One of the projects on the to-do list of Beth Williams, vice president of finance at Norwood Promotional Products, is measuring the amount of time that elapses from the moment Norwood receives an invoice until it's paid. Driving her actions is a desire to more accurately forecast cash and boost Norwood's ability to take advantage of early payment terms. The company, an Indianapolis-based provider of promotional products, currently uses about 60 percent of the discounts available on the 60,000 invoices it pays each year. Capturing the other discounts, which usually offer 1 or 2 percent off for payment within 15 or 20 days, will have a clear bottom-line impact.
Once Williams has measured the time used to get invoices into the system, her next task will be to pinpoint and eliminate (or at least reduce) the causes of any delays. Her theory is that paper invoices are held up when managers with approval authority are on the road. After all, invoices that are received electronically and don't require approval are quickly processed; only paper invoices tend to get stalled. If Williams's theory is on target, her next step will be to work with the operating units to develop procedures so that all invoices continue moving through the system even when managers are out of town.
Williams's goal is to measure and improve the process by midsummer, when production ramps up heading into the holiday season. "Cash tightens then, so we want greater visibility into the payables queue," she says.
Measurement Moves to Treasury
With a generation of business leaders schooled in the concepts of quality, Six Sigma, and the like, the idea that measuring a function is a necessary step to improving it has become conventional thinking. After proliferating in certain work areas, such as assembly lines, the practice now is showing up more frequently in treasury departments. "Traditionally, treasury has been a metrics-free zone, due in part to frequently volatile financial markets and risk factors outside the treasurer's control, " says Marie Hollein, director of the financial risk management practice with KPMG. However, companies today often have complex operations and need sophisticated performance measurements to make sound business decisions.
Like Williams, more financial executives are focusing on financial operations; it used to be that financing costs and investment returns captured the most attention. "Although it tends not to be viewed as often, measuring back-office operating costs can really save money for a company," says Jim Abel, vice president of finance and treasurer with PPL Corporation, a $6.5 billion energy company in Allentown, Pa.
One driver behind this trend, not surprisingly, is the heightened regulatory environment. To ensure that their firms comply with Sarbanes-Oxley and other laws, treasurers need a firm grasp of their organizations' financial operations. "For better or worse, Sarbanes-Oxley had a tremendous impact on helping people to look at treasury from a process perspective," says Mike Nichols, principal consultant with Nichols Quality Associates in Greensboro, N.C., and president of the American Society for Quality.
Treasurers also discover that publishing performance metrics can help them to spread the word about the value treasury brings to the company, says Ken Parkinson, managing director with Treasury Information Services, a consultancy in Hopewell, N.J. Traditionally, "lots of treasury people kind of run scared and don't really promote themselves within the company, so they're seen as a black box," he says. By taking the initiative to measure their own performance, treasurers can remove some of the mystique and boost their image.
Moreover, in the absence of any other metrics, most treasurers' de facto performance measure is their last mistake, notes Jeff Wallace, managing partner with Greenwich Treasury Advisors LLC. "And, in treasury, most mistakes are easily quantifiable and, in hindsight, easy to prevent." Treasurers who publish metrics regularly are less likely to be known only for a bad call.
"Publishing this information helps us to communicate up the chain of command," says Joe Broce, assistant treasurer with Ashland Inc., a $7.8 billion diversified chemical company based in Covington, Ky. Among other metrics, Broce benchmarks the return on Ashland's short-term investment portfolio against LIBOR, tallies how quickly cash received is applied, and measures collected balances in Ashland's 100 or so banks. "The treasurer and CFO aren't involved in the daily cash management operations. This helps them to understand what we do."
Making the metrics available helps in other ways, too. Last year, Broce was discussing with a colleague in HR the time and cost demands placed on his department when employees call about lost or ruined paychecks. He could show that the use of direct paycheck deposit by Ashland's employees lagged that of others in the industry. This supported Broce's argument that the company could push harder to have employees shift to direct deposit.
While the reasons for measuring treasury's operations are significant, doing so is not easy. The first obstacle that comes to mind is simply finding the time, given lean staff and ever-expanding responsibility. "When you've got ten fingers plugging holes in the dike, you're not looking for more to do," Wallace notes.
However, many experts in performance measurement extend little sympathy, acknowledging the challenge but noting that it's hardly unique. "I've never been involved in a corporate quality deployment that hasn't had this problem," Nichols says. The key is ranking problems according to their importance and risk, as well as the effort required to address them, and then tackling them in a logical order.
It's not only treasury's lack of time that can hamper its efforts to measure performance. Corporate IT resources often are stretched thin, as well, says Ashland's Broce. To overcome this, Broce talks with Ashland's banks about providing IT implementation support on any project they undertake.
In many companies, the business units also can present a challenge, particularly when they have responsibility for banking transactions and relationships yet have little (or even no) incentive to minimize banking costs or idle balances. The challenge is exacerbated when the operations people prefer to keep this information to themselves, says James Sagner, managing principal with Sagner/Marks, West Orange, N.J.
Similarly, few operating areas are charged with building liquidity. This makes it difficult for treasury, which is unable to simply manufacture liquidity, notes Bruce Lynn, managing partner with Financial Executives Consulting Group, LLC, Darien, Ct. In most companies, treasury can't, for instance, simply change sales terms with an eye toward accelerating cash receipts. Yet when it comes time to measure liquidity, treasury may get nailed if it's not where management wants it.
