (Otley, 1999). Here organizational strategy kicks in and one of the questions that has to be asked is: “How does performance management contribute to the strategy of the company” in terms of performance improvements (Smith and Goddard, 2002, Langfield-Smith 1997).

This thesis contributes to the literature of Cash management by giving a more substantiated and in-depth analysis of centralized Cash management systems and how they change. More importantly it contributes to the literature by giving a possible answer to the question: “How can companies best organize the performance management of their CM so that Cash management can add more value to the company”. Up until now, to my knowledge, there has been very little research focused on performance management of Cash management. The question will be addressed by analyzing the performance management of centralized Cash management of 4 multinational industrials with existing theory on PM. Most of them already have such a system in place and thus have experienced employees who are able to answer the interview questions best. Also a case-study approach was chosen, while the research is exploratory of nature and more in-depth information is needed to get a grip on the subject.

Problem Statement

The goal of this master thesis is to review the literature on centralized Cash management and research the way in which the Treasury management department of multinational industrials, with centralized Cash management, can add more (strategic) value to the company, through improved performance management.

The resulting research question is the following:

“How could a multinational industrial company with centralized Cash management manage performance of its Treasury department in such a way that Cash management adds more (strategic) value to an organization?”

In order to answer the research question the following sub questions are formulated: 1. What does Cash management entail?

2.What does centralized Cash management entail?

A. How could centralized Cash management be described? B. Why do companies centralize their Cash management?

C. How did centralized Cash management develop in terms of use and the role in an organization?

3. How does Cash management add (strategic) value to a company?

4. How are performance management and the added-value function of Cash Management connected?

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9 B. How could a performance management system in the Treasury department be designed?

C. Howdo companies arrange performance management of the Treasury function in practice?

5. How does the Treasury function differ between companies with different Cash Management structures in terms of adding value and performance management and why?

6. How can companies improve performance management of the Treasury function to add more value to the organization?

Key Findings

The major findings of this study entail giving a thorough description of the added value of the Treasury function and confirming for the specific cases studied, the expectation of the struggles companies have in their performance management of Cash management. Arising from this is the question of how to possibly influence/improve PM of CM on which the thesis finds a few suggestions derived from how these issues are arranged in the companies studied. Furthermore, the holistic view employed in this research shows just how interconnected the Treasury function in an organization really is and points out why Treasury issues need to be addressed keeping the big picture in mind.

Structure

The first section will describe the literature on Cash management and performance management.The first sub question will be answered in the first paragraph and the second sub question will be answered in the second paragraph. These are informative descriptions of what constitutes Cash management and centralized Cash management taken from books and journals, mostly based on case research.The third sub question will be answered at the end of paragraph 2 and in paragraph 3 with the performance management/management control literature and the paragraphs 1 and 2. Sub question 4A will be answered in the first part of paragraph 3 with short review of the relevant performance management review. Sub question 4B will be answered by giving a proposition of an ideal PM of CM through a conceptual model of which the rest of paragraph 3 describes its development. Section 2 entails the research method used for this thesis. In section 3 the results of the interviews will be discussed, as well as it will provide a conclusion and an answer to sub questions 4C, 5 and 6. Finally section 4 will give describe implications of this research and proposals for further research.

SECTION 1 – LITERATURE AND PRACTICE

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10 This section gives a general outline of important concepts for this thesis, with theory and practice. Then it will explain the concept: “centralized Cash management” followed by a historical overview of the development of this system and some of its techniques. Furthermore it examines the role of centralized CM. Finally a brief review of performance management/management control literature, relevant for Cash management, will follow as well as the introduction of aconceptualmodel used for analysis of PM of CM.

§1 Cash management

Cash management is the art-and increasingly the science- of managing a company’s resources to sustain its ongoing activities, mobilize funds, and optimize liquidity (Allman-Ward and Sagner 2003 : 12). Two very important functions of Cash management are liquidity management and foreign exchange management and risk management becomes more and more important as well in the current financial landscape. First this paragraph will elaborate on the functions of Cash management and second it will pay special attention to financial risk management.

§1.1 Cash management and its functions. Cash management is a part of the more general concept of Treasury management, which could be described as: “financial management that is related to a future financial balance and cash flows of any operation” (Klusáček and Polák, 2010 : 13). In Treasury management you can distinguish different tasks: “Cash management, financial risk management, assets and liabilities management”. Financial risk management focuses on customer credit management, vendor/contractor financial analysis, liability claims management, business disaster recovery, and employee benefits program risk. Assets and liability management is about control of matching short-term and long-term investments with short-term and long-term financing and it includes optimizing the balance sheet structure. Finally Cash management is mainly focused on two functions: cash flow budgeting/forecasting and working capital management. Figure 1 (taken from Klusáček, Polák, 2010) on the next page shows the activities in Treasury management. The circle around Cash management indicates its place in Treasury management according to Klusáček and Polák (2010 : 14) their view.

Even though figure 1 shows the tasks of Cash management as limited to forecasting, budgeting, planning and working capital management tasks, the distribution of these tasks between Cash management, A&L management and risk management can differ per company.

This is assumed because of the fact that the literature uses the terms of A&L management and risk management also in a Cash management setting. Examples: accountants payables, risk management and investments as shown as well in figure 2 on page 12.

