CU-BBA-SEM-IV-Treasury Management

BACHELOR OF BUSINESS ADMINISTRATION SEMESTER IV TREASURY MANAGEMENT

CHANDIGARH UNIVERSITY Institute of Distance and Online Learning SLM Development Committee Prof. (Dr.) H.B. Raghvendra Vice- Chancellor, Chandigarh University, Gharuan, Punjab:Chairperson Prof. (Dr.) S.S. Sehgal Registrar Prof. (Dr.) B. Priestly Shan Dean of Academic Affairs Dr. Nitya Prakash Director – IDOL Dr. Gurpreet Singh Associate Director –IDOL Advisors& Members of CIQA –IDOL Prof. (Dr.) Bharat Bhushan, Director – IGNOU Prof. (Dr.) Majulika Srivastava, Director – CIQA, IGNOU Editorial Committee Prof. (Dr) Nilesh Arora Dr. Ashita Chadha University School of Business University Institute of Liberal Arts Dr. Inderpreet Kaur Prof. Manish University Institute of Teacher Training & University Institute of Tourism & Hotel Management Research Dr. Manisha Malhotra Dr. Nitin Pathak University Institute of Computing University School of Business © No part of this publication should be reproduced, stored in a retrieval system, or transmitted in any formor by any means, electronic, mechanical, photocopying, recording and/or otherwise without the prior written permission of the authors and the publisher. SLM SPECIALLY PREPARED FOR CU IDOL STUDENTS 2 CU IDOL SELF LEARNING MATERIAL (SLM)

First Published in 2021 All rights reserved. No Part of this book may be reproduced or transmitted, in any form or by any means, without permission in writing from Chandigarh University. Any person who does any unauthorized act in relation to this book may be liable to criminal prosecution and civil claims for damages. This book is meant for educational and learning purpose. The authors of the book has/have taken all reasonable care to ensure that the contents of the book do not violate any existing copyright or other intellectual property rights of any person in any manner whatsoever. In the event the Authors has/ have been unable to track any source and if any copyright has been inadvertently infringed, please notify the publisher in writing for corrective action. 3 CU IDOL SELF LEARNING MATERIAL (SLM)

CONTENT Unit - 1: Introduction To Corporate Treasury Management ................................................... 5 Unit - 2: Organization Structure Of Treasury....................................................................... 21 Unit - 3: Liquidity Planning And Managing Cash Assets..................................................... 40 Unit - 4: Business Risk Management................................................................................... 56 Unit - 5: Corporate Liquidity Risk Management.................................................................. 69 Unit - 6: Treasury Risk Management................................................................................... 89 Unit - 7: Financial Risk ..................................................................................................... 104 Unit - 8: Enterprise And Forex Risk Management ............................................................ 121 Unit - 9: Foreign Exchange Risks ...................................................................................... 138 Unit - 10: Working Capital Management........................................................................... 155 Unit - 11: Management Strategies For Working Capital .................................................... 183 Unit - 12: Perspectives Of Treasury Function .................................................................... 211 4 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT - 1: INTRODUCTION TO CORPORATE 5 TREASURY MANAGEMENT STRUCTURE 1.0 Learning Objectives 1.1 Introduction 1.2 Treasury Management-Definition 1.3 Objectives of Treasury Management 1.4 Difference between Treasury Management and Financial Management 1.5 Seven M’s of Treasury Management 1.6 Functions of Treasury Management 1.7 Need of Treasury Management 1.8 Principles of Treasury Management 1.9 Roles and Responsibilities of the Treasurer 1.10 Characteristics of the Treasurer 1.11 Scope of Treasury Management 1.12 Summary 1.13 Key words 1.14 Learning Activity 1.15 Unit End Questions 1.16 References 1.0LEARNINGOBJECTIVES After studying this unit, you will be able to:  Define Corporate Treasury Management  Identify Objectives of Treasury Management  State the need and benefits of Treasury Management  List the functions of Treasury Management  Describe the scope of Treasury Management CU IDOL SELF LEARNING MATERIAL (SLM)

1.1INTRODUCTION Treasury generally refers to the funds and revenue of the bank. Treasury is a department in all the financial institutions i.e., banks, insurance companies, investment companies etc. Treasury was just a service center before liberalization 1991. There were no major efforts to manage cash. As regulation and technology in the financial sector changes at an escalating pace and the business environment becomes increasingly competitive, there is great pressure on business organizations to deal with cash efficiently. After liberalization the scope of treasury functions have been expanded into trading activities and it became the profit center. The need for funds for business growth tied with exorbitant interest rates, foreign exchange unpredictability and the huge number of financial transactions have necessitated professional management of capital. Every company effectively manage both cash inflows and cash out flows in order to increase its’ profitability. Treasury Management includes a firm’s collections, disbursement, concentration, investment and funding activities. It is also called as Treasury Operations which aims to facilitate managing the firm’s liquidity and keeping down its operational, financial and reputational risk. The operations include the following:  Firm’s Collections  Firm’s Disbursements  Firm’s Concentration  Firm’s Investment  Firm’s Funding Activities. In larger firms, it may include the following:  Trading in bonds  Trading of Currencies  Financial Derivatives  Associated Financial Risk Management 1.2 TREASURY MANAGEMENT-DEFINITION The association of Corporate Treasures, defines Treasury Management as “the corporate function handling of all financial matters, the generation of external and internal funds for business, the management of currencies and cash flows and complex strategies, policies and procedures of corporate finance” 6 CU IDOL SELF LEARNING MATERIAL (SLM)

Treasury Management is the “Management of all financial affairs of the business such as raising funds for the business from various sources, currency management, cash flows and various strategies and procedures of corporate finance.” It is the art of managing the consolidated fund of the company both optimally and profitably.“Treasury Management is the function concerned with the provision and use offinance. It covers provisional ofcapital, short-term borrowing, foreign currency , management, banking, money and capital marketsinvestments”. 1.3 OBJECTIVES OF TREASURY MANAGEMENT The key objective of treasury management is planning, organizing and controlling cash to suit the financial objectives of the organization. a. To ensure the accessibility of money in the required quantity; b. To assure availability of money at the accurate time c. To deploy the funds in the right measure. d. To arrange the money at the right time; e. To earn profit from availability and deployment of funds f. Maintaining Liquidity g. Optimizing Cash Resources h. Establishing and Maintaining Access to Short-Term Financing i. Maintaining Access to Medium- and Long-Term Financing j. Maintaining Shareholder Relations k. Managing Risk l. Coordinating Financial Functions and Sharing Financial Information 1.4DIFFERENCE BETWEEN TREASURY MANAGEMENT AND FINANCIAL MANAGEMENT Treasury management involves the process of managing the cash, investments and other financial possessions of the business. The purpose of these activities is to optimize short term and medium-term liquidity and make sound financial decisions of invested and investable assets. Treasury management also includes hedging where needed to reduce financial risk exposure. The following differences are listed in comparison with financial management. BASIS TREASURY MANAGEMENT FINANCIAL MANAGEMENT Meaning Treasury Management is a part of Financial Management refers to the financial management, which is managerial activity that stresses on 7 CU IDOL SELF LEARNING MATERIAL (SLM)

concerned with the management of the management of firm's financial firm's cash and funds. resources, to achieve the overall aim of the enterprise. Plan Execution of financial plan Formulates, coordinates and Focus on administersfinancial plan, for Strategy controlling operations. Periodic examination of income and Preparation of financial statementsto expense budgets summarize the financial condition of the business over a certain time period. Short term Long term 1.5SEVEN M’S OF TREASURY MANAGEMENT With the ever increasing pace of change to regulation, compliance and technology in the financial sector, Treasury has increasingly become a strategic business partner across all areas of the business, adding value to the operating divisions of a company. These are theseven M’s of Treasury Management. 1. Liquidity Management 2. Investment Management 3. Working Capital Management 4. Risk Management 5. Financial Management 6. Bank Relationship Management 7. Technology Management 1. Liquidity Management Liquidity refers to the ability to trade an asset, such as a stock or bond, at its current price. Liquidity is essential in all businesses to compensate for expected and unexpected balance sheet fluctuations and to provide funds for growth. Liquidity management is the process of generating funds to meet contractual obligations of the company. 2. Investment Management The professional management of various securities shares, bonds, debentures, bills, promissory note etc., and other assets (e.g., real estate) to satisfy investment goals for the welfare ofthe investors. 8 CU IDOL SELF LEARNING MATERIAL (SLM)

