What's sometimes lost in the discussion about the growing commercial ties between the United States and China and India is the fact that European businesses remain major trading partners of many North American companies. Exports from North America to Europe totaled $216 billion in 2004; imports were valued at $367 billion, reports the World Trade Organization.
For many treasurers, then, managing their company's European cash flows is a critical job responsibility, and one that's made more complicated by the mix of languages, cultures and regulations on the continent. However, as these two case studies show, an effective cash and treasury management strategy designed to accommodate Europe's complexities can result in significant efficiencies, enhanced investment returns and more effective tax management.
Avnet Distributes Its Cash Management
With locations in more than 70 countries, Phoenix-based Avnet Inc. distributes computer products and electronic components to just about everywhere around the globe. Until the early 1990s, most of Avnet's operations stopped at the borders of the United States, says Ray Sadowski, CFO of the $16 billion company. Since then, Avnet has acquired about 45 other companies. Twenty-five or so of the acquisitions bolstered Avnet's European operations, and about one-third of the company's revenue now comes from Europe. Avnet now has more than 100 active legal entities in Europe, Sadowski says.
In 2000, Sadowski and his team began developing the treasury structure that's currently in operation in Europe. First, they hired three treasury professionals to run Avnet's European treasury center in Belgium, and another employee who is based in Germany. These professionals partner with the finance teams that are housed within the operating units, where they provide business support and handle financial operations.
This organizational structure enables these treasury professionals to work with the business units to provide cash management information and assist in identifying and hedging foreign exchange exposures. At the same time, it offers the tax and cash management efficiencies of a centralized treasury function. "If you look at the complexities, as well as the need for tax and cash efficiency, you have to do some treasury on a centralized basis," says Sadowski.
Avnet also established cash pooling bank accounts in about a dozen European countries. Each of these master accounts receives funds from 10 to 12 sub-accounts; because Avnet has multiple legal entities in each country, it needs a separate bank account for each entity. The sub-accounts are designed to zero out at the end of each day; any cash remaining in the account is transferred to the master account for the particular country. If a sub-account is short of cash, it can draw from the pooling account to bring its balance to zero.
In setting up Avnet's banking structure, Sadowski chose to work with one bank in each country, rather than using a single bank for all of Europe. One reason for this arrangement is the fact that Avnet occasionally needs to borrow up to about $1 billion in working capital at the corporate level. "You need a lot of banks to do this," Sadowski says, adding that Avnet's credit syndicate includes about 20 banks. These banks gain a share of Avnet's cash management business as well. "They're willing to participate in the lending side of the business," says Sadowski. "Part of the partnership is asking where we can use those banks so they can make money."
In addition, although many of the suppliers and banks that Avnet deals with operate globally, in Europe they tend to be locally run. Decisions often are made by a country manager. "You have to have local relationships to some extent," Sadowski says.
The banks that Avnet has partnered with hold a total of 21 cash-pooling or master accounts. Many banks hold more than one account because Avnet does business in both U.S. dollars and local currencies, depending on customers' and suppliers' preferences. The various currencies go into different accounts.
As part of the treasury structure, Sadowski and his team created Avnet Financial Services (AFS), a division of Avnet Europe CVA. "Avnet Financial Services acts as an in-house bank. It's a legal entity that runs a banking function for all the subsidiaries in Europe," Sadowski reports.
AFS is the account holder for the cash-pooling account in each country, says Joe Burke, Avnet's vice president and treasurer. Each cash-pooling account can end the day with excess cash or a deficit balance. Excess cash can be invested short-term, transferred to another pooling account that needs funds, or used to repay intercompany loans from Avnet in the United States. If an AFS master account ends the day with a deficit, it can receive funds from another pooling account or use an overdraft provision to draw cash from the bank.
Each subsidiary works with Avnet Financial Services in an "arm's-length relationship," Sadowski notes. That is, the subsidiary and AFS negotiate just as two disinterested parties would. However, because AFS holds funds from across Europe rather than from one country, it gains economies of scale and can offer better credit and debit terms than the subsidiaries can get locally. Accurate, timely and optimized tax management is a primary objective. With the funds consolidated with AFS, Avnet's treasury team can move money around the world based on the funding needs of different Avnet businesses. AFS conducts intercompany, cross-border cash transactions in accordance with arms-length standards that reflect a "willing-buyer" and "willing-seller" relationship.
"For in-house bank accounts, we make sure there is a current account agreement between AFS and the in-house bank participant that is properly executed and contains the arms-length terms and conditions," says Burke. For example, arms-length terms would require that loans are granted at a market-based spread over a benchmark -- Euribor, for example -- and that investments are made at a market-based spread below a benchmark.
Intercompany account agreements structured in this manner help minimize the ability of tax authorities in different countries to dispute the transactions and claim tax on the same income. The tax authorities also want to ensure that the Avnet subsidiaries that earn interest from their excess cash are properly taxed. Subsidiaries that contribute cash to the consolidation account are credited with interest earnings and pay taxes on that income. Subsidiaries that borrow from the account pay interest, reducing their taxable income.
