1. © 2012 Northern Trust Corporation northerntrust.com © 2011 Northern Trust Corporation ServiceExpertiseIntegrityServiceExpertiseIntegrity P R I N C I P L E S T H A T E N D U R E Windy City Summit CTP Review Chapter 8 Presented by: Dan Carey

2. IntegrityExpertiseService 2 Windy City Summit CTP Review Chapter 8 Cash Management and Forecasting

3. IntegrityExpertiseService 3 Windy City Summit CTP Review Introduction Treasury’s fundamental responsibility is to determine and manage the daily cash position. The primary objective of establishing the cash position is to plan the day’s borrowing or investment decisions based on whether the closing position is projected to be a shortfall or surplus.

4. IntegrityExpertiseService 4 Windy City Summit CTP Review Liquidity Management Effective liquidity management provides for a company to meet its daily obligations without incurring the opportunity costs that come from holding excess cash or from not having enough cash on hand to meet obligations.

5. IntegrityExpertiseService 5 Windy City Summit CTP Review Cash Inflows and Outflows Concentrated Cash Position Short-Term Borrowing Disbursements (Cash Outflows) Short-Term Investments Collections (Cash Inflows)

6. IntegrityExpertiseService 6 Windy City Summit CTP Review Liquidity Management Reasons to maintain liquidity Transaction Requirements – Inflows and outflows are uneven, creating unexpected demands for cash Precautionary Requirements – To address unexpected obligations Speculative Requirements – To address unexpected investment opportunities Regulatory Requirements – In some industries liquid or a “safe” funds level must be maintained.

7. IntegrityExpertiseService 7 Windy City Summit CTP Review Liquidity Management Proper level of liquidity It is important that adequate liquidity be maintained. Opportunity costs are associated with paying more interest on a loan than necessary or losing interest earnings.

8. IntegrityExpertiseService 8 Windy City Summit CTP Review Liquidity Management Stress Test of liquidity policy or contingency funding plan Test assumes an adverse shock to a company’s funding sources such as competitor’s action, litigation issue, product recall, plant disaster or some other trauma. The proposed sudden change in funds availability could involve the loss of a funding source, decrease in credit rating or violate loan covenants. All of these resulting events can increase the cost to borrowing significantly.

9. IntegrityExpertiseService 9 Windy City Summit CTP Review Using Short-Term Investments for Liquidity Management Market for debt and equity instruments Two major components Money Markets – short-term debt securities Capital Markets – longer-term debt and equity securities

10. IntegrityExpertiseService 10 Windy City Summit CTP Review Short-Term Investment Markets and Instruments Money Market Participants  U.S. Treasury  Federal agencies  Government-sponsored enterprises (GSE’s)  Securities dealers  Banks  Thrifts  Individuals via money markets and money market mutual funds

11. IntegrityExpertiseService 11 Windy City Summit CTP Review Short-Term Investment Markets and Instruments Money Market Instruments  U.S. Treasury Bills (T-Bills)  Federal agency and government sponsored enterprise (GSE) securities  Bank issues  Corporate commercial paper  Municipal notes and commercial paper  Money market mutual funds  Short-term mutual funds  Repurchase Agreements  Hedge Funds

12. IntegrityExpertiseService 12 Windy City Summit CTP Review Investment Strategies Matching - purchasing securities that mature when another obligation is due  Requires careful forecasting of future cash flows Ride the Yield Curve - buying highly liquid marketable securities that mature on day other than intended sell date  Yield curve is upward sloping or normal – purchase securities that mature beyond time when funds are needed  Yield curve is inverted or downward sloping – purchase securities that mature before funds are needed Tax-Based Strategies  Yield advantage is directly related to investor’s marginal tax rate

13. IntegrityExpertiseService 13 Windy City Summit CTP Review Role of Short-Term Investments Liquidity - helps adjust for working capital imbalances Temporary surplus funds generated by:  Ongoing Operations  Seasonal Performance  Asset Sales  Securities Issuance Surplus funds held temporarily to address specific dollar distributions at specific times in the future

