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TREASURY MANAGEMENT IN CORPORATES
05/01/2023
TREASURY MANAGEMENT
Treasury Management (or treasury operations) includes management of an
enterprise's holdings, with the ultimate goal of maximizing the firm's liquidity and
mitigating its operational, financial and reputational risk
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05/01/2023 3
IN CORPORATES
To maintain the liquidity of business
Develops and executes all capital market activity
Manages the financial risks of the company
Implementing company’s optimal capital structure
To provide quick finance to Company
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TREASURY MANAGEMENT
Working Capital
Management
Cash Management
Financial Risk
Management
Capital Markets and
Funding
Corporate Financial
Management
Treasury Management
CASH MANAGEMENT
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SIGNIFICANCE OF CASH MANAGEMENT
• Cash – “Life blood of a business”
Motives of holding cash
Transactions Motive
Precautionary Motive
Speculative Motive
05/01/2023 7
CASH PLANNING
Cash Planning is a technique to plan and control the use of cash
Cash Forecasting and Budgeting Cash budget is the most significant device to plan for and control cash
receipts and payments Cash forecasts are needed to prepare cash budgets
805/01/2023
TYPES OF CASH FORECASTING
SHORT TERM LONG TERM
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METHODS OF CASH BUDGETING• Receipts and Payments MethodShows timing and magnitude of expected cash receipts and payments over forecast period
Advantages: It gives a complete picture of all the items of expected cash flows.
Limitations: Its reliability is reduced because of the uncertainty of cash forecasts It fails to highlight the significant movements in the working capital
items
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Month Month Month Balance b/d ( 1 )
Receipts Cash SalesCredit SalesBank Loans Other Receipts Total Receipts ( 2 )
Payments Cash and Credit PurchasesGeneral and Admin ExpensesTax payments Interest payments DividendsInvestment in short term securities Total Payments ( 3 ) Net Cash Flow ( 2 - 3 )
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ADJUSTED NET INCOME METHOD
• Adjusted Net Income Method
This method involves tracing of working capital flows
It is also called as the Sources & Uses approach
It generally has 3 sections: Sources, Uses & Adjusted cash balance
Objectives:
To project company’s need for cash at a future date
To show whether company can generate funds internally
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Year Year Year Cash beginning of year
Sources of Cash Net Income Non cash charges Increase in Borrowing Sale of equity shares Miscellaneous Total ( 1 )
Uses of Cash Capital Expenditures Increase in Current Asset
Repayment of borrowings Dividends Payments Total ( 2 )
Surplus/ Deficit ( 1 – 2 )
05/01/2023 13
Advantages:
It highlights the movements in the working capital items, and thus helps to keep a control on a firm’s working capital
Limitations:
It fails to trace cash flows, and therefore, its utility in controlling daily cash operations is limited
CASH COLLECTIONS AND DISBURSEMENTS
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FLOAT
Float : Difference between the available balance and book balance of company
Float Time is the time between a customer initiating a payment and the company being informed that it has obtained value at the bank
Types of Float: Payment or Disbursement Float Availability or Collection Float Net Float
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• Cheques issued by a firm creates Disbursement Float
Eg : Bharat Company
• On 1st April it pays 1 million by cheque to one of its suppliers
• Disbursement Float = Firm’s available balance – Firm’s book balance = Rs 1 million
On 31st March
Book Balance Rs. 4 million
Bank Balance Rs. 4 million
On 1st April
Book Balance Rs. 3 million
Bank Balance Rs. 4 million
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• Cheques received by a firm creates Collection Float
Eg : Bharat Company
• On 1st May it receives a cheque for 1.5 million from customer
• Collection Float = Firm’s available balance – Firm’s book balance = Rs -1.5 million
On 30th April
Book Balance Rs. 5 million
Bank Balance Rs. 5 million
On 1st May
Book Balance Rs. 6.5 million
Bank Balance Rs. 5 million
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• Net Float = Disbursement Float + Collection Float
Disbursement float > Collection float.
Positive Float, Available balance > Book Balance
Disbursement float < Collection float
Negative Float, Available balance < Book Balance
If the company has a positive net float, it may issue more cheque amounts, even though the balance as per its book is lower.
