Putting a Figure on it – How Corporate Treasury Helps Boost the Profitability of Businesses

Treasurers use a number of instruments to manage their company’s cash flows with maximum efficiency, ensuring obligations can be met at all times. In two previous blog posts, we set out to highlight that this work directly benefits a company. Taking the examples of FX risk management and interest management, I was able to demonstrate the concrete monetary value treasury management creates. Today, we will be taking a closer look at intercompany netting, which can potentially be a particularly powerful tool depending on a company’s treasury profile.

The more complex and the more decentralized the exchange of goods and services in a group, the more value can be added by engaging in intercompany netting. The volume of intercompany payments is another important factor to determine whether or not netting can make a significant value contribution, helping to recoup investments and running costs. Netting is generally used to minimize intercompany payment volumes and to reduce the number of individual transactions. Moreover, netting can be a supporting factor in currency management efforts, as currencies can be pooled and hedged centrally.

We can distinguish between three different types of intercompany netting: receivables-driven netting, payables-driven netting and AgreementDrivenNetting^®. The most commonly used form of netting is receivables-driven netting, where each entity reports their receivables to the Netting Center on a specific cut-off date and will receive the total amount from the Netting Center. Payables-driven netting on the other hand involves the payer reporting a payable to the Netting Center. The sum is then transferred to the creditor by the Netting Center. AgreementDrivenNetting tops both these methods and is particularly flexible. Unlike receivables-driven or payables-driven netting, AgreementDrivenNetting focuses on the reconciliation process, identifying any non-matching invoices and allowing creditor and debtor to clarify any disagreements directly between them, sometimes confirmed at a higher level by the Netting Center.

Echoing my last two posts, I’d like to once again take the realistic example of fictitious Supplier plc. in order to contrast costs and benefits of netting as a treasury instrument.

Supplier plc. is a globally active group with FX flows and international payments. Their treasury profile can be summed up as follows:

• Turnover: EUR 1.5 billion
• EBIT: EUR 70 million
• EBT: EUR 50 million
• Borrowed capital: EUR 500 million
  Of which long-term borrowed capital: EUR 200 million
  Of which short-term borrowed capital: EUR 80 million
• Equity:  EUR 300 million
• Liquid assets: EUR 30 million
• 20 offices in 10 different countries
• 5 different currency areas: Euro (EUR 50%), US Dollar (USD 20%), Pound sterling (GBP 10%), Japanese Yen (JPY 10%), Swiss Franc (CHF 10%)
• Average borrowing rate: 4.0 %
• Average investment rate: 0.5 %
• Average gross payment volume (incoming and outgoing) per year: EUR 1.5 billion
• Gross intercompany payment volume per year: EUR 0.75 billion
• Number of intercompany payments per year: 120,000
• Number of group-wide bank accounts: 80 (an average of 8 per group entity)
• Cash pools: 1 EUR zero-balancing cash pool, pooling the EUR entities

Contrasting bank charges alone illustrates how much money Supplier plc. could be saving by implementing intercompany netting. Experience shows that introducing a netting process can reduce intercompany payments by approx. 75%.

Netting can bring about a gross payment volume reduction of around 75%, and this in turn reduces costs in connection with FX management. In addition to the FX payment volume to be hedged, netting also lowers FX spreads by 0.1% to 0.15%, as it enables groups to engage in bulk hedging at headquarters/through the Netting Center.

Netting also has an impact on interest, mainly because groups can eliminate float. Without an intercompany netting process in place, Supplier plc. might have to refinance or would not be credited until the value date. Float has an active and a passive component, so we can assume an average interest rate of 2.00%.

These calculations show that netting creates savings in connection with bank charges, FX management and interest management. Another area where netting presents a particularly high potential for savings is personnel costs. You no longer need various employees to hedge FX exposure at a decentralized level. Instead, you can centralize hedging. What’s more, netting allows you to replace the tedious and time-consuming process of needing to match every invoice and agree on its correctness with an efficient, system-based reconciliation process. For a company such as Supplier plc., this can easily amount to saving two man-days per entity per month. Assuming a daily rate of EUR 400 per man-day and 20 entities, this represents savings of EUR 16,000 per month, or EUR 192,000 per year respectively.

We’ve based my calculation of costs for the system on the following values, which represent standard market prices, and a time span of 10 years. If you contrast the savings of around EUR 900,000 with the gross intercompany payment value per year before the introduction of a netting process and after, you get the following scenario:

In the first post of this series we worked out Supplier plc.’s corporate profitability at 8.75%. If you incorporate the EUR 900,000 savings achieved through intercompany netting in this calculation, the figures are as follows:

You can see that savings achieved through the introduction of an intercompany netting process alone can boost group-wide corporate profitability by 0.11% per year.

We've demonstrated that interest management, FX management and netting represent value drivers. Next time, in the final post of this series, we will take a look at cash pooling as a treasury instrument and value driver. Does cash pooling also have a direct positive impact on corporate profitability? Stay tuned! 

Want to learn more about our powerful treasury solutions? Time to discover Coupa Treasury.