14. IntegrityExpertiseService 14 Windy City Summit CTP Review Investment Risk Considerations Factors that Influence Short-Term Investments Credit or Default Risk – risk that payments on a security will not be made under the original terms Liquidity Risk – risk that a security cannot be sold quickly without a significant financial loss Market or Price Risk – uncertainty over the price at which a security can be sold prior to maturity Longer maturities = More price risk

15. IntegrityExpertiseService 15 Windy City Summit CTP Review The Yield Curve Normal Yield Curve Inverted Yield Curve Percentage Yield Time to Maturity Depicts differences in yield of securities that are identical except for maturity. Normal Yield Curve - The longer the maturity, greater price risk and higher the yield. Most common Inverted Yield Curve - The longer the maturity, the lower the yield stemming from expectations that future rates may decline. Demand for locking in long-term in a declining rate environment drives the yield for those securities down.

16. IntegrityExpertiseService 16 Windy City Summit CTP Review Using Short-Term Financing for Liquidity Management Three Primary Sources of Short-Term Funds  Spontaneous financing such as trade credit  Sale or factoring of accounts receivables  Borrowing arrangement with banks Short-Term Financing Objective  Ensure adequate availability of credit while:  Minimizing cost  Minimizing risk  Maximizing flexibility

17. IntegrityExpertiseService 17 Windy City Summit CTP Review Short-Term Financing Strategic Objectives guide planning for:  Level of debt  Mix of debt among short-, intermediate- and long-term sources  Appropriate mix of debt and equity Factors Influencing Financing Costs  Risk  Liquidity  Length of maturity  Fees  Credit enhancement and backup credit costs

18. IntegrityExpertiseService 18 Windy City Summit CTP Review Short-Term Funding Alternatives  Trade credit  Internal borrowing  Asset sales  Line of credit  Commercial bank credit  Single payment notes  Reverse repurchase agreement  Revolving credit agreement  Commercial paper (CP) issue  Asset-based borrowing  Banker’s Acceptance (BA)

19. IntegrityExpertiseService 19 Windy City Summit CTP Review Short-Term Funding Alternatives - Notes Reverse Repurchase Agreement (Reverse repo)  Securities sold to bank providing seller with cash  Seller repurchases securities at later date  Seller accesses liquidity of portfolio without disposing of investments Line of Credit – Cost Components  All-in interest rate  Commitment fees  Compensating balances

20. IntegrityExpertiseService 20 Windy City Summit CTP Review Short-Term Funding Alternatives (Cont.) Commercial Paper (CP)  Short-term, unsecured promissory note issued in the money markets with maturity of 270 days or less  CP is issued at a discount  Sold through dealers or directly  May be backed by standby letter of credit (LC)

21. IntegrityExpertiseService 21 Windy City Summit CTP Review Cash Concentration and Pooling Systems Global Concentration of Funds International companies need to concentrate cash to use all available cash more efficiently. The typical method of concentrating cash is known as pooling. Pooling has three forms: 1. Notional pooling 2.Physical pooling 3.Bank Overlay Structure

22. IntegrityExpertiseService 22 Windy City Summit CTP Review Notional Pooling This type of pooling requires a company’s subsidiaries to use branches of the same bank. All excess and deficit balances in the company’s subsidiary accounts are summed each day to calculate the net interest earned or due. Funds are not actually transferred. They are totaled for the purpose of calculating interest. Banks usually require credit facilities to support any deficit balances in the pool.

23. IntegrityExpertiseService 23 Windy City Summit CTP Review Physical Pooling This type of pooling requires the use of a single currency. Balances are transferred out of the sub- accounts and into a main account on a daily basis. Physical pooling can be used in cross-border structures but since there is one main account for each currency this method is expensive and more complex.