So, a company that has a positive net float at a point of time can effectively use and manage the float in such a way that it can maintain a smaller cash balance.
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SPEED UP COLLECTIONS
• Collection Time
Customer mails the cheque
Company receives the cheque
Company deposits the cheque
Cash available
Mailing Time
Processing Availability delay
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SPEED UP COLLECTIONS
Concentration banking
Company asks its customer in a particular area to send payments to a local branch office rather than to the corporate HQ
Clients pay in Local branch office instead
Company’s HQ
Deposit cheque into Local bank
A/c
Surplus Funds are transferred to
Concentration A/c
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SPEED UP COLLECTIONS
Lock boxes
Customers are advised to mail their payments to special post office boxes called lockboxes, which are attended to by local collecting banks, instead of sending them to corporate headquarters
• Cuts down the mailing time
• Reduce the processing time
• Shortens availability of delay
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Corporate Customer
Corporate Customer
Corporate Customer
Corporate Customer
Local banks collect funds
Separation of cheques and
receipts
Cheque deposited in
banks
Bank clears cheques
Post office box 1 Post office box 2
Details of receivable go to
firm
Firm processes receivables
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Avg. number of daily payments to Lock Box 150
Avg. size of payments Rs. 1200
Rate of Interest per day 0.02 %
Saving in Mailing time 1.2 days
Saving in Processing time 0.8 day
Thus, the Lock Box would increase the collected balance by:150 (payments per day) * Rs. 1200 (Avg. Payment) * (1.2 + 0.8) days saved = Rs.360,000
Invested at 0.02% per day, gives a daily return of: 0.0002 * Rs. 360,000 = Rs. 72
If bank charges 0.26 per check , i.e. 0.26 * 150 = Rs. 39 per dayNet gain is Rs.72 – Rs. 39 = Rs. 33
Favorable to have Lock Box
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SPEED UP COLLECTIONS
Electronic Fund Transfer
• Online based transaction from one bank account to another
• Reduces the time taken to carry out a transaction
• RTGS and NEFT
• Wire transfer for International transactions (SWIFT)
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OPTIMUM CASH BALANCE
Enough in order to make payments when needed Additional cash for unexpected requirements
Two Models for Optimum Cash Balance
Under certainty –
Baumol’s model
Under uncertainty -
Miller-Orr model
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BAUMOL’S MODEL
William J. Baumol developed a model (The transactions Demand for Cash : An Inventory Theoretic Approach) which is usually used in Inventory management & cash management.
It Trade off between opportunity cost or carrying cost or holding cost & Transaction cost
As such firm attempts to minimize the sum of the holding cash & the cost of converting marketable securities to cash
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The firm is able to forecast its cash needs with certainty
The firm’s cash payments occur uniformly over a period of time
The opportunity cost of holding cash is known and it does not change over time
The firm will incur the same transaction cost whenever it converts securities to cash
Baumol’s Model–Assumptions
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F = The fixed cost of selling securities to raise cash
T = The total amount of new cash needed
K = The opportunity cost of holding cash: this is the interest rate.
If we start with $C, spend at a constant rate each period and replace our cash with $C when we run out of cash, our average cash balance will be
2C
The opportunity cost of holding is
2C KC
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F = The fixed cost of selling securities to raise cash
T = The total amount of new cash needed
K = The opportunity cost of holding cash: this is the interest rate.
As we transfer $C each period we incur a trading cost of F each period. If we need T in total over the planning period we will pay $F, T ÷ C times.
The trading cost is FCT
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C* Size of cash balance
FTKC
C2cost Total
Opportunity Costs
KC
2
FT
CTrading
costs
The optimal cash balance is found where the opportunity costs equal the trading costs
FKTC
2*
05/01/2023 31
Limitations :
The model assumes the firm has a constant disbursement rate
The model assumes there are no cash receipts during the projected period
Treasurers may want a ‘safety stock’ for cash
THE MILLER-ORR MODEL
The firm allows its cash balance to wander randomly between upper and lower control limits.
The models answers the following questions: When should transfers be effected between marketable securities and cash? What should be the magnitude of these transfers?