The Technology Infrastructure
Underlying this structure is a treasury workstation that records all transactions, says Burke. Each day, the workstation receives two feeds. The MT940 messages (statements from the bank to the account holder, sent via the SWIFT network) contain balance and transaction information for the AFS master accounts and all of the sub-accounts. The treasury team can review each subsidiary's activity in the account and determine upcoming cash needs. The workstation also receives a data feed from a foreign exchange rate provider that lists daily fx rates and interest rates for various currencies.
The workstation interfaces with Avnet's ERP system in Europe. The treasury team can also upload the balance sheet and income statement information, such as realized and unrealized foreign exchange results, from the workstation into Avnet's general ledger system, eliminating the need to enter these transactions manually, Burke notes.
The current treasury structure has resulted in a number of benefits. As a starting point, Avnet has reduced its banking costs due to the economies of scale it can offer its banking partners. These savings are passed on to the subsidiaries and help strengthen treasury's relationships with them, Sadowski says.
Plus, since 2000, Avnet has freed up some $200 million through its cash consolidation efforts. Assuming a 5 percent interest rate, Avnet is earning an extra $10 million, which can be invested or used to pay down debt. Previously, cash was tied up in the smaller accounts at the subsidiary level, and it earned little interest. "The cash-pooling structure, together with AFS acting as an in-house bank, affords Avnet the flexibility of optimizing its cash internally before externally investing with or borrowing from a bank," Burke says.
For Universal Weather & Aviation, Consolidation Makes Sense
Houston-based Universal Weather & Aviation Inc. offers a wide range of services to business aviation operators, including flight planning, weather briefings, online trip information services and a fuel management program. The company has a global network of ground-handling facilities in more than 50 countries.
Like Avnet, Universal Weather & Aviation is working to consolidate its cash balances in Europe. However, it's proceeding a bit differently. Universal is partnering with one international bank across Europe that offers a Web-based platform users can access from anywhere, says Diane Bird, assistant treasurer. This structure makes sense for Universal because about 80 percent of its business is billed through the Houston office.
The field locations receive the remainder of the bills. In the past, these offices sometimes lacked the funds to pay them, so Universal's corporate office had to transfer money to the subsidiaries. That usually occurred with larger expenditures, such as payments for fuel or taxes, Bird says. To minimize these disbursements in the future, Universal is working to consolidate the cash that comes in to its various European operations. Until about two years ago, each location held the money in an account with a local bank. However, some subsidiaries ended up just holding excess funds, while other locations were sometimes short of funds and needed to call on corporate to make up the difference.
In 2004, Bird and her team began moving funds to a concentration account with one international bank. "Anywhere I can, I try to minimize the number of banking platforms," she says. Universal's credit and collection team in Europe is offering its customers the option of submitting their payments directly to the concentration account, rather than to the United States. Customers save by sending their payments to the concentration account because that transaction is considered an in-country ACH transfer. To remit payment to Houston, customers must use an international wire transfer, which is more expensive.
Bird is working to spread the word about the concentration account to Universal's European clients so that more will use it. If about 30 percent of those clients use the account, Bird estimates that she no longer would have to wire money from the United States to cover cash shortfalls. And the shift would save Universal money because it wouldn't have to pay a financial institution to convert dollars to euros, an expense that currently runs about $80,000 annually.
Using the concentration account in Europe also reduces Universal's exposure to currency exchange risk. The company currently spends about $27 million annually to purchase euros, Bird reports. Given exchange rates as of January 2007, a 5 percent change in the currency rates would change Universal's cash position by about $1.6 million, she estimates.
Even as the European locations switch to the concentration account, they are keeping their local banking accounts to cover petty cash items. Bird would like to cap each account at about 1,000 euros (about $1,300 as of January). Keeping the accounts open, albeit with nominal balances, helps ease the transition to the new structure for those employees who have established relationships with their local banks, Bird notes.
KEYS to Cash Management Success
As the treasury professionals at Avnet Inc. and Universal Weather & Aviation Inc. have fine-tuned their cash management operations in Europe, they've identified several steps that are critical to success.
Make attracting and retaining top employees a priority. In order for Avnet's European treasury center to work as effectively as it needed to, the company had to attract skilled professionals with strong experience in treasury and treasury systems, says Avnet CFO Sadowski.
Provide the tools employees need to do their job. Treasury systems aren't cheap and may be more than some organizations need. However, these tools can greatly streamline daily cash management activities, such as searching for optimal short-term investments. And by providing visibility into cash flows and account balances, they make it possible to use funds more efficiently. "There's a tremendous ROI, especially when you consider [the ability to] free cash," says Sadowsky.
Know your customers. Customers and suppliers will have some contact with your cash management system, and many of these people have particular ways that they like to work with other companies. For example, Diane Bird, assistant treasurer with Universal Weather & Aviation Inc., reports that some of her company's small business clients wanted the opportunity to pay their bills by having Universal directly debit their account.
Set up a banking structure that facilitates the movement of cash. When cash is disbursed among many accounts, it's more difficult to determine exactly how much is available for investing or paying down debt. More cash has to be held in shorter-term investments just in case it's needed; these investments typically offer lower returns. Plus, banking fees tend to be higher because the banks don't benefit from the economies of scale that would come with a single, larger account. Finally, reconciling and accounting for a multitude of accounts is more cumbersome.