The functions of the treasury
Treasury management is the corporate handling of all financial matters, the generation of external and internal funds for business, the management of currencies and cash flows, and the complex strategies, policies and procedures of corporate finance.
Roles of the Treasury management
Managing financial risks
Effective taxation administration
The Association of Corporate Treasurers
|cash management||the treasury section will monitor the company's
cash balance and decide if it is advantageous
to give/take settlement discounts to/from
customers/suppliers even if that means the bank
account will be overdrawn.
|financing||the treasury section will monitor the company's
investment/borrowings to ensure they gain as
much interest income as possible and incur as
little interest expense as possible.
|foreign currency||the treasury section will monitor foreign exchange
rates and try to manage the company's affairs so
that it reduces losses due to changes in foreign
|tax||the treasury section will try to manage the
company's affairs to legally avoid as much tax as
The role of the finance function in determining business tax liabilities
One of the roles of the finance function is to calculate the business tax liability and to mitigate that liability as far as possible within the law.
is the legal use of the rules of the tax regime to one’s own advantage, in order to reduce the amount of tax payable by means that are within the law.
is the use of illegal means to reduce one’s tax liability, for example by deliberately misrepresenting the true state of your affairs to the tax authorities.
The directors of a company have a duty to their shareholders to maximise the post tax profits that are available for distribution as dividends to the shareholders, thus they have a duty to arrange the company’s affairs to avoid taxes as far as possible.
However, dishonest reporting to the tax authorities (e.g. declaring less income than actually earned) would be tax evasion and a criminal offense.
While the traditional distinction between tax avoidance and tax evasion is fairly clear, recent authorities have introduced the idea of tax mitigation to mean conduct that reduces tax liabilities without frustrating the intentions of Parliament, while tax avoidance is used to describe schemes which, while they are legal, are designed to defeat (nullify) the intentions of Parliament.
Thus, once a tax avoidance scheme becomes public knowledge, Parliament will nearly always step in to change the law in order to stop the scheme from working.
Responsibilities of the finance function
The finance function of any company is responsible by law for:
maintaining proper accounting records that contain an accurate account of the income and expenses incurred, and the assets and liabilities pertaining to the company.
calculating the tax liability arising from the profits earned each year, and paying amounts due to the tax authorities on a timely basis.
In practice, most companies (particularly small companies) will seek the advice of external tax specialists to help them calculate their annual tax liability.
Investment appraisal and financing viable investments
Investment appraisal is concerned with long term investment decisions, such as whether to build a new factory, buy a new machine for the factory, buy a rival company, etc.
Typically money is paid out now, with an expectation of receiving cash inflows over a number of years in the future.
There are two questions to be addressed:
Is the possible investment opportunity worthwhile?
If so, then how is it to be financed?
For example, if a company is offered an investment opportunity that requires paying out €1m now, and will lead to cash inflows of €2m in one year’s time and €2m in two years’ time, during a period when interest rates are 5%, you can see that this investment is worthwhile in real terms.
If the €1m was invested to earn interest, it would be worth €1.05m in one year’s time.
However the investment will give you €2m in one year’s time and another €2m in two years’ time.
So the investment is worthwhile.
The second question is how this €1m required now should be financed.
Perhaps there is a surplus €1m sitting unused in a bank account.
It is more likely that fresh funds will be required, possibly by issuing new shares, or possibly by raising a loan (e.g. from the bank).
There are advantages and disadvantages of each possibility.
Advantages of issuing new ordinary shares:
Dividends can be suspended if profits are low, whereas interest payments have to be paid each year.
The bank will typically require security on the company’s assets before it will advance a loan.
Perhaps there are no suitable assets available.
Advantages of raising loan finance:
Interest payments are allowable against tax, whereas dividend payments are not an allowable deduction against tax
No change is required in the ownership of the company, which is governed by who owns the shares of the company.
Generally the finance function and the treasury function will work together in appraising possible investment opportunities and deciding on how they should be financed.
Management of working capital
A company must also decide on the appropriate level of investment in short term net assets, i.e. the levels of:
trade receivables (amounts due from debtors for sales on credit)
trade payables (amounts due to creditors for purchases on credit).
There are advantages in holding large balances of each component of working capital, and advantages in holding small balances, as below.
|advantage of large balance||advantage of small balance|
|inventory||customers are happy since they
can be immediately provided
|low holding costs. less risk of
|trade receivables||customers are happy since they
|less risk of bad debts, good
for cash flow.
|cash||creditors are happy since bills
can be paid promptly
|more can be invested elsewhere
to earn profits.
|trade payables||preserves your own cash||suppliers are happy and may