Assumptions: There is no underlying trend in cash balance over time The optimal values of LL and RP depend not only on the fixed and opportunity
costs but also on the degree of likely fluctuations in cash balances
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LL – Set By Management
RP + LL
UL = 3RP – 2LL
CASH MANAGEMENT TOOLS
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NETTING
A process where instead of settling each separate transaction, the company creates a netting center
This acts like a clearing house that adds & subtracts the various amount of inter subsidiary payables & receivables
At the end of month, each subsidiary pays or collects one net payment from the netting center.
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BILATERAL NETTING: AN EXAMPLEConsider a U.S. MNC with three divisions and the
following foreign exchange transactions:
$10 $35 $40$30
$20
$25 $60
$40$10
$30
$20$30
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BILATERAL NETTING: AN EXAMPLEBilateral Netting would reduce the number of foreign exchange
transactions as follows; Examine U.S and Canadian affiliate
$10 $35 $40$30
$20
$25 $60
$40$10
$30
$20$30
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BILATERAL NETTING: AN EXAMPLEBilateral Netting: U.S. and Canada net out at $10
$10 $35 $40$30$25
$60
$40$10
$10
$20$30
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BILATERAL NETTING: AN EXAMPLEBilateral Netting: Canadian and U.K. affiliates.
$10 $35 $40$30$25
$60
$40$10
$10
$20$30
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BILATERAL NETTING: AN EXAMPLEBilateral Netting: Canadian and U.K. affiliates net out
at $10
$10 $35 $10$25
$60
$40$10
$10
$20$30
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BILATERAL NETTING: AN EXAMPLEBilateral Netting: U.K. and German affiliates.
$10 $35 $10$25
$60
$40$10
$10
$20$30
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BILATERAL NETTING: AN EXAMPLEBilateral Netting: U.K. and German affiliates net out
at $10
$10 $35 $10$25
$60
$40$10
$10
$10
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BILATERAL NETTING: AN EXAMPLEBilateral Netting: U.S. and German affiliate.
$10 $35 $10$25
$60
$40$10
$10
$10
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BILATERAL NETTING: AN EXAMPLEBilateral Netting: U.S. and German affiliate net out at
$25.
$25 $10$25
$60
$40$10
$10
$10
05/01/2023 45
BILATERAL NETTING: AN EXAMPLEBilateral Netting: U.S. and U.K. affiliate.
$25 $10$25
$60
$40$10
$10
$10
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BILATERAL NETTING: AN EXAMPLEBilateral Netting: U.S. and U.K. affiliate net out at $20.
$25 $10$25
$20 $10
$10
$10
05/01/2023 47
BILATERAL NETTING: AN EXAMPLEBilateral Netting: German and Canadian affiliates.
$25 $10$25
$20 $10
$10
$10
05/01/2023 48
BILATERAL NETTING: AN EXAMPLEBilateral Netting: German and Canadian affiliates net
out at $15
$25 $10$15 $20
$10
$10
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BILATERAL NETTING
Before bilateral netting: Total funds (gross) to be moved: $350
With bilateral netting: Total funds (net) to be moved: $90
This is a reduction of $260 in foreign exchange transactions.
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MULTILATERAL NETTING: AN EXAMPLEConsider simplifying the bilateral netting with
multilateral netting: Start with the bilateral amounts.
$25 $10$15 $20
$10
$10
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MULTILATERAL NETTING: AN EXAMPLEU.K. affiliate owes the German affiliate $10; the
German affiliate owes U.S. $10.
$15 $10$15 $20
$10
$10
$10
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MULTILATERAL NETTING: AN EXAMPLEThus, the U.K. affiliate nets its payment to the U.S. of
$10.
$15 $10$15 $20
$10
$10
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MULTILATERAL NETTING: AN EXAMPLEU.K. net payment of $10 to U.S. is combined with the
$20 it owes.
$15 $10$15 $20
$10
$10
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MULTILATERAL NETTING: AN EXAMPLEU.K. affiliates owes $30 to U.S.
$15 $10$15 $30
$10
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MULTILATERAL NETTING: AN EXAMPLEConsider Canadian and German affiliates.
$15 $10$15 $30
$10
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MULTILATERAL NETTING: AN EXAMPLECanadian affiliate owes German affiliate $15 and the
German affiliate owes the U.S. $15.
$15 $10$15 $30
$10
05/01/2023 57
MULTILATERAL NETTING: AN EXAMPLECanadian affiliate nets its payment to the U.S. of $15;
total Canadian affiliate payment to U.S. $25.