3. Working Capital Management It refers to the efforts of management towards effective management of current assets and current liabilities. The deployment of capital at right tight and right quantity helps to increase the profitability of the company. 4. Risk Management Management of risks involves five processes Risk Identification, Risk Measurement, Risk pricing, Risk monitoring and control, Risk mitigation. 5. Financial Management Business finance can broadly be defined as the activity concerned with planning, raising, controlling, administering of the funds used in the business. Financial Management is concerned with the efficient use of an important economic resource namely, capital funds. 6. Bank Relationship Management The company tries to lower the risk and complexity associated with managing a company’s interaction across all their banking relationships, reducing the risk of fraud or an audit violation, or the risk of liability from non-compliance with company and industry guidelines. It facilitates banking relationships by disseminating information to drive the relationships with their banks, resulting in better visibility, lower fees, better cash utilization and accurate performance reporting. 7. Technology Management The risks i.e. liquidity risk, price risk and credit risk that treasury addresses are well managed with the help of new emerging technologies. 1.6 FUNCTIONS OF TREASURY MANAGEMENT 9 CU IDOL SELF LEARNING MATERIAL (SLM)

Figure 1.1 Functions of treasury management 1. Cash Management: the responsibility of cash department is as follows:  Predicting of cash necessities and preparation of cash budgets.  Estimation of working capital needs and setting up the levels of investment in current assets.  Organization of banking relationships, arrangement of funds for working capital require- ments, providing of security for working capital money.  Monitoring the credit collection, liquidity and funds position of different sections of the firm.  Investment of temporary additional funds in short-term marketable securities and sale of it when the need of cash arises.  Ascertainment of collection and payment floats, efficient playing of the float etc.  Transmission of funds to various divisions and receipt of funds from various collection centres.  Ensure that sufficient cash is available for meeting day to day financial commitments.  Maintaining sufficient cushion for meeting contingencies and unexpected financial obligations.  Discover excess funds in certain divisions and relocate them to the divisions which are facing insufficiency of cash. 2.Liquidity Management: An optimum level of liquidity is supposed to be maintained for the improved and smooth carrying out of the business, i.e. the financial duties of the company will be fulfilled when they become payable such as payment to suppliers, employees, creditors, etc.The cash flow analysis and working capital management operate as the most important tools for treasury management to achieve its strategic goals. 3. Availability of funds in adequate quantity and at the right time: The treasury manager has to guarantee that the funds are accessible with the organization in adequatemeasure, i.e. neither be more nor less, to discharge the day-to-day cash necessities for the evenperformance of the venture.Further, timely availability of funds also smoothens the firm’s operations, resulting in the confidence as to the amount of inflows existing with the company at a particular point in time. 4. Employment of funds in adequate quantity and at the right time: The employment of funds has to be done in exact quantity such as the purchase of fixed assets, procurement of raw materials, payment of expenses like rent, salary, bills, interest and so forth. For this motive, the treasury manager has to keep an eye on all receipts of funds and the utilisation thereof. 10 CU IDOL SELF LEARNING MATERIAL (SLM)

5. Optimum utilization of resources: Treasury Manager must ensure that the effective utilization of the firm’s resources thereby the higher operating costs and also liquidity shortage in future will be prevented. 6.Risk Management: One of the principal objectives of the treasury management is to deal with financial risk to permit the enterprise to meet its financial obligations. It tends to identify, appraise, analyse and manage risk in order to alleviatelosses that have the potential to affect the company’s success and growth. Hence, treasury manager is liable for all kinds of risk that can influence the business entity. Further, the treasury management intends to increase return on the funds available with the company, by making such investments with higher return and low risk. 1.7 NEED FOR TREASURY MANAGEMENT a.Cash Flow Management Cash is critically important for small businesses. Profitable companies can fail due to insufficient cash on hand to pay bills. The treasury management monitors the timing and amounts of cash inflows and outflows, a vital component of cash flow management. Cash inflows include accounts receivable conversions to cash, short-term and medium-term borrowing, asset sales or dispositions, and accounts payable conversions to actual bill payments. Treasury management also includes monitoring and tracking those activities that require the largest use of cash. b.Float Treasury management's role also involves lengthening the amount of time a company retains the money needed to pay its bills while shortening the time period it forgoes money due from its customers. Treasury management processes therefore include setting accounts payable and receivable policies, setting credit approval policies and defining collection terms. These activities provide a company with float, or extra short-term cash on which it can earn interest. Larger companies may establish savings and money market accounts to use as sweep accounts to earn short-term interest on incoming funds that the firm will soon use to pay its bills. c.Relationships and Risks In larger corporations, treasury management also includes managing shareholder relations, managing financial risk and ensuring adequate and appropriate sharing of financial information. The shareholder relations piece has significance, because strong relations and a belief in the company’s strategy allow corporations that need additional funds to raise those funds from existing shareholders. Financial risk management may range from hedging against commodity or currency risk to establishing alternative financing plans for upcoming projects. 11 CU IDOL SELF LEARNING MATERIAL (SLM)

d.Information Sharing Treasury managers need information from internal departments and groups to make suitable decisions. They must also share information to adequately support those groups and assist with their decision-making. In addition, treasury management plays an important communication role with lenders as part of the financing duties. This function provides lenders and other financial institutions with the financial information required to show compliance with loan terms. 1.8 PRINCIPLES OF TREASURY MANAGEMENT i.Principle of Security The funds of the company should be deployed for productive purpose so that they bring revenue to the business. No money is kept idle and at the same time the manager ensures safety and default risk will be lowered. ii.Principle of Liquidity Liquidity ensures the timely payment of financial obligations without incurring much cost. The company maintains ample level of cash assets to meet the demands of the various interested parties. The regular follow-up with bills receivables and negotiations for extension of bills payables help to improve liquidity position. iii.Principle of Profitability The ultimate goal of Treasury management is profit maximisation as it is looked upon as a profit center in the beginning. The maximum possible returns will be the result of all the financial decisions and governance of Treasury Manager. iv.Principle of Portfolio The company should invest in the portfolio of various assets with the objectives of the risk mitigation. 1.9 ROLES AND RESPONSIBILITIES OF TREASURER There are varieties of positions like CFO, Vice-President / Director of Finance or Treasurer, controller, or comptroller to handle treasury functions.The following list of functions is carried out by the treasury personnel for the proper management of cash.  Determining of financial objectives, plans and strategies.  Setting up of financial and treasury policies. 12 CU IDOL SELF LEARNING MATERIAL (SLM)

 Establishing financial and treasury systems.  Designing of credit policies and control procedures.  Framing of policies and procedures for receipt and disbursement of funds.  Setting up centralized or decentralized treasury management procedures.  Planning of short-term, medium-term and long-term cash needs.  Setting of funding policies and procedures.  Partaking in financial decisions like, corporate structuring, dividend payment, buyback of shares, redemption of debentures etc.  Identification of sources of funds and cost-benefit analysis of different sources of funding.  Procurement and raising of funds from various sources like issue of shares and debentures, raising of term-loans from banks and financial institutions etc.  Setting up of policies and procedures relating to currency exposure.  Hedging of currency rate risk and interest rate risk through various financial derivative instruments and techniques.  Monitoring of trends in capital market, debt market, government policies and regulations, inflationary tendency etc. and its impact on corporate finance.  Complying with exchange regulations of various countries.  Resolution of intra-group indebtedness.  Advising on proposals relating business acquisition and disposal, mergers and takeover, buy back of shares, diversification and divestment decisions.  Mentoring on project finance, foreign collaborations and joint ventures.  Advising on long-term funds management.  Planning for redemption debentures and bonds, repayment of term loans, restructuring and financial reorganization, financial re-engineering etc. 13 CU IDOL SELF LEARNING MATERIAL (SLM)