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11 control and manage cash collections and cash disbursements. These cash flows go through a concentration account, which combines the accounts of the different parts of the company in order to make the best use of potential total surplus cash. On the basis of forecasts can be estimated if a cash deficit or a cash surplus will result from the current situation. Frequency of forecasting depends on the company and the predictability of the cash

FIGURE 1

Treasurer’s principal activities (Klusáček and Polák, 2010)

flows. Furthermore the thick small arrows at start and end display the different transaction methods which can be used (EFT meaning Electronic Financial Transaction).

A distinction can be made between domestic Cash management and international Cash management. Domestic Cash management focuses on managing cash flows within a country and does not concern itself with foreign exchange risk, but with making sure liquidity levels of the company are sufficient. International Cash management gives more complexity, firstly Treasurer’s Principal Activities Treasury Cash Management Assets and Liabilities Management Payments

Cash flow Monitoring Banking Relationships Cash Pooling Netting Cash Concentration Working Capital Management Risk Management Cash flow,

Balance sheet and P&L Planning

Cash flow Forecasting and Budgeting

Liabilities Management

Short-term Investments Long-term Investments Portfolio Management Accounts Payable and Receivable Management Financial Risk Management, Strategy Designing Rules,Setting Limits

Risk Measurement VaR, Stress Testing Reporting Natural Hedging Hedging Products on Financial markets Market, Credit and

Operational Risk Management

Assets Management

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12 because of the different geographic locations of subsidiaries, each with different needs. Secondly because of the fact that countries have different legislation in place, for example China has very strict legislation, putting a limit on certain Cash management structures.

Cash management entails more responsibility than it did years ago. Before Cash management was just about cash flow budgeting: “How to make paying and receiving cash as efficient as possible and how to use surplus cash?“ Iturralde, Maseda and San-Jose (2008) call this: basic Cash management (: 3).

FIGURE 2

Cash management system (Allman-Ward and Sagner 2003)

Nowadays Cash management entails much more, like financial risk management and banking relationship management, mostly because of globalization and technological improvements. Together with its responsibilities it entails a corporate culture (Iturralde et al., 2008 : 4) with its own codes of conduct and performance management and could be called “advanced Cash management”. Though this is also dependent on the company, multinational companies have more responsibilities for CM than smaller domestic companies who are closer to “basic Cash management”. With the changes in responsibilities come more opportunities and difficulties. These will be gradually discussed during this thesis. The biggest opportunity lies within centralization of CM.

§1.2 Financial risk management. Financial risk management needs some additional attention while this is one of the core activities of the Treasury department and although figure 1 shows it as a separate function it does form a part of the activities of Treasurers. It becomes more and more important now during the crisis, because of problems such as

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13 financing problems for working capital and politics influencing the interest rates etc. and thus Treasuries focus more and more on financial risk management.

Some of the risks treasurers need to deal with are interest rate risk, foreign exchange risk (both market risks) and credit risk. Interest rate risk management needs to prevent that interest rate changes negatively affect borrowing costs and deposits. Foreign exchange risk exists of three aspects: transaction risk, translation risk and economic risk (Klusáček and Polák, 2010 : 24). Transaction risk is the risk that movements in FX rates negatively affect international dealings in foreign currency. Translation risk entails risk following from adverse movements in FX rates having a negative effect on the overseas values of assets and liabilities when translated to domestic currency. Economic risk is the risk of FX rate movement having a negative effect on the competitive position in a foreign setting. Finally credit risk is the risk that a counterparty cannot pay its debt to the company and thus results in a loss.

Also centralization has advantages for financial risk management, while centralization makes it possible for risk management to be better connected to companies’ strategies. For example it supports management decision making in that Treasury can advise if current strategies are sustainable financially. Next centralization of CM will be discussed.

§2 Centralization of Cash management

More and more multinational companies are centralizing their Cash management since the liberalization of the financial market and the introduction of the Euro (Eije van, Westerman 2005). According to Mulligan (2000 : 7) and Lind, Polak and Robertson (2011 : 60) most multinational companies have already implemented some kind of centralization of Cash management. However the way in which a company centralizes its Cash management differs per company. A few drivers for these differences are amongst others: “company size, locations, complexity of technologies used etc. This perspective comes from the contingency theory and explains that the difference in a company’s information systems design, like management control, follows from internal and external contextual factors (Chenhall 2003). These differences can also have their effect on the architecture of performance management in the Treasury department, this will be further elaborated upon in paragraph 3.

Firstly a definition of centralized Cash management will be given, secondly a short summary of the evolution towards centralized CM will follow, thirdly a description will be given of how CM functions are set up in a company which has a centralized CM structure.

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14 definition which is the following: “The consolidation of cash flow decisions within a multi-faceted company or conglomerate to a central authority for the purposes of achieving greater control of intra-company cash balances”.1 The definition of centralized CM for this thesis is: “Pooling highly qualified people, their skills and knowledge into one centre which has full authority over managing a company’s resources to sustain its ongoing activities, mobilize funds, and optimize liquidity” (Allman-Ward and Sagner, 2003 : 7, Klusáček and Polák, 2010 : 8).

Although the definition of centralized Cash management for this thesis is now clear, in general Treasury management and Cash management are used interchangeably, which could be confusing. Even though every company arranges this differently, Cash management is but one part of Treasury managementas explained in the former paragraph. Therefore it has to be mentioned that this thesis uses these terms interchangeably as well, but the focus is on CM. Furthermore there are multiple business units (BU’s) which have to perform Treasury activities, only the BU’s towards which decision making is centralized have absolute authority. The other BU’s just have the function of performing Treasury activities as the fully authorized units dictate.