$10
$15
$30
$10
05/01/2023 58
MULTILATERAL NETTING: AN EXAMPLEConsider Canadian and U.K. affiliate
$10
$15
$30
$10
05/01/2023 59
MULTILATERAL NETTING: AN EXAMPLEU.K. affiliate owes Canadian affiliate $10; Canadian
affiliate owes U.S. $10.
$10
$15
$30
$10
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MULTILATERAL NETTING: AN EXAMPLEU.K. affiliate nets its payment to the U.S. of $10.
$10
$15
$30
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MULTILATERAL NETTING: AN EXAMPLECombine this $10 with the $30 the U.K. affiliate owes
the U.S.
$10
$15
$30
05/01/2023 62
MULTILATERAL NETTING: AN EXAMPLEU.K. affiliate owes the U.S. $40.
$15
$40
05/01/2023 63
MULTILATERAL NETTING: AN EXAMPLETotal funds to be moved under multilateral netting is
$55.
$15
$40
05/01/2023 64
SUMMARY OF NETTINGCompare this (before netting).
$10 $35 $40$30
$20
$25 $60
$40$10
$30
$20$30
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BILATERAL NETTINGTo this.
Bilateral Netting: Total funds moved = $90
$25 $10$15 $20
$10
$10
05/01/2023 66
Decrease in the expenses associated with moving funds internationally Decrease in the number of foreign exchange transactions (also reduces costs) Reduction in intra-company float (wire transfers can take up to 5 days)
Financial rewards Favorable foreign exchange rates due to consolidation of several smaller payments to one
large payment
Reduces administration cost
Control advantages Forces tighter control over information on transaction between subsidiaries
Reduces time spent on administration & simplifies the reconciliation process
Benefits of Netting
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Cash in excess of operating requirement may be held for two reasons To meet fluctuations in working capital
As a buffer to meet unpredictable financial needs
Selecting Investment Opportunity Safety
Maturity
Marketability
Investing Surplus cash
05/01/2023 68
INVESTING OF SURPLUS CASHInstruments Safety Maturity
Treasury Bills Safe 91 days & 364 days
Commercial Papers RiskyMin 7 days & Max 1
year from date of issue
Certificates of Deposits
Safe 7 days to 1 year
Bank Deposits Safe Min 14 days
Inter-corporate deposits
Risky Min 1 day, Max 1 year
Money market mutual funds
Risky 15 days
CORPORATE FINANCIAL MANAGEMENT
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CAPITAL DECISIONS
Financing
How much?
From where/whom?
What cost?
When to mobilize?
WORKING CAPITAL MANAGEMENT
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WORKING CAPITAL MANAGEMENT• Working capital management is the management of the short-term investment and financing of
a company.
• Working capital management is to do with management of all aspects of both current assets and current liabilities, so as to minimize the risk of insolvency while maximizing return on assets
GOALS:
• Adequate cash flow for operations
• Most productive use of resources
• Satisfy maturing short term debt
05/01/2023 73
DETERMINANTS OF WORKING CAPITAL• Nature of the business
• Sales and demand conditions
• Manufacturing policy
• Credit policy
• Availability of credit
• Operating efficiency
• Price level changes
• Growth and expansion plan
05/01/2023 74
CLASSIFICATION OF WORKING CAPITAL
• There are two possible interpretations of working capital concept
KINDS OF WORKING CAPITAL
ON THE BASIS OF TIMEOPERATING CYCLE CONCEPT
ON THE BASIS OF CONCEPTBALANCE SHEET CONCEPT
05/01/2023 75
BALANCE SHEET CONCEPT
• There are two interpretations of working capital under the balance sheet concept
BALANCE SHEET CONCEPT
GROSS WORKING CAPITAL
NET WORKING CAPITAL
GROSS WORKING CAPITAL = TOTAL CURRENT ASSETS
NET WORKING CAPITAL = CURRENT ASSETS – CURRENT LIABILITIES
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WORKING CAPITAL CYCLE
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ON THE BASIS OF TIME
OPERATING CYCLE CONCEPT
REGULAR WORKING CAPITAL
PERMANENT OR FIXED WORKING
CAPITAL
TEMPORARY OR VARIABLE WORKING
CAPITAL
SPECIAL WORKING CAPITAL
SEASONAL WORKING CAPITAL
RESERVE WORKING CAPITAL
05/01/2023 78
PERMANENT WORKING CAPITAL
It is the minimum level of current assets that the firm maintains
Permanent Working Capital can be further divided into:
Regular working capital:
It is the minimum amount of liquid capital required to keep up the circulation of the capital from cash to inventories to receivables and back again to cash.