1.10 CHARACTERISTICS OF THE TREASURER Figure 1.2 Treasurer Treasurer means custodian of cash. Treasurer responsibility in the organization is very significant as it involves management of cash. A Treasurer, or Cash Manager, is accountable for carrying out basic book-keeping tasks for an organization. The duties include monitoring a company's cash flow, ensuring the liquidity to satisfy any bills and working with other financial stakeholders to ensure tax conformity. Traditionally this role was viewed as the cash Manager, As the organization becomes larger, this job demands more than financial management it views the responsibilities from Financial governance point. There are difference between the financial management and financial governance. Foreign Exchange dealings, Money Market Dealings, Investment in capitals dealings, dealings in commodity management are the other functions of Treasury Manager which are part of financial governance. Financial management is meant for the efficient and effective management of cash which is the particular task directly related with the upper management. Sometimes, it is considered as an activity of treasury management. Treasury management brings worth to the financial decisions of the company and facilitate in predicting the cash needs and verifies the liquidity situation of the company. Treasury management is the formation and governance of policies and measures that guarantee that the company manages economic risks productively. An excellent treasurer will be a person with the following traits. 14 CU IDOL SELF LEARNING MATERIAL (SLM)

 He is capable of managing data and cash  He should have an systematic mind and disciplined way of thinking  Rich experience in dealing with enormous sums of money and budgets  He has financial control and budgeting  He gives ad-hoc counsel  He has financial qualification or relevant experience  He has experience of pension schemes  Good command over knowledge and interpersonal skills  He has the capacity to take right decisions and follow-up  Time Management skills  Strong business acumen.  Good leadership skills.  High attention to detail.  High level of organization.  Capacity to work under pressure.  Acquaintance of cash management principles.  Knowledge of banking systems and processes. A good treasurer will be a trustworthy and impartial person. He should not commit fraud - i.e. 'borrow' collected funds for his/her personal use. He neither ignores law nor neglect to pay bills. He makes the work easy by keeping clear records. Figure 1.3 Functions of treasury management 15 CU IDOL SELF LEARNING MATERIAL (SLM)

1.11SCOPE OF TREASURY MANAGMENT The extent of treasury management function is quite enormous and it keeps on expanding. A treasury manager should be able to comprehend and realize the link between business strategy and organization. Treasury management includes the organization of cash transactions, banking, money-market and capital-market transactions; the successful control of the risks associated and the search of optimum performance with those risksregularly. The organizations use capital and project financings, borrowing, investment, and hedging instruments and other techniques for Treasury Management. I. Treasury Management at unit level  Maintaining Liquidity  The shortage in liquidity and statutory positions of the company is administered at corporate level. For example, over all liquidity levels can be determined at single location so that deficits and surpluses can be managed. The overall requirement of money is managed through repo borrowings etc.,  Optimizing Cash Resources By using the technology in cash conversion cycles, the company should reduce the cash conversion cycle. Effective cash management practices like regular follow up with vendors, negotiating better rates with Suppliers etc., help in optimisation of cash resources.  Establishing and keeping Access to Short-Term Financing The manager must have a loan of money (debt), sell ownership shares (equity) and retain earnings (profits). He must consider all accessible sources and decide the one most likely to help capitalize on the firm’s value.  Stabilising Access to Medium- and Long-Term Financing Long-term financing facilitates for long-term initiatives and to better manage monetary risks. This money is supplied by institutional investors with fixed interest rate over the course of the loan. II. Treasury Management at domestic level/National Level 16 CU IDOL SELF LEARNING MATERIAL (SLM)

It covers provisions of capital, short-term borrowing, foreign currency management, banking, money and capital marketsinvestments. The manager maintains reserve ratios, i.e., CRR and SLR (which are basically the govt. securities) and Fund Management by dealing in funding and managing foreign currency assets and liabilities. III. Treasury Management at International Level The countries impose currency controls in order to maintain the financial stability. The treasury Manager should aware of these exchange regulations and comply with exchange regulations of various countries. 1.12SUMMARY  Treasury management involves the process of managing the cash, investments and other financial assets of the business.  Every company effectively manage both cash inflows and cash out flows in order to increase its’ profitability. Treasury Management includes a firm’s collections, disbursement, concentration, investment and funding activities.  After liberalization the scope of treasury functions have been expanded into trading activities and it became the profit center.  The need for funds for business growth tied with exorbitant interest rates, foreign exchange unpredictability and the huge number of financial transactions have necessitated professional management of capital.  Treasury management at unit level covers cash management, liquidity management, Medium and long term financing whereas the domestic level covers provisions of capital, short-term borrowing, foreign currency management, banking, and moneyand capital marketsinvestments. 1.13 KEYWORDS  Treasury –It generally refers to the funds and revenue at the disposal of the bank and day to-day management of the same.  A treasurer - Person responsible for running the treasury of an organization.  Cash -Bills and coins, checks and other negotiable instruments that are acceptable at banks and are considered to be liquid assets 17 CU IDOL SELF LEARNING MATERIAL (SLM)

 Liquidity risk- the risk of running out of money.  Price risk- potential losses from price movements such as foreign exchange, interest rates, etc.  Credit risk - the risk of loss from counterparty reduced credit worthiness. 1.14LEARNING ACTIVITY 1. Define Fund. ___________________________________________________________________________ ___________________________________________________________________________ 2. State the functions of Treasury Management. ___________________________________________________________________________ ___________________________________________________________________________ 1.15UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Define Treasury Management 2. What is the difference between Treasury management and Financial Management? 3. State the objectives of Treasury Management. 4. List out the responsibilities of treasurer. 5. What are the three levels of Treasury management? 6. What do you mean by credit risk? Long Questions 1. Explain the seven Ms of Treasury Management. 2. Enumerate the functions of Treasury Management. 3. Elucidate the need for Treasury Management. 4. Describe the scope of Treasury Management. B. Multiple Choice Questions 1. After Liberalisation 1991, Treasury was considered as_________ a. Service centre b. Profit centre 18 CU IDOL SELF LEARNING MATERIAL (SLM)

c. Costcentre d. None of these 2. The ultimate goal of Treasury Management is ___________--. a. To manage Liquidity b. To reduce financial risk c. To reduce operational risk d. All of these 3. Which of the following is not the responsibility of a treasurer? a. Monitoring the capital market b. Setting up of financial and treasury policies c. Financial planning d. Preparation of balance sheet. 4. What is the process of identification, analysis and mitigation of uncertainty in investment decisions? a. Cash Management b. Liquidity Management c. Risk Management d. Foreign Exchange Management 5. Bill is an example for__________. a. Cash b. Fixed asset c. Stock d. Equity Answers 19 1-b, 2-d, 3-d. 4-c, 5-a CU IDOL SELF LEARNING MATERIAL (SLM)

1.16 REFERENCES References books  IIBF, Mumbai Theory and Practice of Treasury & Risk Management in Banks – Taxmann Publications Pvt. Limited IIBF, Mumbai  C. Jeevanandam Treasury Management – Macmillan Publishers India Limited  Sunil ParameswaranForeign Exchange & Risk Management – Sultan Chand & Sons  Rajiv Srivastava Fundamentals of Financial Instruments – An Introduction to Stocks, Bonds, Foreign Exchange and Derivatives – Wiley India Pvt. Limited Textbooks  Sangeet Kedia, Pooja. (2014)Financial Treasury and Forex Management by Law Publishing Co  Dr.V.A.Avadhani Treasury Management In India by Himalaya Publishing House; Third Edition 20 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT - 2: ORGANIZATION STRUCTURE OF 21 TREASURY STRUCTURE 2.0 Learning Objectives 2.1 Introduction 2.2 Organization Structure of Treasury 2.2.1 Types of Treasury Structure 2.2.2 Fully Centralized Corporate Treasury 2.2.3 Benefits of centralised treasury 2.2.4 Disadvantages of centralization 2.2.5 Decentralized Corporate Treasury 2.2.6 Disadvantages 2.2.7 Regional Treasury Centres 2.2.8 Treasury Centre vs In-house Banks 2.2.9 Typical treasury center activities include: 2.2.10 FX center 2.3 TreasuryProducts 2.3.1 Money Market 2.3.2 Instruments of the Money Market 2.3.3 Features of Money Market Instruments 2.3.4 Functions of Money Market Instruments 2.3.5 Objectives of Money Market Instruments 2.4 Capital Market 2.4.1 Capital Market – Features 2.4.2 Capital Market - Structure 2.4.3 Capital Market – Functions 2.4.4 Advantages of the capital market 2.4.5 Instruments of capital market 2.5 Foreign Exchange Market CU IDOL SELF LEARNING MATERIAL (SLM)