24. IntegrityExpertiseService 24 Windy City Summit CTP Review Bank Overlay Structure Bank overlay structure is an approach that combines both sweeping and pooling. It is typically used when a company’s primary bank has branches in several countries but the branches do not provide a full range of domestic banking services. (See Exhibit 8.2 in the text)

25. IntegrityExpertiseService 25 Windy City Summit CTP Review Cash Concentration and Pooling Systems Cash Concentration Systems (U.S.) Two major objectives of a cash concentration system are:  To efficiently move funds from local or regional deposit banks to the primary concentration bank.  Minimize excess balances.

26. IntegrityExpertiseService 26 Windy City Summit CTP Review Over The Counter/Field Deposit Systems Receipts collected at local offices or retail locations. Cash Checks Credit/Debit Cards Remote Deposit Capture Virtual Vault

27. IntegrityExpertiseService 27 Windy City Summit CTP Review Cash Concentration System Configuration Configuring a company’s cash concentration system involves three main considerations: 1. The size and geographic distribution of its collection system. 2. The transfer alternatives for concentrating funds. 3. The branch footprint of its banking network. Study Example of Break-even Wire Transfer Amount Calculation

28. IntegrityExpertiseService 28 Windy City Summit CTP Review Break-even Wire Transfer Amount Calculation u Wire vs. ACH Breakeven Computation  Total ACH costs are $ 1.00  Total wire costs are $ 10.00  Opportunity cost is 3.5%  Wire accelerates funds one day faster than ACH Minimum transfer = Wire Cost – EDT Cost Days Accelerated X Opportunity Cost/365 = $ 10.00 - $ 1.00 1 Day X.035/365 = $ 93,857

29. IntegrityExpertiseService 29 Windy City Summit CTP Review Cash Concentration and Pooling Systems Concentration System Costs  The number of banking relationships a company has will impact the transfer and administrative costs of a concentration system. Components include:  Excess Balances  Bank Charges  Administrative Costs and Responsibilities

30. IntegrityExpertiseService 30 Windy City Summit CTP Review Cash Forecasting  Steps  Estimate future operating cash inflows and outflows  Generate a pro forma cash position  Identify how to cover any cash deficits or use any cash surpluses  Process  Forecasting horizon – short, medium, long  Cash flow components  Degree of certainty  Selection and validation of method

31. IntegrityExpertiseService 31 Windy City Summit CTP Review  Forecasting Methods  Receipts and disbursements forecast  Core of short term cash forecasting  Create separate schedule of cash receipts and disbursements  Complete forecast and compare to minimum cash balance  Distribution Forecast  Estimate impact of single event/transaction type  May use simple average or regression analysis Cash Forecasting

32. IntegrityExpertiseService 32 Windy City Summit CTP Review  Pro Forma Financial Statements  Forecast cash flows over longer horizon  Uses historical relationship between sales and liquid balance sheet accounts to forecast specific balance sheet values  Other balance sheet accounts not related to sales use other factors to forecast accounts Cash Forecasting

33. IntegrityExpertiseService 33 Windy City Summit CTP Review Projected Closing Position  Opening available balance  Plus paper and electronic collections and concentration  Less disbursements  Uses prior day and same day information  Certain transaction types must be estimated  Closing position used to determine if cash surplus of deficit

34. IntegrityExpertiseService 34 Windy City Summit CTP Review Cash Management Risks and Controls Internal Controls Use checks and balances  Separation of duties  Periodic audits External Fraud  Positive Pay  ACH Debit blocks Bank Failure Monitor credit worthiness of your bank

35. IntegrityExpertiseService 35 Windy City Summit CTP Review Questions for Chapter 8 1. What is the significance of the lack of synchronization between cash inflows and outflows? 2. What is liquidity and why is managing it an important treasury responsibility? 3. What are the primary considerations in short-term investment management? 4. What is the primary objective of short-term investment financing? 5. Describe pooling and explain where and why it is used? 6. What factors are used to determine whether funds should be wired or transferred using the ACH system? 7. Define when an account is considered to have excess balances? 8. For what types of disbursements is a distribution forecast most useful? 9. What is a receipts and disbursements forecast and how is it used? 10. What process is used to determine a projected cash closing position?