Reserve margin or cushion working capital:
It is extra capital required to meet unforeseen contingencies that may arise in future.
ON THE BASIS OF TIME
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TEMPORARY OR VARIABLE WORKING CAPITALIt is the extra working capital required to support the changing production and sales activities of the firm
Variable Working Capital can be further divided into:
Seasonal working capital:
It refers to liquid capital needed during the particular season.
Special working capital:
It is that part of the variable capital which is needed for financing special operations
05/01/2023 80
DIFFERENCE BETWEEN PERMANENT & TEMPORARY WORKING CAPITAL
Amount Variable Working Capitalof WorkingCapital
Permanent Working Capital
Time
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Variable Working CapitalAmount of WorkingCapital
Permanent Working Capital
Time
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DANGERS OF INSUFFICIENT WORKING CAPITAL
Full utilization of fixed assets is not possible
Difficulty in the Maintenance of Machinery
Decrease in Credit Rating
Non utilization of favourable opportunities
Decrease in Sales
Difficulty in distribution of dividends
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DANGERS OF EXCESSIVE WORKING CAPITAL
Excessive Inventory
Excessive Debtors (liberal Credit policy)
Adverse effect on profitability
05/01/2023 84
FINANCING WORKING CAPITAL
Long Term Financing
Short Term Financing
05/01/2023 85
APPROACHES TO DETERMINE AN APPROPRIATE FINANCING-MIX
The Matching approach
Conservative approach
Aggressive approach
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FINANCING NEEDS OVER TIME
Fixed Assets
Permanent Current Assets
Total Assets
Fluctuating Current Assets
Time
$
05/01/2023 88
MATCHING APPROACH TO ASSET FINANCING
Fixed Assets
Permanent Current Assets
Total Assets
Fluctuating Current Assets
Time
$
Short-termDebt
Long-termDebt +EquityCapital
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CONSERVATIVE APPROACH TO ASSET FINANCING
Fixed Assets
Permanent Current Assets
Total Assets
Fluctuating Current Assets
Time
$
Short-termDebt
Long-termDebt +Equity capital
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AGGRESSIVE APPROACH TO ASSET FINANCING
Fixed Assets
Permanent Current Assets
Total Assets
Fluctuating Current Assets
Time
$
Short-termDebt
Long-termDebt +Equity capital
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RELATIVE PROPORTION OF LONG TERM AND SHORT TERM DEBT
05/01/2023 92
COMPARING THE THREE STRATEGIES OF WORKING CAPITAL FINANCING
FACTORS CONSERVATIVE AGRESSIVE MATCHING
LIQUIDITY HIGH LOW BALANCED
PROFITABILITY LOW HIGH BALANCED
RISK LOW HIGH BALANCED
ASSET UTILIZATION LOW HIGH MODERATE
WORKING CAPITAL HIGH LOW MODERATE
RISK MANAGEMENT
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WHAT IS RISK?
Risk is the potential that a chosen action or activity (including the choice of inaction) will lead to a loss (an undesirable outcome)
Damodaran says, risk includes not only "downside risk” but also "upside risk" (returns that exceed expectations)
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CORPORATE RISKS
• Business Risks-
Sales
Marketing
Manufacturing
Competition
Reputation
• Market Risks
Foreign Exchange
Interest Rates
Commodity
Equity
Inflation
Liquidity Risks
Funding Risks
Long Term v/s Short Term
Capital
Credit Risks
Commercial
Counterparty
Settlement
Operational Risks
Systems
Controls
Regulatory
Frauds
Weather
Natural disasters
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Definition
It is the identification, assessment, and prioritization of risk followed by coordinated and economical application of resources to minimize, monitor, and control the probability and/or impact of unfortunate events or to maximize the realization of opportunities.