2.5.1 Five broad categories 2.5.2 Forex Market Participants 2.6 Summary 2.7 Keywords 2.8 Learning Activity 2.9 Unit End Questions 2.10 References 2.0LEARNING OBJECTIVES After studying this unit, you will be able to:  Describe types of treasury structure  List the treasury products  Differentiate the difference between money market and capital market  Understand the features of financial markets. 2.1INTRODUCTION Treasury is a nerve center of any organisation. Over the time, corporate treasury has evolved into anextensive and wide-ranging function. It consists of Board of Directors, internal shareholders, Banks, Regulators, Rating Agencies, Fund Managers and Capital Markets. Strategic initiatives related to organization are Staffing - Treasurer, Treasury Analyst, Treasury Specialist, Treasury Operations Analyst and their skill sets. 2.2ORGANISATION STRUCTURE OF THE TREASURY Treasury departments are structured differently to best meet the needs of smaller companies, treasury operations are sometimes carried out by just one person or may be a role conducted by a finance department. In a big, multifaceted, global business, however, it is probable to engageseveral staff, who may be professional managers such as a regional treasurer, or specialists in particular treasury activities such as foreign exchange dealers or investment managers. Because these activities include transactions with huge sums of money, processes are often set up in such a way thatstep-by-step transactionscannot be performed by adistinct person. This is to prevent errors and also deceit. 22 CU IDOL SELF LEARNING MATERIAL (SLM)

2.2.1 Types of Treasury Structure  Centralized vs. Decentralized  Regional Treasury Centre vs In-house Banks  FX center 2.2.2 Fully Centralized Corporate Treasury A treasury center is defined as a “Centralized treasury management function which is legally structured as a separated group or as a branch and is normally located in a tax efficient environment.” There are three key drivers of treasury centralization: Globalization Due to the internationalization of companies, the intricacy of processes increases. Companies have to cope payments across diverse currencies including various banking partners. They strive to improve their understanding of their global cash positions and synchronization of payment processes through centralisation. Technology The key driving force is digitalization which is facilitated throughreal-time data exchange between subsidiaries, banks and the treasury centre. The role of emerging technologies contributes for the successful implementation of centralisation. Regulation After the global financial crisis in 2009, centralization assists treasuries in gaining a better control in cross-border and thus conformto reporting and documentation norms. 23 CU IDOL SELF LEARNING MATERIAL (SLM)

Figure 2.1 Treasury Centre 2.2.3Benefits of centralized treasury  Economies of Scale can be realized by maximization of individual transaction volumes  Elevatedcharges for depositing cash surpluses to the central treasury than those available in home markets, where subsidiaries are situated  Lesser borrowing rates for subsidiaries that need financing than in local markets;  Expertise Knowledgein managing group-wide exposures in the best interest of the group  Better purchasing environment for treasury products. 2.2.4Disadvantages of centralization Less flexibility and responsiveness to local needs The centralization hinders local managers to respond quickly to developments in the local market and might also contribute to a lack of inducement of local managers since cash management is not to any further extent under their control. Increased bureaucracy Centralization is associated with boost in internal rules, procedures and reporting requirements, which may also harmfully influence the drive of local managers 24 CU IDOL SELF LEARNING MATERIAL (SLM)

Performance evaluation Centralization brings implications regarding merit rating of subsidiary managers. They can’t be held responsible for the actions of the centreand also vice versa. 2.2.5Decentralized Corporate Treasury Decentralised (as opposed to centralised) Treasury is a financial management structure, used by some multinationals in which decisions about the company’s financial operations are taken by different teams in different locations. Decentralised (as opposed to centralised) Treasury is a financial management structure, used by some multinationals in which decisions about the company’s financial operations are taken by different teams in different locations. In a decentralised treasury management system, each unit or subsidiary is responsible for its own operations and has complete independence from the central office. 2.2.6Disadvantages  Inability to leverage the economies of scale  Duplication of functions  Cash management activities may not be possible  Lack of control of risk and liquidity 2.2.7Regional Treasury Centres There are two main options on how companies centralize their treasury: (1) building a central treasury function in one location from which all treasury activities are managed or (2) operate treasury as a single operation, but with locations in more places in the world. Polák defends the opinion that these regional treasury centres are responsible for regional cash management and make it possible to always have access to financial markets independently from the time-zone. When a single system with the same database is used, companies can enjoy the benefits of centralization and at the same time retain more contact with business units and local markets than in the case of full centralization, but of course less contact than in a decentralized system. Most commonly a treasury department will be set up into three different departments: 25 CU IDOL SELF LEARNING MATERIAL (SLM)

Figure 2.2 Treasury Structure A. Front office It is responsible for carrying out day-to-day analysis and transactions relating to the management of funding, risk, cash and liquidity. B. Middle office Their roles are to identify measure and monitor the different Treasury risks metrics on a regular basis. C. Back office It administers and supports the front office and its main functions are to validate (confirm and verify), settle, and account for deals. 2.2.8Treasury Centre vs In-house Banks The treasury centre acts as an in-house bank where operating entities can make loans to, take deposits from, and transact foreign exchange with. IHB also refers to a very specific treasury technique centered on intercompany current accounts and executing flows on behalf of operating entities. For the sake of clarity, it is preferable to use the term treasury centre when referring to making loans, taking deposits, and transacting foreign exchange with operating entities; and IHB when referring to executing flows on behalf of operating entities and posting them to intercompany current accounts. It is possible that one treasury team in one location or legal entity does all or a part of the treasury centre, SSC, and IHB's activities. Nonetheless, it is helpful to keep these definitions separate because they refer to distinct and separable activities. 26 CU IDOL SELF LEARNING MATERIAL (SLM)

2.2.9Typical treasury centre activities include: Intercompany deposits and loans: Treasury centres typically concentrate intercompany cash using intercompany deposits and loans - operating entities with excess cash place deposits with the treasury centre who then recycles the deposits into cash (via foreign exchange swaps where necessary) to make intercompany loans to operating entities who are short of cash. Foreign exchange: Treasury centres typically transact foreign exchange with operating entities with a view to concentrate foreign exchange exposures in the treasury centre, and to minimise the volumes traded with banks and save spreads Bank relationships: Treasury centres typically manage bank relationships which include arranging banking services and facilities for operating entities, as well as setting up liquidity management and similar arrangements Process: Treasury centres often facilitate or manage treasury related processes such as payments, collections, hedge accounting, cash flow forecasting Policy: Treasury centres often set and implement treasury policies and monitor cash. 2.2.10 FX center It is the market where one currency is traded for another currency. 2.3TREASURY PRODUCTS- MONEY MARKET Treasury products are dealt in financial markets which include money market, capital market and foreign exchange market. Financial markets come in a variety of flavors to accommodate the wide array of financial instruments or securities that have been found beneficial to both borrowers and lenders over the years. Money market basically refers to a section of the financial market where financial instruments with high liquidity and short-term maturities are traded. Money market consists of negotiable instruments such as treasury bills, commercial papers and certificates of deposit. The money market is an unregulated and informal market. Money market instrument is an investment mechanism that allows banks, businesses and the government to meet large, but short-term capital needs at a low cost. They serve the dual purpose of allowing borrowers meet their short-term requirements and providing easy liquidity to lenders. 2.3.1 Examples of Money Market Instruments 1. Promissory Note 2. Bills of exchange or commercial bills 3. Treasury Bills (T-Bills) 4. Call and Notice Money 27 CU IDOL SELF LEARNING MATERIAL (SLM)

5. Inter-bank Term Market 6. Commercial Papers (CPs) 7. Certificate of Deposits ( CD’s ) 8. Banker’s Acceptance (BA) 9. Repurchase Agreements (Repo) 2.3.2Instruments of the Money Market 1.Promissory Note A promissory note is one of the earliest types of bills. It is a written promise by one party, to pay to another party, a definite sum of money by order or at a specified future date, although it falls in due for payment after 90 days within three days of grace. However, Promissory notes are usually not used in the business in India. 2.Bills of exchange or commercial bills The bill of exchange is drawn by the creditor and is accepted by the bank of the debtor. The bill of exchange can be discounted by the creditor with a bank or a broker. The foreign bill of exchange becomes due for payment from the date of acceptance. 3.Treasury Bills (T-Bills) The Treasury bills are considered to be one of the safest money market instruments and issued by the Central Government.Since they carry zero risk, the returns are not so attractive. The maturity periods may range from 1 year, 6 months or 3 months.They are circulated by primary and secondary markets. There are three types of treasury bills 91-day, 182-day and 364-day treasury bills issued by the Government of India through auction. 4.Call and Notice Money In call Money market the funds are borrowed and lent for one day whereas in the Notice Market, they are borrowed and lent up to 14 days, without any collateral security. Funds are borrowed and lent by the commercial banks and cooperative banks in this market. The lender of funds are financial institutions and mutual funds. 5.Inter-bank Term Market The cooperative and commercial banks in India borrow and lend funds for a period of over 14 days and up to 90 days. This is done without any collateral security at the rates determined by markets. 6.Commercial Papers (CPs) Commercial papers are issued by top rated companies with anintention of raising capital to meet requirements directly from the market.They usually have a rigid maturity period ranging from1 day up to 270 days.They propose higher returns as compared to treasury bills. They are traded actively in secondary market. 28 CU IDOL SELF LEARNING MATERIAL (SLM)