The next subparagraph contains a brief review of the developments that lead companies to centralize their Cash management. Subsequently the changes within systems of centralized Cash management will be discussed

§2.2 Evolution towards and in centralized Cash management. To understand the present developments and its influence on performance management better it is useful to describe the influences on- and- progress in Cash management. This subparagraph gives a historical overview of developments which make CM what it is today. Firstly it will describe its origin, secondly it will discuss how CM develops itself towards centralized Cash management (see figure 3 for a timeline with the historical overview).

Early articles about CM originate from America (Gitman et al. 1979), so the developments will be described from an American perspective and it will be assumed that most of the developments also apply to Europe to a certain extent. Before the 1920’s and 1930’s there was not so much attention given to the management of liquidity and liquidity forms the core of Cash management. During these years the great depression took place and firms with high leverage needed to take more care of their liquidity in order to stay in business (Gitman et al. 1979). The additional consequences were losses on investments in American firms by European companies.

Later in the late 1930’s and early 1940’s companies grew steadily, because of the huge demands from governments in the wartime. This increasing demand made predictability of cash flows better. After the war, the world economy landed into a recession and companies

1

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15 focused even more on liquidity management. This led to developments of cash forecasting and budgeting (Gitman et al. 1979, Allman-Ward 2003).

After the second world war the interest rates steadily increased which gave implications as well as opportunities for Cash management. It became profitable to invest more in managing the tasks of Cash management namely: “collections, disbursements borrowing and investments”.

The first step towards centralized CM is called lock-boxing and was made possible through technical innovations of computer systems in the 1970’s (Allman-Ward 2003). There is a lot of time between the phases in the cash flow cycle. The collection of cash takes time as well as it takes time until a payable of cash is due, these intervals are called collection float and disbursement float respectively. By means of a lockbox, collections float times can be diminished by setting up a system on a central location in which multiple collections take place.Usually banks set them up, because they have the knowledge and technology needed.

Continued technological- and financial innovations improved Cash management with big steps. Especially the use of the personal computer, from the 1980’s and onwards, made possible that the Cash management system could evolve from a data gathering system to the role of an analyzer of cash information. Through this last development it had become possible to make cash forecasts and subsequently liquidity optimization could be acquired.

Finally what became important in Europe was the fact that the financial markets liberalized just like these markets had been liberalized in the United States. The establishment of the European Monetary Union made international Cash management easier and especially the adoption of centralized Cash management (Von Eijen en Westerman 2005).

FIGURE 3

Historical overview of centralized Cash management

1929-1945 The Great Depression 1945-1970 Post WOII Recession/ Revival of World economy Maintaining solvency by further developing Cash management (CM) 1970-1980 Developments towards centralized CM: “Lock-boxing” 1980-1990 1990-2000 Further deregulation banking industry and establishment EMU 2000-present Start of CM revolution: “forecasting, budgeting, etc. from a central location” Introduction personal computer Further technological innovations: new payments systems: “SEPA” Easier international payments, better opportunities for centralization CM Attention High-leverage firms on liquidity management Innovations of computer systems

Less need for multiple banking relationships due to increased knowledge Developments of Cash management

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16 Another effect of the adoption of the EURO has been the reduction of risk management activities regarding foreign exchange management within Europe. The paper on centralization of CM from Von Eijen and Westerman (2005) emphasized the logical consequence of the centralization processes, as displayed in figure 3, has been the disintermediation of banking services. Multinational companies with the technological advances, knowledge and specialists had no need for the many banking relationships anymore. It had become more efficient to just keep a few banking relations going to keep up with Treasury developments. In paragraph 2.4 and paragraph 2.6 these concepts will be explained.

Concluding Cash management can be described as a continuously changing system, also regarding the centralization processes. The case-study of Holland et al. (1994) reveals that a huge information system (IS) like the one(s) used by the Treasury department, needs constant adaption to present developments. They use IT-impact theories, which state that not only technology is important, but also more adaption and synchronizing of the organizational strategy and IS’s with the Treasury management system are important. This is particularly important for more integrated performance management (see paragraph 3).

This subparagraph has shown the dynamic nature of Cash management, but what does this mean for its techniques? This will be discussed in the subparagraph 2.4. Following is first a subparagraph about the structure centralized Cash management can have.

§2.3 Cash management structure. Not every company has the same structure of Cash management. Mulligan (2000) looks at companies with decentralized CM versus companies with centralized CM. She describes decentralized Cash management as: “An approach whereby responsibility for Treasury management activities will remain with the operating units” (: 11).

There are different structures for centralized CM as well. Each company can have a different degree of centralization dependent on factors like technology, geographical spread, volume of cash flows etc. (Klusáček and Polák 2010 : 26-28). Klusáček and Polák (2010) give a possible description of the phases of centralization and in particular regarding geographical spread they name three possible centralization structures namely: “Global, regional by time zone and regional by country” (Klusáček and Polák, 2010, : 26-28 and : 30). Soenen (1986) survey multinational companies in the UK regarding their cash- and foreign exchange management practices and find evidence that there are companies as well who partially centralize their Cash management, either regionally (for example by time zone) or at division headquarters (for example by country) (Soenen, 1986, : 348-349). Soenen (1989) does the same survey, but for the UK, The Netherlands and Belgium. The results regarding centralization are the same, tendency towards centralization with an amount of companies who turn to partial centralization as well, regionally and on division base (Soenen, 1989, : 606-607).