To really improve treasury's performance, treasurers and their staffers have to work productively with the operating units. Treasury needs to know what they're doing and help them to improve processes that work for them but may not benefit the company overall. A quick way to get the business units' attention is by charging them for their use of working capital and reward them when they contribute cash to the company, Lynn says.
Another obstacle to accurately measuring treasury's performance is the fact that functions often are split between several departments, says Wallace. A credible measurement effort will consider the all-in cost on the banking side, as well as the cost to process transactions through the general ledger. However, the accounts payable and receivable departments often report to accounting, rather than treasury. This makes it difficult to accurately estimate the overall cost of completing a financial transaction, Wallace notes.
Finally, treasury usually receives information from a variety of ERP and front-office systems, further complicating the measurement process. "You have to cobble together the information," Abel notes. Moreover, outside benchmarks are few and far between. So, Abel keeps tabs on historical trends within PPL, such as the speed with which cash is applied.
First Steps
Given the challenges inherent in any effort to measure performance, the first requirement is an entrepreneurial, forward-thinking CFO, says Wallace. He or she should be comfortable measuring these functions and presenting the results to show how the treasury department is adding value to the organization -- and where improvement is needed.
Many larger companies review a range of measures in assessing treasury's performance, says Hollein. "Companies are taking a more holistic approach to managing risk, liquidity, and working capital." Among the metrics they're using are RAROC, or risk-adjusted return on capital, as this considers the risk-return equation; more traditional measures such as return on equity (ROE) don't explicitly account for risk. They're also monitoring day-to-day operating costs, such as bank account fees and the cost of credit and collections.
Over the next year, Abel and his team will be developing a "dashboard" that will highlight metrics in three areas: the cost of processing receipts and disbursements; quality, as measured by error rates; and timeliness, or the speed at which customers' receipts are transmitted to the bank account and posted to PPL's accounts. While Abel and his team have monitored these functions in the past, they're taking their efforts to a new level, backed by a mandate from PPL's chief financial officer. "This gives us political support," Abel says.
Previously, their measurement efforts were hindered by the difficulty of gathering information from multiple systems. For instance, to measure the time required to process "exceptions," or payments that required manual processing, treasury would have to interface with one system for dividend checks, another for vendor checks, and so on.
To remedy this, the treasury department is creating an internal settlement hub. This system, scheduled for completion in early 2009, will consolidate all corporate information relating to billed and invoiced amounts, Abel says. All invoices for any of PPL's divisions will enter the company through treasury rather than the operating units. Paper invoices will be converted to electronic images using OCR technology. "We will be 'unplugging' the disbursing features of all the company's various front-office systems and instead have them pass the relevant payment information into the settlement hub," Abel says. In addition to slashing processing costs by about 25 percent, this will boost PPL's ability to monitor how quickly and accurately it processes payments and invoices.
Clearly, one way to beat the time crunch is through technology. Increasingly robust treasury workstations and other tools allow treasurers to automate tasks and easily access performance benchmarks, such as investment returns on different instruments, says Jim Etten, managing director with Cache Matrix Holdings, LLC, a Denver-based provider of trading software.
Also critical to success is viewing treasury as a process, or a series of steps that produce a deliverable, Nichols says. Rather than just measure the return on invested cash, treasurers need to examine the steps involved in processing transactions and moving cash to accounts where it can earn money.
They also need to employ a metric that's relatively straightforward to calculate and can be measured over time. Ideally, it also is one that can be compared to a benchmark outside the company. Ashland, for instance, holds about $1 billion in its short-term investment portfolio, which management is reserving for strategic acquisitions. Broce compares the return on these funds against LIBOR, although he's careful to adhere to Ashland's investment guidelines of safety of principal, liquidity, and yield. On $1 billion, even an extra 15 basis points adds $1.5 million to the bottom line each year.
Given that no one really knows which way interest rates will head, another option is to assemble a model portfolio split evenly between fixed and floating interest rates, Wallace says. "If a treasurer beats a 50/50 portfolio, it's a good measure of his or her value-add."
Broce and his colleagues also measure and minimize average collected balances across the company by moving the funds to concentration accounts. To be sure, many banks offer an earnings allowance on the collected balances to offset their fees. However, most allowances fall short -- by about 200 basis points -- of the return that Broce can get by investing. Currently, the average collected balances at Ashland's banking partners pay for less than 4 percent of banking fees.
Broce also measures a range of financial operations, such as cash applications. Currently, his goal is to reduce the time required to apply exceptions from two days to one, through the launch of an imaging project that is scheduled for completion this month. The imaging technology will replace any paper, as well as images from the Internet, that Ashland still receives from its banks.
Going forward, treasurers are likely to employ increasingly sophisticated measurement tools, says Hollein. An example is what's known as Value at Risk, or VaR. VaR is most commonly used to estimate the market risk of a company's portfolios. Among the methods used to measure VaR are scenario analysis. The treasurer performs a "what if" analysis to assess possible outcomes under a range of circumstances and to establish best- and worst-case scenarios, says Hollein. Sensitivity analysis calculates how an outcome is influenced by changes in the value of a particular variable, such as financing cost.
Of course, no matter which measurement tools are used, the goal is a positive impact on the bottom line. At Norwood, Williams has been measuring a range of insurance data over the past year, including workers' compensation costs. Also during 2007, management spearheaded several safety initiatives. The result? Costs for workers' compensation claims dropped 44 percent between 2006 and 2007. Man-agement used the savings to help fund a company match for employees' 401(k) accounts. "It helped employees to understand how controlling workers' comp costs can benefit them," Williams says.