7.Certificate of Deposits (CD’s) The Certificate of Deposit differs from a Fixed Deposit receipt in two ways. i. it involves huge sum of money ii. Certificate of deposit is freely negotiable.The RBI first announced in 1989 that the Certificate of Investments is the most preferred option of organization in terms of investments as they carry low risk with high interest rates than the Treasury bills and term deposits.The Certificate of Deposit issued by banks range from 3 months, 6 months and 12 months. 8.Banker’s Acceptance (BA) A Banker’s Acceptance is a document that promises future payment which is guaranteed by a commercial bank. It specifies the details of repayment like the date of repayment, amount to be paid, and details of the individual to which the repayment is due.The maturity periods varies between 30 days up to 180 days. 9.Repo It stands for Repurchase Agreements. They are loans of small duration which are agreed by buyers and sellers for the purpose of selling and repurchasing.RBI approved parties carry out these transactions.Eg.central or state government securities, treasury bills, central or state government securities, and PSU bonds. 2.3.3 Features of Money Market Instruments a. Liquidity: They are considered very liquid as they are fixed-income securities which carry short maturity of one year or less than a year. b.Safety: The strong credit ratings of the issuing party ensuressafety. c. Discounted price: The unique feature is that they are issued at a discount on their face value. 2.3.4 Functions of Money Market Instruments a.Provides Funds The private and public institutions who need finance for their working capital requirements rely on money market. These funds are provided by discounting the trade bills through commercial banks, brokers, discount houses, and acceptance houses. Therefore, the money market instruments, in turn, can aid the development of trade, industry and commerce. b.Use of Surplus Funds The banks and financial institutions use their excess funds profitably for a small period of time through money markets. They consist of commercial banks as well as big non-financial corporations, states and other local governments. c.No Borrowings from banks 29 CU IDOL SELF LEARNING MATERIAL (SLM)

If there is a short of cash requirement, they can call in some of their loans from the money market. Also, the most of the commercial banks would rather prefer to recall their loans than recalling it from the central banks at a higher rate of interest. d.Helps Government The money market instruments prove helpful to the government in borrowing short-term funds on the basis of treasury bills at small interest rates. Besides, it would lead to inflationary pressures in the economy if the Government had to issue paper money or borrow from the central bank. e. Helps in Monetary Policy The existence of a well-developed money market will assist in successfully implementing the monetary policies of central bank. f.Financial Mobility The Monet market helps in financial stability by smoothening the transfer for funds from one sector to another. And, financial mobility is important for the development of commerce and industry. g.Promotes Liquidity and Safety Apart from encouraging savings and investments, the money market instruments promote liquidity and safety of financial assets. h.Equilibrium between Demand and Supply of Funds The money market brings a balance between the demand and supply of loanable funds by allocating saving into investment channels. 2.3.5 Objectives of Money Market Instruments  The money markets not only facilitate in the storage of short-term surplus funds but also aid in lowering short term deficits.  Money markets assist the central bank in regulating liquidity in the economy.  Money market provides the short-term fund users to fulfil their needs at a very reasonable rate.  Money markets help out in designing effective monetary policies. 2.4TREASURYPRODUCTS-CAPITAL MARKET Capital Market is a place where different financial instruments are traded between different entities. 30 CU IDOL SELF LEARNING MATERIAL (SLM)

2.4.1 Capital Market – Features In capital markets, there are 2 entities, one who supplies capital and the other entity is the one who needs capital. Usually, entities with surplus capital in the capital markets are retail and institutional investors. Entities seeking capital are people, governments and businesses. Some common examples of suppliers of capital are  Pension funds  Life insurance companies  Non-financial companies  Charitable foundations. Some common examples of users of capital  People looking to purchase vehicles, homes  Governments  Non-financial companies. 2.4.2 Capital Market - Structure Capital market is made of primary and secondary markets. Primary markets consist of companies that issue securities and investors who purchase those securities directly from the issuing company. These securities are called Initial Public Offerings (IPO). If a company wants to raise fund, it sells its stocks and bonds to institutional investors like hedge funds and mutual funds. Secondary markets are places where the trade of already issued certificates are overseen by regulatory bodies. Issuing companies do not take part in the secondary market. The popular secondary markets are New York Stock Exchange (NYSE), London Stock Exchange (LSE) and Bombay Stock Exchange (BSE). 2.4.3 Capital Market - Functions  Capital markets bridges the gap between the needy people and those having the excess money.  It helps in economic growth.  It ensures that there is the continuous availability of funds.  Through proper utilization of capital,the capital market promotes GDP.  It minimizes transaction costs and information costs.  6 The trading of securities for companies and investors is simple and uncomplicated.  It offers insurance against market risk. 31 CU IDOL SELF LEARNING MATERIAL (SLM)

2.4.4 Advantages of the capital market  Money transfer between people who need capital and who have the capital.  There is more efficiency in the transactions.  Securities like shares help in earning dividend income.  The escalation in worth of investments is soaring. 2.4.5 Instruments of capital market a.Shares b.Debts  Bonds  Debentures  Government Securities c.Derivatives  Future and Forward  Options  Forwards a. Shares The share capital of a company restricted by shares shall be of two categories, namely Equity share capital and Preference share capitalas per Section 43 of the Companies Act 2013. Equity Shares The purpose of equity instruments issued by corporations is to raise funds for the firms.It is equity ownership that allows the holders of this stock to enjoy voting rights on corporate matters. However, in case the company suffers serious losses and ends up insolvent, the holders of the common stock will receive their money aftercreditors, bondholders, and preferred stockholders are settled. Preference shares Preference shares are also a type of shares issued by a company that provides a predetermined dividend to the holder unlike dividend to equity share holder where shareholder gets dividend as per the profit earned. Even though dividend on the preferred stock is more, the holders have no voting power on the company affairs. In case of liquidation of company, preference shareholders are entitled to redeem their shares prior to common stock holders. b. Debt 32 CU IDOL SELF LEARNING MATERIAL (SLM)

A debt instrument is used for mobilizing funds through the primary or secondary market for capital-intensive projects by companies and government.The borrower – creditor relationship does not necessarily mean ownership in the business of the borrower. The contract is for a definite duration and receives interest for specific period. Types of Debt Instruments are of different types like Bonds, Debentures and Government Securities (G - Secs) etc. Bonds Bonds are debt instrument that are issued by companies and government. Major issuers of bonds are governments (Treasury bonds in US, gilts in the UK, Bunds in Germany) and firms, which issue corporate bonds. Some corporate bonds are secured against assets of the company that issued them, whereas other bonds are unsecured. By purchasing a bond, an investor lends money for a fixed period of time at a predetermined interest rate. During this period of time, investor receives a regular payment of interest semi-annually or annually. Issuing a bond increase the debt burden of the bond issuer because contractual interest payments must be paid to the borrowers. Debentures A debenture is a long-term debt instrument used by governments and large companies to obtain funds. It is a certificate of agreement of loans which is given under the company's stamp and carries an undertaking that the debenture holder will get a fixed return (fixed on the basis of interest rates) and the principal amount whenever the debenture matures. In contrast to equity capital, which is a variable income security, the debentures are fixed income (i.e. in respect of interest) security with no voting rights. Debentures are generally freely transferrable by the debenture holder. Government Securities Government securities, popularly known as G-Secs, are issued by Reserve Bank of India (RBI) on behalf of the central or state governments to finance fiscal deficit. These securities are absolutely risk-free and guaranteed by the government. Difference between bonds and debentures  Bonds are more secured than debentures. The holders are paid guaranteed interest rate that does not change in value irrespective of the profit of the company.  In case of liquidation, bondholders will be paid off prior to debenture holders.  The Debenture holders are paid higher interest rates than bond holders. c. Derivatives Derivatives are financial instruments which derive their value from their underlying assets or securities. For examples, if a buyer enters into a contract with a seller to buy a specified 33 CU IDOL SELF LEARNING MATERIAL (SLM)