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17 -Global centralization: one central location for CM decision making (hedging, surplus cash investing etc.).

-Regional centralization: multiple locations for CM decision making for example by time-zone, continent or group of countries.

This dividence is the way in which this research categorizes the companies’ CM structure, more will follow in §3.4 as one point of the conceptual model. The next subparagraph will describe techniques used to centralize Cash management.

§2.4 Techniques of centralized Cash management. A centralized Cash management system has different techniques in use, this subparagraph will give a few examples and explain the general concepts. This is important in understanding what place the Treasury department has in the organization and which information flows take place (see paragraph 3 and 2.5 respectively. The following techniques will be briefly discussed: “Cash pooling, payment netting, disintermediation of banking services”, finally one vehicle of centralized CM will be discussed: “the payment factory”.

Pooling of cash. Debit accounts can be offset by credit balances in other accounts within a company, dispersed over different locations. One central point where this is performed can be the headquarters of the firm, here the cash will be concentrated on a concentration account (see paragraph 3.1). There is a lot of literature on cash pooling and there are many different structures. I will just explain the forms which are relevant for centralized Cash management within one company as explained in the article of Kocurek and Polák (2007 : 35): “Cash pooling is basically a bank product which can be used globally to collect money and use this money to invest and/or lend”. The differentiation of a company’s cash pooling system can depend on its independence of separate units, like plants.

The most used structures of cash pooling are: Real cash pooling (zero-balancing) and Notional cash pooling. In the EMU zero-balancing is most effective and mostly used, also called real cash pooling. Real cash pooling entails having one master bank account and moving the money from the several “junior accounts” to the master bank account at the end of the day until the junior accounts are on a zero-balance (daily cash sweeping) (Kocurek and Polák 2004).

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18 Netting of payments. One illustrative example is a manufacturing company which has factories for different parts of products dispersed over different locations. To get the parts to another factory of the company transaction costs will be incurred, so payment netting is mainly about setting off intra company transfers. Costs can be reduced by not letting cash change hands right away but hold an account so that different payments can be netted towards one payment.

Payment factory. “The so-called “payment factory” (PF) acts as an agent on behalf of the entities” (Von Eije and Westerman 2005 : 69). This factory takes care of most of the company payments and makes sure third-party payments from international companies are turned into domestic payments via resident, non-resident accounts and currency agreements with these parties (Von Eije and Westerman 2005).

Disintermediation of banking services. The process of diminishing banking relationships and the setting up of in house banks (IHB’s) is called: “disintermediation of banking services” (Von Eije and Westerman 2005 : 68). Before this process the company holds a lot of banking relationships, because of different currencies and different specializations of banks. Small banks have local advantages (ties to community) and bigger banks (Citibank, Abn-Amro etc) have the advantage of big pools of resources and knowledge. The reasons for this development are amongst others: “less currency differences because there are no FX differences anymore within the monetary European Union (Von Eije and Westerman 2005), furthermore globalization together with technological advances give organizations the possibilities to arrange more banking services themselves. The company keeps ties to the bigger banks like Citibank so it can follow most recent technological- and global developments.

To find out more about disintermediation of banking services, Von Eije and Westerman (2005) use Philips as a case study to see the possibilities and advantages of centralization of CM functions and disintermediation of banking services like significant cost savings and control improvements. Disintermediation of banking services in bigger companies like Philips mostly lead to the setting up of an IHB. Netting services for example, usually provided by banks will be taken over by the in house bank. The in house bank will keep a so-called “in house bank account” per subsidiary and it will lead the netting process. Furthermore it provides all the banking services needed by the subsidiaries which external banks usually provide (Klusáček and Polák, 2010). The IHB makes all decision making regarding liquidity, financial and financial risk management issues for the entire company.

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19 provide it easier and cheaper than an external bank. It has to be mentioned however that this IHB has “real” bank accounts with several big banks and the accounts it has for the subsidiaries are fictional.

Concluding, the advantage of an in house bank is that it will save costs increases flexibility and it has big control improvements, because of better visibility of the cash flows of the company as a whole (Von Eije and Westerman 2005 : 68).

§2.5 How does Cash management add value? This subparagraph emphasizes the added value of centralized Treasury management to the organization in terms of qualitative performance. The internal customer service perspective (Hallowell, Schlesinger, Zornitsky, 1996, Fleischman, Johnson, Walker 2011, Baker, Finn, Marshall 1998) is used to analyze the supposed function of the Treasury department as a service provider. This involves theories from the information system- and management accounting literature. In order to explore performance management of CM it is important to get to know the position of the Treasury department in an organization in terms of added value for users and subsequently for the company as a whole. This means looking at the relationship of providers and users of this “service” internally.

The advantages of centralized CM so far are mostly about reducing costs, improving efficiency and possibly earning money by properly investing excess cash. These are the advantages a lot of companies focus on (Klusáček, Polák, 2010 : 11), advantages which definitely help in keeping the company solvent and cost-effective. However this thesis tries to emphasize the other emerging advantages. First of all the improvement of the information system leads to better transparency in the firm as a whole (Polák 2010, Fersztand 2011). Treasurers call this “visibility of cash flows” (Lind et al. 2011 : 52), information flows quickly through the company and when a problem occurs this will be quickly known and thus can be solved quickly as well (Mulligan 2000).