Risk Management
05/01/2023 97
How To Manage Risk?
05/01/2023 98
Risk Management TechniquesAvoidance
Loss Prevention
Loss Reduction
Seperation
Diversification
Risk Control
Transfer
Insurance
Hedging
Retention
Risk Financin
g
05/01/2023 99
HEDGING
Hedging is the act of reducing your risk of losing money in the future.
05/01/2023 100
BENEFITS OF HEDGING
Hedging as a strategic resource
Capital raising capability
Lowering distress costs
Lowering tax liabilities
Hedging as a tool for corporate governance
05/01/2023 101
HEDGING STRATEGIES/ INSTRUMENTS
Forwards
Futures
Options
Swaps
FOREX HEDGING
102
05/01/2023 103
FOREIGN EXCHANGE EXPOSURE RISK
Transaction
Translation
Economic
05/01/2023 104
TRANSACTION EXPOSURE
∆ in FE rate ∆ in outstanding obligations
Hits the P&L a/c, profitability takes a hit
Initiate the deal
Negotiation Modifying or accepting the deal
Final delivery date
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The Net Positive Transaction Exposure indicates strengthening of the domestic currency against the foreign currency and depreciation of the foreign currency makes it profitable.
The Net Negative Transaction Exposure indicates strengthening of domestic currency against the foreign currency and appreciating of the foreign currency makes it profitable.
05/01/2023 107
STRATEGIES FOR TRANSACTION EXPOSURE
Hedging
Currency invoicing
Exposure netting
Leading & lagging
05/01/2023 108
EXAMPLE ON HEDGING
05/01/2023 109
ON HEDGING
05/01/2023 110
LEADING & LAGGING
Indian Manufacture has today $1million for import material and to receive $1million from export order
1USD = 60 INR
Expecting rupee to appreciate (eg 59)
Expecting rupee to depreciate(eg 61)
Payments – delay the payment (lagging) Payments- prompt payments (leading)
Receipts-immediate receipt (leading) Reciepts- delay the receipt (lagging)
05/01/2023 111
EXPOSURE NETTING
XYZ CO.(CANADA)
US SUPPLIER
A CO.(Europe)
B CO.
Pay $10million
Receive Euro 5million
Receive 1millionCHF
The company’s net currency exposure is USD 2.15 million (i.e. USD 10 million – [(5 x 1.35) + (1 x 1.10)]
05/01/2023 112
TRANSLATION EXPOSURE
Four Methods to translate foreign currency to home currency:
Current/Non-Current Method: All current assets and current liabilities are translated at current exchange rate
Monetary/ Non-Monetary Method: All monetary assets and liabilities are translated at current exchange rate
Temporal Method: Same as Monetary/Non-Monetary method BUT inventory may be translated at current exchange rate IF it is shown at market value
Current Rate Method: All balance sheet and income statement items are translated at current exchange rate
05/01/2023 113
TATA UK (Parent company) has a subsidiary in US
Tata invests $5,00,000 in its subsidiary in US (USD/EUR=1)
On the year end closing date the $ (USD/EUR=2)
Instead of 5,00,000 euros only 2,50,000 euros are translated (5,00,000/2)
EXAMPLE
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ECONOMIC EXPOSURE
Unexpected currency fluctuations on a company’s future cash flows and market value
Long term in nature
Substantial Impact
Difficult to quantify
INTEREST RATE HEDGING
115
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Cash Flow of A = - Fixed – Float + Fixed
Cash Flow of B = - Float – Fixed + Float
Bank
B A
Bank
Fixed
Float
Float
Fixed
COMMODITY HEDGING
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CASE STUDY
• Oil refinery XYZ ltd needs 1,00,000 barrels of crude oil in 3 months.
• Current market price is $44.20/barrel
• Crude oil futures $44.00/barrel
100 contracts of 1000 each: 100 x 1000
=1,00,000 barrels
Total cost =$44,00,000
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SCENARIO #1: CRUDE OIL SPOT PRICE ROSE BY 10% TO USD 48.62/BARREL ON DELIVERY DATE
05/01/2023 120
SCENARIO #2: CRUDE OIL SPOT PRICE FELL BY 10% TO USD 39.78/BARREL ON DELIVERY DATE
THANK YOU
121