number of shares of a company at a specified price after a specified period, the buyer has entered into a futures contract. It is important to note that the buyer has bought the contract and not the stock of shares under reference. This contract is called a derivative while the stock of shares to which it applies is called the underlying asset. Apart from futures, other commonly used derivatives are options, warrants, convertibles and many more. The Underlying Securities for Derivatives are:  Commodities (Castor seed, Grain, Coffee beans, Jaggary Pepper, Potatoes)  Precious Metals (Gold, Silver)  Short-Term Debt Securities (Treasury Bills)  Interest Rates  Common Shares/Stock  Stock Index Value (NSE Nifty) Derivative contracts are primarily of two kinds – contracts that are traded on the exchanges and contracts that are traded outside the exchanges. Products/contracts that are traded on the exchanges are called Exchang-traded320 PP-FT&FM derivatives. Products/contracts traded outside the exchanges are called Over-the-counter derivatives. The generic term used for the market outside the exchanges is over-the-counter market. Worldwide, large volume is traded in both exchange-traded and OTC derivative products. India also trades in both exchange- traded and OTC derivative products on different asset classes. Forwards and futures The financial contracts that require the contracts’ buyers to buy an asset at an agreed price on a particular future time. Since the parties can customize the underlying commodity, quantity of the commodity and the date of the transaction,forwards are supposed to be more flexible contracts. But futures are standardized contracts that are traded on the exchanges. Options Options contracts are instruments that give the holder of the instrument the right to buy or sell the underlying asset at a preset price.An option can be a 'call' option or a 'put' option.A call option gives the buyer, the right to buy the asset at a given price. This 'given price' is known as 'strike price'. Likewise, a 'put' option gives the buyer a right to sell the asset at the 'strike price' to the buyer. Characteristics of Derivatives The important characteristics of derivatives are as follows:  Derivatives traded on exchanges are liquid and involves the lowest possible transaction costs. 34 CU IDOL SELF LEARNING MATERIAL (SLM)

 Low credit-risk associated with the derivatives  Derivatives are traded globally having strong popularity in financial markets.  Derivatives maintain a close relationship between their values and the values of underlying assets.  The change in values of underlying assets will affect values of derivatives. Participants in the Derivatives Market Hedgers: Theyrely on futures or options markets to reduce or eliminate the risk associated with price of an asset. Speculators: They depend onthese contracts to boost both the potential gains and potential losses by usage of derivatives in a speculative venture. Arbitrageurs: They are in business to take advantage of incongruity between prices in two diverse markets. 2.5 TREASURY PRODUCTS-FOREIGN EXCHANGE MARKET It is a place where foreign currencies are bought and sold. The buyers, sellers of claim on foreign money and the intermediaries together constitute foreign exchange market. There is wide variety of dealers in the foreign exchange market. The most important dealers are banks. These exchange banks are available all over the world. There are three important functions of foreign exchange market  Transfer function  Credit function  Hedging function 2.5.1 Five broad categories of participants  Bank and non-bank foreign exchange dealers  Foreign exchange brokers  Hedgers, Speculators and arbitragers  Central banks and treasuries  Individuals and firms conducting commercial or investment transactions Wholesale Forex Market: In this market, banks and non-bank financial institutions transact with each other. They undertake trading on behalf of customers, but majority of trading is undertaken for their own account by proprietary desks. Besides banks and non-bank financial institutions, 35 CU IDOL SELF LEARNING MATERIAL (SLM)

multinational corporations, hedge funds, pension and provident funds, insurance companies, mutual funds etc. participate in the wholesale market. 2.5.2 Forex Market Participants: Foreign Exchange Dealers: Banks and other financial institutions operate as foreign exchange dealers. Brokers: Brokers assist their clients to get better rates from the dealers in currency trade. The role of information technology is indispensable in effective functioning of brokering system. Hedger, Speculators and Arbitrageurs: Depending upon the motives of the traders, they are classified into Hedger, Speculators and Arbitrageurs. Hedger and arbitrageurs are having the transaction motive and speculators transact with speculative motive. 2.6 SUMMARY  Treasury products are dealt in financial markets which include money market, capital market and foreign exchange market.  Money market basically refers to a section of the financial market where financial instruments with high liquidity and short-term maturities are traded.  Capital market is made of primary and secondary markets. Primary markets consist of companies that issue securities and investors who purchase those securities directly from the issuing company.  It is a place where foreign currencies are bought and sold. The buyers, sellers of claim on foreign money and the intermediaries together constitute foreign exchange market.  There is wide variety of dealers in the foreign exchange market. The most important dealers are banks. These exchange banks are available all over the world.  Treasury management aims to identify the risks associated with the treasury products and assists in risk mitigation. Therefore they need team of experts working diligently and taking extra vigilance in handling all these treasury matters.  Depending upon the motives of the traders, they are classified into Hedger, Speculators and Arbitrageurs. Hedger and arbitrageurs are having the transaction motive and speculators transact with speculative motive. 36 CU IDOL SELF LEARNING MATERIAL (SLM)

2.7 KEYWORDS  Bill of Exchange-A written unconditional order by one party to another to pay a certain sum either immediately or on a fixed date.  Hedging-Investment positions intended to offset potential losses that may be incurred.  Forward market-A market where one buys or sells a specific currency pair for a predetermined amount, rate and date which are agreed upon at the time of dealing.  Options contracts-They are instruments that give the holder of the instrument the right to buy or sell the underlying asset at a predetermined price.  Spot market-A market where one buys or sells a currency for settlement or delivery within 2 working days.  Hedgers-Hedgers are traders who undertake forex trading because they have assets or liability in foreign currency. 2.8LEARNING ACTIVITY 1. Define Treasury product. ___________________________________________________________________________ ___________________________________________________________________________ 2. State the features of money market. ___________________________________________________________________________ ___________________________________________________________________________ 2.9 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. What are the types of treasury? 2. Define commercial bill. 3. What do you mean by in-house banks? 4. Explain the capital market structure. 5. What are the departments of treasury? Long Questions 1. Explain the difference between bonds and debentures. 2. What are the characteristics of derivatives? 37 CU IDOL SELF LEARNING MATERIAL (SLM)

3. Differentiate between Money Market and Capital Market. 4. Elaborate the capital market instruments? 5. Discuss the benefits of money market. 6. Explain functioning of foreign exchange market. B. Multiple Choice Questions 1. An Indian company enters into a swap contract to replace its US$ borrowing to INR borrowing is an example of ___________ a. Arbitrage trading b. Speculative trading c. Hedging d. None of these 2. Whois not the supplier of capital among the following? a. Pension funds b. Life insurance companies c. Charitable foundation d. Government 3. The person who trades for profit in foreign exchange market is known as? a. Hedger b. Speculators c. Arbitrageurs d. All of these 4. Which types of market participants can be termed as the most important participant in foreign exchange market? a. Retail customers b. Commercial banks c. Foreign exchange dealers d. Central banks 38 CU IDOL SELF LEARNING MATERIAL (SLM)