Secondly trends show with improvements in the Cash management system companies look more and more to impact the firms’ value chain (the stream of events in the financial supply chain, from procurement to accounts receivable management) instead of just a focus on corporate Treasury activities, Centralization can improve this (Large and Large, 2006). They investigate future trends in International Cash management through surveying some of the worlds’ biggest banks like BNP Paribas. By involving more stakeholders in the supply chain with Treasury activities, amongst others, liquidity/working capital management can improve and more cash can be freed up as well as it can make collaboration with stakeholders better (payment/procurement conditions, improvement of information flows etc.).

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20 important (Mulligan 2000). Mulligan named one big problem (§3.2), financial quantitative measurement is difficult and every company uses different measures (Andersson et al., 2007). Because of these differences, comparing companies’ CM is hard to do from just an objective financial (performance) perspective. Furthermore, Treasury management becomes more and more integrated in the company as a whole instead of just bearing the liquidity management function (Lind et al. 2011).

The remaining of this paragraph discusses the Treasury function as a service centre and as a key function in the organization, before continuing with performance management.

The Treasury department has a lot of expertise in financial matters, financial risk management matters and IT matters. It needs information from other departments as well as other departments/local Treasury units need information from the Treasury department. Example: a sales manager who wants to sell the products to customers has to know if the customers pay on time and more importantly if they pay at all (accounts payable and financial risk management). It involves information processing in a manner that is relevant, timely, accurate and correct in order for managers in the organization to make the right decisions (Fleischman, Johnson, Walker 2011). Concluding Treasury provides a combination of management accounting information (accounts payable status) and financial information (cash forecasts) to other departments/units of the company.

The article of Fleischman, Johnson, Walker (2011) investigates the perceptual differences between users and providers of MA services. The main difficulty in measuring these perceptions is measuring service quality, how does one measure service quality? The article uses different theories to analyze the perceptions of service quality, the contingency theory (Chenhall 2003) is one of them and is also relevant for this thesis. In this context both MA services and financial services of CM are tools designed to assist in user decision making next to the other roles of CM previously explained. Service quality is influenced by the user- (departments) and provider- (Treasury) perceptions of these services. The service function of Treasury can be said to support the other departments in performing their functions and focusing better on core activities. It is hard to measure this kind of qualitative performance, but it does add value to the organization.

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21 strategic value function will be further elaborated on in §3.4.4. as to involve the concepts of performance management, which will first be explained in the next paragraph.

Concluding, service quality of CM is of importance, so the other departments are able to make better decisions and consequently add value to the company by being able to execute their strategies better. Furthermore, the Treasury department can add strategic value by financial risk management and by offering their expertise to enable top management to optimize decision making. The next paragraph discusses performance management and how this perspective/concept can be used to enhance the value added activities of CM.

§3 Performance Management

Every company is different, they use different information systems, have different business cultures etc. There has not yet been decided what factors really influence the organizational architecture of Treasury management units, if it consists of the characteristics of the company, the company’s culture or the managers of the Treasury division (Mulligan 2000, Iturralde et al., 2008). The problem arising here is that also management of the Treasury department becomes more difficult, in particular performance management is seen as difficult (Mulligan 2000 and Newman 2007). However with current developments, as described in the former paragraph, Treasury gets more and more integrated in the organization as a whole (Andersson et al. 2007, Lind et al. 2012).

This paragraph gives a short overview of the performance management literature and the connection to- and implications for Treasury management with a focus on Cash management. Then it will give the development of a conceptual framework used to analyze the Treasury performance management system.

§3.1 Performance management literature. This subparagraph gives a brief overview of the performance management literature, starting with a description of its origin.

Performance management systems (PMS’s) have its origin in management control systems. Management control can be described as: “The process by which managers assure that resources are obtained, used effectively and efficiently in the accomplishment of the organization’s objectives” (Anthony, 1965: 17). He makes the dividence between strategic planning, management control and operational control.

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22 which has this definition at its core and will make apparent which interconnection between the different aspects exist.

Performance management is seen more and more as an integrative system in an organization to connect strategic planning, performance measurement, performance evaluation and subsequent responses/actions to bring the current performance in line with the organization’s objectives, operationally as well as strategically. However, there is no clear definition of performance, because every company uses a different definition. Meyer (2005 : 288) states that performance is so dynamic in nature however you categorize it and it is difficult to lay a finger on. There are some that try to approach the concept somewhat, like Fisher (1988) who defines economic performance as “the magnitude of cash flows still to come” (: 256). Following from the former, in this thesis, organizational performance will be defined as: “Reaching or failing to reach organizational objectives, set by the managers of the company taking into account the interests of the internal- and external stakeholders”.

Whatever the company specific objectives may be (increasing market share, increasing profits/revenues etc.), the system used to steer towards these objectives, the PMS, has to make sure the organization is on the right track and if it is not, give tools to take corrective actions. In this thesis an integrative performance management perspective is used. The remaining part of this subparagraph is used to elaborate on this perspective by using the frameworks described in the work of Dixon, Nanni and Vollmann (1992) and Goddard and Smith (2002).

Dixon et al. (1992) describe “a new way” of management accounting which acknowledges the importance of organizational strategy in the implementation of a management control system within the use of management accounting (MA). They call it “integrated performance measurement” which entails that MA does not only deliver a product (cost data), but it provides a service (: 6). The term “integrated performance measurement” seems limited to measuring of performance, but the authors deliberately choose this term to avoid traditional MA terms like performance evaluation. Their framework entails connecting organization strategy with measurement and with actions in a triangular relationship (see figure 4 on the next page).

As mentioned previously Meyer (2005) explains that it is difficult formulating one measure of performance and every company uses its own measures, for this reason it would be better to focus on one company at a time. Dixon et al. (1992) argues that integrated performance measurement helps with formulating strategies (for the company or the division) by measuring performance in terms deemed relevant to specific customer requirements. For Treasury the customers exist of the departments/actors in need of its support.

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23 behavioral aspects of PM and here there is potential to explore more (Smith and Goddard, 2002 : 253). The question in Smith and Goddard (2002 : ) is: “How does the performance management itself influence practice?” Here is where Cash management comes in, because this is a very difficult area to measure performance in let alone influence it. They discuss an integrated framework to analyze the PMS of an organization. It has a clear focus on strategic management and reasons that this is the missing link in most research about PM (: 249).

Both the frameworks have the view that strategic management should be more incorporated in the analysis and in the action plans of PMS’s of organizations and their business units. The main elements of their framework are given in figure 4 on page 24. The top of the triangle is the same in both frameworks, namely strategy. Smith and Goddard (2002) call this the formulation of strategy and addresses the need to continuously reevaluate the strategies of an organization dependent on internal contingencies (PMS) and external contingencies (like a fast changing environments). Like Dixon et al. (1992) the article adds that strategies should not exclusively be formulated in financial terms, but in non-financial terms as well.

The right corner entails measurement and analysis of performance, Goddard and Smith (2002) state the importance of development of performance measurement instruments and analytic techniques to interpret such measures (: 249), Dixon et al. (1992) uses the a similar description. Furthermore the left corner entails taking of action to implement the strategies and plans (measurement/analysis) and ensuring proper behavioral responses are enforced.

Especially in the article of Goddard and Smith (2002) it becomes apparent again how difficult performance measurement is as to have measures which are representative of short- and long term performance (: 250). Therefore it is particularly interesting to analyze how Treasury managers set measures and targets following company/department strategy, how they analyze the outcomes and how they take actions to influence and enforce them.

Mulligan (2000) looked at companies with centralized CM and companies with decentralized CM and wanted to find out which of the two groups of companies had better “financial health” in terms of liquidity and working capital.

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24 FIGURE 4

Triangular relationship of performance management

§3.2 Performance and centralized Cash management. In this subparagraph the article of Mulligan (2000) will be further discussed. Her insights are relevant for this thesis while it is one of the few studies focused concretely on performance of Cash management.

Mulligan (2000) uses the “financial health model (FHM)” to assess Cash management performance, the model is developed for the purpose of that article. It consists of five ratios to display the liquidity of the company as well as it gives measures of the savings CM establishes. The ratios are as following: Quick Ratio, Cash Flow Liquidity Ratio, Interest Management Proficiency Ratio, Tax Management Proficiency Ratio and Cash Position Ratio. The first two are liquidity measures, the two following are measures of benefits of centralized Cash management regarding interest and tax savings and the last one measures the cash resources available to make short term investments also called “Cash Headroom”.

Mulligan distinguished two groups of companies: companies with centralized CM and companies with decentralized CM, two extremes. She expected to find differences in terms of financial health, which she did, as stated in §3.1, however she did not find a reason for the differences and neither did she find an answer for the question if differences are caused by the CM structure. The FHM could be closer linked to centralized Treasury structures, because the discriminant function used (MDA: multiple discriminant analysis) was more prone to misclassify companies with decentralized CM than companies with centralized CM (Mulligan, 2000 : 28).

So far the statistical part of Mulligan (2000) gives some suggestions for further research, namely answering the questions why there are differences between companies with different CM structures and if these are caused by CM structures. More detailed information is needed to answer these questions, which forms a limitation of her research. One conclusion is that

Strategy

(both Dixon et al. !992 and Smith and Goddard 2002)

Measures (Dixon et al. 1992) Measurement and

analysis (Smith and Goddard 2002) Actions

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25 through use of interviews you can get a better insight in the results of the statistics. In this case by asking the question: “What objectives does the Treasury department have?” (: 28).

Mulligan (2000) however does integrate some exploratory interviews in her research.. The interviewees emphasized that performance measurement is a difficult subject for CM (: 27) and that most of the performance is of non-quantifiable nature. Thus to understand PM of Cash management better, more in-depth research is needed. Furthermore she focused on centralized and decentralized structures, but there are multiple forms of centralization as well (paragraph 2). This research continues where the interviews in Mulligan (2000) left off, namely with a deeper exploration of performance management of (centralized) CM.

Mulligan (2000), Newman (2007) and Andersson et al. (2007) explain that capturing performance in a Treasury context differs a lot per company and thus it is difficult to measure and compare between companies. The next subparagraph will elaborate further on this topic.

§3.3. Capturing/measuring performance of Cash management. This subparagraph further elaborates on the biggest problem CM has in terms of PM, namely performance measurement. The description for CM added value given in §2.5 will be used as main description for CM performance, while giving an absolute definition is rather difficult and is not yet established in the literature (Mulligan, 2000, Andersson et al. 2007).