5. _______________are more secured than debentures. a. Bonds b. Shares c. Bills d. All of these Answers 1. c 2. d 3.b 4. d 5.a 2.10 REFERENCES References books  Bhardwaj, H.P., Foreign Exchange Handbook, Bhardwaj Publishing Company, Mumbai.  Rajwade, A.V., 2000, Foreign Exchange Risk Management and International Finance, A.V. Rajwade & Co.  Joel Bessis, 1998, Risk Management in Banking, John Willey Sons, New York.  Maurice Levi, 1996, International Finance: The Markets and Financial Management of Multi-national Business, McGraw Hill, USA. Text books  Trivedi and Hassan, Treasury Operations and Risk Management, Genesis Publishers, - Mumbai.  Banking in New Millennium: Report on Conference of Chairmen of Banks, MBM, Pune, 2000. Websites  https://www.yourarticlelibrary.com/treasury-management/treasury-of-a-commercial- bank-objectives-and-structure/89454  https://www.investopedia.com/articles/investing/073113/introduction-treasury- securities.asp  https://groww.in/p/commodity-market/ 39 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT - 3: LIQUIDITY PLANNING AND MANAGING CASH ASSETS STRUCTURE 3.0 Learning Objectives 3.1 Introduction 3.2 Concept of Liquidity 3.2.1 Definition 3.2.2 Motives for Liquidity 3.2.3 Types of liquid assets 3.3 Profitability Vs Liquidity 3.4 Liquidity Planning 3.4.1 Importance of Liquidity Planning 3.5 Methods of Measuring Liquidity 3.4.2 Two aspects of Liquidity 3.6 Role of working capital in Liquidity 3.7 Cash Management – Definition & Objectives 3.8 Cash Management- Principles & Strategies 3.9 Functions of Cash Management 3.10 Summary 3.11 Keywords 3.12 Learning Activity 3.13 Unit End Questions 3.14 References 3.0 LEARNING OBJECTIVES After studying this unit, you will be able to:  Understand the concept of liquidity  Differentiate the liquidity and profitability  List out the tools of liquidity planning and management 40 CU IDOL SELF LEARNING MATERIAL (SLM)

 Identify the roleofworkingcapitalmanagementinliquidity 3.1 INTRODUCTION Liquidity relates to quick access to cash. The company holds assets or security, and liquidity refers to the ease with which these may be bought or sold in the market for conversion into cash. Cash is held to be the standard for liquidity as it can be converted to other assets most easily. Liquidity management is a cornerstone of every treasury and finance department. In essence, liquidity management is the basic concept of the access to readily available cash in order to fund short-term investments, cover debts, and pay for goods and services. Liquidity planning is crucial, and involves finance and treasury managers’ ability to look to the company’s balance sheet and convert funds that are tied up in longer-term projects into cash for the firm to use in its day to day operations. 3.2 CONCEPT OF LIQUIDITY Liquidity means that  The firm has adequate cash to pay for its bills  The firm has sufficient cash to make unexpected large purchases  The firm has sufficient cash to meet unexpected emergencies at all times 3.2.1 Definition It is an important concept in financial management and is defined as ability of the business to meet short-term obligations. It shows the quickness with which a business/company can convert its assets into cash to pay what it owes in the near future. According to Ezra Solomon, it measures a company’s ability to meet expected as well as unexpected requirements of cash to expand its assets, reduce its liabilities and cover up any operating losses. Liquidity is the degree to which a security can be quickly purchased or sold in the market at a price reflecting its current value. Liquidity in finance refers to the ease with which a security or an asset can be converted into cash at market price. 3.2.2 Motives for Liquidity Money may be demanded to satisfy a number of motives. i.Transaction Motive: Transactions motive also includes business motive. It takes some time before the businessman can sell his product in the market.This is because the company needs cash to run day-to-day business operations. This includes 41 CU IDOL SELF LEARNING MATERIAL (SLM)

 Manufacturing and selling costs  Payment of salaries to employees  Payments to creditors, tax authorities and interest on borrowed funds ii. Precautionary Motive: Money must be kept to meet unforeseen situations and emergencies. For example in banks the depositors may decide to withdraw money from their accounts without advance notice.Bank creditors may decide not to renew short term wholesale funding as it matures.Line of credit agreements give customers the right to take out loans on short notice. iii. Speculative Motive: Future is uncertain. Rate of interest in the market continues changing. Some money, therefore, is kept to speculate on these probable changes to earn profit.E.g. in banks off- balance sheet operations like third party loan guarantees and complex derivative transactions create additional needs for liquid funds. 3.2.3 Types of Liquid Assets Liquid assets are such assets held by businesses or individuals, which can be converted into cash quickly. It can include cash, marketable securities as well as money market instruments. All such assets are reflected in the balance sheet of the company. The following assets can also be liquidated easily.  Cash  Cash equivalents like commercial papers and treasury bills etc.,  Accrued income  Stocks  Government bonds  Promissory notes  Accounts receivable  Marketable securities  Certificate of deposits 3.3 PROFITABILITY VS LIQUIDITY Profitability and liquidity are two indicators of financial position of the company. Liquidity can be seen as a major contributor to long-term profitability. The key difference between profitability and liquidity is that while profitability is the degree to which the company earns a profit, liquidity is the ability to swiftly convert assets into cash. 42 CU IDOL SELF LEARNING MATERIAL (SLM)

The difference between profitability and liquidity is simply the availability of profits vs availability of cash. Profit is the principle measure to assess the stability of a company and is the priority interest of shareholders. While profit is the most important, this does not necessarily mean that the business operation is sustainable. Further, a profitable company may not have enough liquidity because most of the funds in the company are invested into projects, and a company which has a lot of cash or liquidity may not be profitable because it has not utilized excess funds effectively. Thus, the success depends on the better management of both profit and cash.There is a short-run trade-off between liquidity and profitability Figure 3.1 Profitability Vs Liquidity 3.4 LIQUIDITY PLANNING Liquidity planning concentrates on guaranteeing that immediately available funds are obtainable atthe lowest cost. If management is successful, long-term earnings will exceed peer banks’ earnings, as will bank capital and overall liquidity (Cooper R. and Thomas R., 1998)while using liquidity as a decision criterion, the management makes use of ratios. They give a bird’s eye view of the current liquidity position or shortages thereof. Financial decisions are affected by liquidity analysis of a company in the following areas: 1. Managing of cash and marketable securities; 2. Credit policy of a firm and realization procedures; 3. Inventories Management 4. Fixed assetsAdministration 43 CU IDOL SELF LEARNING MATERIAL (SLM)

5. Making decisions for competent use of current assets at lower cost; and 6. Decisions to keep the company’s position on sound basis to avoid eventualities. The above investigation of liquidity recommends assessment of current assets of an organization. On liabilities side, liquidity position is analyzed and managed through evaluation of long and medium term obligations of the organization, and the courses of action for their reimbursements. This is done absolutely according to the prudent perspective with the goal that the organization could be saved from the danger of liquidation for non-payment of its obligation to the lenders. There are a wide range of methods applied by firms across the globe that assist with relieving liquidity dangers and help with liquidity planning Receivables Management – the systematic approach to deal with timely and orderly payments is key element. The customers will pay in such a way that the firm will actually able to utilize the funds to meet short term commitments. In any case, with numerous agreements, arrangements and solicitations specifying a necessary time span inside which the customer should meet their payment commitments, checking every customer's outstanding payments and capacity to pay themselves is central to the smooth running of the business. This component of receivables management comes under the umbrella of cash forecasting – a vital concept in good liquidity management. A good cash flow forecast precisely predicts the cash inflows and outflows expected over a pre-defined period in the future, normally twelve months. 3.4.1 Importance of Liquidity Planning A.Provides provisions for cash reserves Theorganization will like to have liquid resources for transaction purposes, as a precautionary measure and for speculative opportunities. The management’s attitude towards these i.e., transaction motive, precautionary motive and speculative motive (taking advantage of lower prices of raw materials etc., in the market) is an important determinant of a company’s liquidity position. b.A balance for liquid and non-liquid securities The right balance of liquid and non-liquid securities must be maintained by the company inorder to avoid eventualities. The company profitability depends on how well the securities are utilized and capable of bringing revenue to the company.The failure of setting up right mix may result in unprofitability and detrimental to the organization. 3.5 METHODS OF MEASURING LIQUIDITY The financial tools help to measure the liquidity position of the company. 44 CU IDOL SELF LEARNING MATERIAL (SLM)