In general most companies favour objective performance measures like accounting measures, because these are easily quantifiable and simple in use. Also in the literature these formal financial controls are still more emphasized than informal controls (Berry et al. 2009). However more and more research focuses on the role of non-financial controls/performance measurement with an integrative perspective. Kaplan and Norton (1992, 1993) for example introduce the balanced scorecard which takes into account many performance measures, financial and non-financial, on all hierarchical levels to support business strategies and consequently organization strategies.

The difficulty of measuring Treasury performance is the fact that Treasury performs in a rapidly changing financial landscape. The crisis demands new approaches of CM to keep the company stable and “healthy” and in the process support the objectives of the company to perform its core activities (Andersson et al. 2007, Lind et al., 2012). However also environmental uncertainty differs per company as will become apparent with the analysis later in this thesis. One company may have more predictable cash flows than the other, depending on this also the performance measures differ. This is in line with the contingency theory which explains that PM of organizations is influenced by contextual factors of which environmental uncertainty is one (Govindarajan 1984 and Chenhall 2003).

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26 plays relative unimportant role), profit conscious style (superior relies on both budget and subjective use of this data) and budget constrained style (high reliance on budget). The formula-based style is comparable to the budget constrained style and subjective evaluation style is comparable to the non accounting style. Hopwood (1972) mainly studied the effect of superior evaluation style on individual managers not on the overall effectiveness of operations like Govindarajan (1984) researches.

Govindarajan (1984) researches if there is a relationship between environmental uncertainty and evaluation style. The results support their contingency-based model which table 1 displays. It shows that managers working in a function with high environmental uncertainty would be better off using a more subjective evaluation style. This relationship is of importance to Cash management, as will be explained shortly.

Govindarajan (1984) uses a subjective performance measure, while it is very difficult to get measures of objective performance which are aligned in cross-organizational studies (: 130). He uses self-ratings of business units on a multiplicity of performance dimensions and these dimensions are weighted as to the importance per BU. Furthermore he mentions that his research can be used in a variety of other organizational settings like on department level as is done in this thesis. However a thorough replication of his study goes beyond the exploratory nature of this thesis and thus any conclusion from his theory is on hypothetical basis.

For Treasury thus it can be concluded from table 1 that it would pay off to use more subjective approaches in performance evaluation and not focus too much on a budget-constrained style of measuring/evaluating performance unless the environmental uncertainty is lower and allows for a budget constrained style to be effective. §3.5 will elaborate further on the measures used for CM performance on hypothetical basis.

TABLE 1

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27 Here performance management and its variability based upon contextual factors was discussed (according to the contingency theory) and environmental uncertainty is one of the biggest factors. However this forms but a portion of performance management and the next subparagraph will explain the whole of performance management with the framework of Fereirra and Otley (2009)

§3.4 Conceptual model. Here the framework of Otley and Fereirra (2009) will be explained and a conceptual model will be created from this framework and the models discussed in §3.1 (Goddard and Smith, 2002 and Dixon et al., 1992). This conceptual model will be used to make a proposition in §3.5 of how PM of Cash management could be arranged.

The framework of Fereirra and Otley (2009) is called performance management systems framework (PMSF) and consists of 12 questions in the following key areas: 1. Vision and mission, 2. Key success factors, 3. Organization structure, 4. Strategies and plans, 5. Key performance measures, 6. Target setting, 7. Performance evaluation, 8. Reward systems, 9. Information flows, systems and networks, 10. PMS’s use, 11. PMS’s change and 12. Strength and Coherence (see appendix A for this list of questions which are used in the interviews). See figure 5 for sketched overview of the framework. It is not meant as a normative framework, but as a “heuristic tool to facilitate the rapid description of significant aspects of PMS’s design and operation” (: 263).

FIGURE 5

Performance management systems framework (Fereirra and Otley 2009 : 268)

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28 address the issue of change of the PMS (Ferreira and Otley 2009), all issues important for assessing the PM of Cash management, while this aspect is in discussion presently. The current framework does address these areas, however it deliberately emphasizes the first levers of control of Simons (1995) (diagnostic controls and interactive controls).

The article assumes belief systems and boundary systems to be imbedded in the questions about organizational culture and strategy. They are viewed as contingent variables with which one can assess the differences in effectiveness of patterns of control and not as characteristics of the PMS (figure 5).

The framework leaves room for modification, for each question Ferreira and Otley (2009) explains the basic idea and suggests theories to use for assessment. This is one of the reasons for choosing this model, namely to assess multiple cases and being able to supplement the model with theories relevant for the assessment of PM of CM. Figure 6 on the next page shows the conceptual model, in which all aforementioned frameworks are integrated. The models of the last two articles are supplemented to the framework of Ferreira and Otley (2009), because it accentuates the interaction between strategies, actions and measurement more. This is where companies’ Treasury differs and most emphasis is put on, while the Treasury department requires strong controls to manage employees’ behavior, see the analysis for further elaboration.

Following, the points in the figure will be briefly summarized by explaining the approaches used to assess the answers to the interview questions. These questions can be found in appendix A. The idea is to make the different cases better comparable to each other in more general terms instead of providing a thorough description per case as Ferreira (2008) does with the model of Otley (1999) to describe the PMS’s of 4 health organizations in Portugal. The PMS of Cash management will be described and where needed also comments of the organizational PMS will be given. To describe the full organizational PMS is beyond the scope of this thesis, however the PMS of Treasury management is extensively derived from organizational performance management. This will become clear in the analysis.

§3.4.1 Vision and mission. Every industrial has overarching objectives it wants to accomplish now and in the future. They want to contribute something to the world, to their customers etc. The mission can be described as “the overriding purpose of the organization in line with the values or expectations of stakeholders” , the vision can be described as the “desired future state: the aspiration of the organization” (Johnson et al., 2005 : 13).

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29 §3.4.2 Key Success Factors. KSF’s are a codification of the vision and mission in more concrete terms and in a more compressed timeframe, recognizing the control measures needed to be reported on a routine basis (Ferreira and Otley, 2009 : 269). These differ also per company following the mission and vision. This also goes for CM, although there are many common success factors amongst companies as the basic premises of CM stay the same. The classification in the analysis is: formalized or not and per company the factors are described.

§3.4.3 Organization Structure. Organization structures are formed as a means of establishing formally the specification of individual roles and tasks to be carried out (Ferreira and Otley, 2009 : 269, Chenhall, 2003). Organization structure will be categorized as centralized or decentralized with a description of how the formal structure (rules/procedures) and authority are arranged which are a few of the choices organizations make in forming the structure (Johnson et al. 2005). Here describing the organization structure first is important to see how the structure of Cash management functions in the overall structure.

CM structure will be described as either regionally centralized or globally centralized, as explained in §2.3. Furthermore there will be a short description of a few Treasury policies, which are part of the CM structure. Figure 6 (on the page 31) shows the interrelationship between strategies and plans and organization structure and as Ferreira and Otley (2009 : 269) explain these have to match with each other in order for the PMS to be effective. This means that decentralized organizations do not always benefit from further centralization of CM.

§3.4.4 Strategies and plans. For Cash management these strategies and plans are in each case supportive of the organization strategies, it sets out what is possible financially (on the short- and middle long term), at what cost and with what risks (ACT and ICAA, 2012). In the other cases CM itself can also be part of organization strategies (Iturralde et al. 2008) and form a business/competitive advantage. An example is Motorola, which has centralized its CM and uses it as a strategy by enhancing supplier relationships by involving them more deeply in their Treasury information system. This forms an advantage cost-wise as well as it enhances the relationships itself, while it enables quick and clear communication (Holland et al., 1994).

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30 Added strategic value. This thesis names added strategic value as an important component of the added value of centralized Treasury, for this reason a further explanation is deemed necessary as to clarify what strategic added value means.

Langfield-Smith (1997) gives a review of research in management control and strategy and how these two concepts are interconnected. They describe many different typologies

regarding strategies of companies, for example Porter’s classification of company strategies: cost leadership, differentiation and focus (1980). An interesting aspect of their article is the concept of resource sharing, which entails: “The sharing of functional resources by two or more SBU’s within a single firm” (: 220). For CM shared resources can be classified as sharing technology (information system, IS) and sharing information. Regarding Treasury this goes further than just sharing resources within one single firm and involves external

stakeholders as well.

How does this influence strategy? The PMS and it’s IS make it possible to quickly and accurately share information, as previously explained, so better decisions can be made by the receivers of information from Treasury. A trend within Treasury is that the department has to give insight into different market scenarios affecting the BU’s and departments of the

company financially (Lind et al. 2011). During the financial crisis this means that financing needs are harder to satisfy, because of lenders (banks) having stricter conditions for

borrowing money on short- and long term. This could affect strategies on lower aggregated levels and thus on a company level (less investments to support innovation for example). Also Treasury gets pulled in the process of decision making in business strategies, because of essential financial risk considerations. These decisions could be about location of expense centers, while this has an effect on financial risk exposures (: 64).

Finally another essential function is banking relationship management which falls under the responsibilities of the Treasury department. This way valuable information about the financial market is obtained as well as support for the continuous improvement strategies of the

Treasury department. It is now clear that Treasury is an essential central function within a multinational industrial and it influences strategic decision making.

The other important aspect of this aspect in the analysis is the way in which these strategies and plans are being communicated. “This process can be as important as the outcome of the strategic planning and thus warrants explicit consideration” (Ferreira and Otley, 2009 : 270). The choice in this research is not to classify strategy according to existing (limiting) typologies, because Treasury actually supports many kinds of strategies throughout the organization and Treasury itself has also a general strategy of supporting other BU’s and departments.

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31 the conceptual model emphasizes the interrelationships between measurement actions and strategies. There are however many indicators which measure efficiency and controlling KPI’s like password changes every month and trades made in error (ACT and ICAA, 2012 : 25). What companies need is a set of measurable short-term KPI’s (1 year or less) to assess if strategies are being followed and proper actions are being taken (Mulligan, 2000; Newman, 2007 and Ferreira and Otley, 2009).

FIGURE 6 PMS conceptual model

(Ferreira and Otley, 2009, Goddard and Smith, 2002 and Dixon et al. 1992)

Andersson et al (2007) discuss the changing role of Treasury and the importance of different KPI’s for Treasury. Treasury is moving towards being a strategic BU and adds extra value to companies. However they emphasize that the exact nature of this added-value is not yet defined by the Treasury community (: 125) or research for that matter. They divide Treasury KPI’s in three categories: process measures; Treasury measures and added-value KPI’s (see Table 2 next page). Added-value KPI’s are mostly of qualitative nature and, thus, are the hardest to measure and/or interpret. This dividence will be used in the analysis of the key performance measures. Client refers to the internal customer as explained in §2.5.

Performance Management of a Centralized Cash management System in 4 non-financial multinational industrials: a multi case- study