3.6.1 Two aspects of Liquidity i. Market Liquidity Market liquidity indicates such state of the market when assets may be bought or sold off quickly. Such liquidity is especially apparent in the case of real estate or financial market. The conversion of assets into cash across markets is also referred to as liquidity in economics. The market for equities or stocks can be held to be liquid only if the purchase and selling of shares can happen quickly with minimal impact on the price of the shares. The shares that are traded on big stock exchanges are usually found to be liquid. ii.Accounting Liquidity The ease with which a company or an individual is capable of meeting financial obligations, using liquid assets constitutes accounting liquidity. It compares the liquid assets held by the company or an individual to that of current liabilities in a financial year. Accounting liquidity may be measured by current ratio and cash ratio. 3.6.2 Tools of Assessment Liquidity is assessed through the use of ratio analysis. Liquidity ratios provide an understanding into the present cash solvency of a firm and its capability to remain solvent in the case of contingencies. Current Ratio i.e. ratio of current assets to current liabilities is broadly used by corporate units to judge the capacity to fulfill short-term liabilities covering the period upto one year. The interpretation of the current ratio is that 'higher the ratio, greater is the ability of the firm to pay off its bills. Nevertheless, it is a crude ratio and does not take into account the disparity amongst different categories of assets. For example, stock may not be turned into cash as quickly as account receivables. Companies use liquidity ratios to estimate their liquidity and determine their financial health. The three most important ratios to measure liquidity are: Current Ratio This calculates a company's current assets against its current liabilities. It determines whether a company can pay off all its short-term debt with the money received from selling assets. Current Ratio = Current Assets / Current Liabilities Quick Ratio This is similar to the current ratio but only considers accounts receivable, cash, and bonds/stocks as assets. Current Assets = Current Liquid Assets / Total Liabilities Cash Ratio 45 CU IDOL SELF LEARNING MATERIAL (SLM)

This ratio equals to cash divided by current liabilities. This is helpful when a firm can only make use of its cash to pay off debt. If the cash ratio is 1 or greater, the business has abundant liquidity and would possibly face no problems in paying its liabilities. Cash Ratio = (Cash and Cash Equivalents + Short-term Investments) / Current Liabilities The main trouble that emerges in treating inventory as a quick item is to ensure about the quality, condition and marketability of the inventory.Otherwise it may be impossible to transform it into cash immediately. Therefore, to assess quick liquidity position, inventory is excluded while calculating Quick Ratio. The ingredients of current assets while computing the Quick Ratio are cash, marketable securities and receivables. In addition to cash, the other two items are near cash and at very short notice can easily be converted into cash. Therefore, for assessing cash position of the company and its ability to discharge current obligations, Quick Ratio is normally relied upon. However, the main deficiency of the Quick Ratio is that it ignores inventories and concentrates on cash, marketable securities and receivables in relation to current obligations.But inventory is also a fundamental input in current ratio without which company’s decision process cannot be complete. Liquidity ratio enables a company to evaluate its Net Working Capital. Working Capital is denoted by the combination of current assets or current liabilities of a company.Working capital is calculated by taking away current liabilities from current assets. The company is left with the ready money in hands to meet everyday necessities of the business. Tailor-made measurement can be devised for calculating liquidity ratio in different circumstances. For example, the principle of liquidity can be extended to study liquidity of receivables (or inventories) separately to enable the executives to take decisions about the collection period of bills. Liquidity of receivables is assessed through Average Collection Period (ACP). It denotes the average time an invoice takes to translate into cash. The inverse to this ratio is Receivables Turnover Ratio (RTR). Both ratios help in taking corrective steps for maintaining the optimum liquid position for the company at any given point to avoid risk of losing goodwill and chances of insolvency. The proportion, to put it plainly, uncovers the accompanying outcomes:  Too low average collection period may propose exorbitantly limited credit policy of an organization.  Too high average collection period (ACP) may demonstrate too liberal credit policy. A huge number of receivables may stay behind due and outstanding, resulting in less profits and more likelihood of amount overdue. Average collection period and receivables turnover ratio should be compared to the average period of accounts payable or accounts payable turnover ratio. The credit standing of the company in business and banking circles depends on efficient inventory management system of the company. 46 CU IDOL SELF LEARNING MATERIAL (SLM)

3.6 ROLE OF WORKING CAPITAL IN LIQUIDITY Working capital is the difference between a company’s short-term assets, such as cash and its short-term liabilities, such as its debts or bills.Working capital is a measure for liquidity. Working capital is the measure of how well a company can sell its current assets to pay its current liabilities. Working capital influencesa range of company activities, such as debt management, revenue collection, payments to suppliers, and inventory management. These activities are reflected in working capital, as it covers not only cash but also accounts payable, accounts receivables, inventory and portions of debt owed within twelve months. For instance, a company can develop its working capital by receiving their accounts receivables from the customers quicker or asking suppliers for a short-term extension dates for their accounts payables. A number of factors affect working capital needs, including asset purchases, past-due accounts receivable being written off, and differences in payment policies. The two elements of working capital are called current assets and current liabilities, which are depicted underneath. Current Assets Current assets are the assets that a company owns that are expected to be used up within the next 12 months. Examples of current assets include:  Cash and cash equivalents  Accounts receivables are the payments owed by customers for products and services sold  Inventoryconsists of merchandise and finished goods sold to earn cash  Marketable securitiesare investments that are not locked up and can be redeemed for cash without much difficulty.  Prepaid expenses include any payments to contractors or vendors for services yet to be received. II. Current Liabilities Current liabilities are the temporary debts or bills that a business owes within the next 12 months and are usually paid through current assets. The list of current liabilities is given below.  Accounts payable are debts owed to suppliers and vendors  Wages payable are due to employees within the subsequent year  Short-term debtincludes bank loans used to fund the company's operating expenses  Dividends payable are cash payments due to equity shareholders as a gain for being an investor in the company  Current portion of long-term debt that's due in the next 12 months 47 CU IDOL SELF LEARNING MATERIAL (SLM)

 Interest payable on outstanding debts including long-term obligations  Income taxes owed within the next year A company that has positive working capital indicates that the company has enough liquidity or cash to pay its bills in the coming months. For a company, liquidity essentially measures its ability to pay off its bills when they are due, or how easily and effectively a company can access the money it needs to cover its debts. I. Positive Working Capital A company that has an excess of current assets over its current liabilities has positive working capital. A company with the capability to generate cash holds the company in a better position for any contingencies. There are some ways to enhance the positive working capital. ii.Negative Working Capital Negative working capital can indicate short-term cash issues and it may become more serious long-term management issue in case it exists persistently.The company might experience negative working capital due to cash outlays,seasonal businesses and Long-term Issues. 3.7 CASH MANAGEMENT-DEFINITION &OBJECTIVES Definition: Cash management is a wider area of finance which involves the collection, treatment, and utilizationof cash. It involves assessing market liquidity, cash flow and investments. It is a practice in which the money is sourced, distributed and invested so that there is highest liquidity. The company can increase its profitability by optimising the cash resources. It also facilitates in keeping provisions for future uncertainties such as economic recession, bad debts, lock down etc. The company can estimate the cash profits and not just profits from outstanding incomes and credit sales through cash management.It ensures the smooth flow of operations of an organization. Objectives of Cash Management The objectives of cash management are listed below;  To fulfill working capital requirements of the company  To manage the unorganized costs  To allocate capital expenditure  To ensure appropriate utilization of funds  To initiate new projects and plan investments  To enhance the liquidity position of the company  To regulate the cash inflows and outflows 48 CU IDOL SELF LEARNING MATERIAL (SLM)

 To maximize the value of existing funds  To cut down the cost related to acquisition of funds. Cash Cycle The lead time between transforming the raw materials into cash is called as Cash cycle or cash conversion cycle. The company with shorter cash cycle has more liquidity and able to meet its financial obligations without difficulty. The notion is used to establish the amount of cash needed to invest ongoing operations and is a key reason in assessing financing needs. Figure 3.2 Cash Cycle 3.8 CASH MANAGEMENT- PRINCIPLES & STRATEGIES Principles of Cash Management: 1. Keeping lower inventory levels: If the company maintains more cash, it leads to unnecessary accumulation of raw materials, inventories and production items. But it is a rational decision to keep lower inventory levels which avoids losses due to obsolescence, deterioration etc., The Manager should be cautious in managing the cash conversion cycle. 2. Follow -up on speedy recovery of Bills receivables: The Manager should ensure the timely recovery of outstanding bills which are due through regular monitoring and follow up with their customers. This will facilitate the company to pay for its accounts payables to the creditors, suppliers, vendors etc., in a prompt manner. Cash Management Strategies: 49 CU IDOL SELF LEARNING MATERIAL (SLM)

Figure 3.3 Cash Management Cycle The strategies pertaining to cash management are:  One must always ask for a milestone or deposit payment.  The customers must be encouraged to clear their bills faster.  One must always make sure that the expenses are always bare minimum or even delayed.  One must request the vendors to modify their payment terms.  Finance and fulfill purchase orders.  Idle equipment must be put for sale or on lease.  Boost profit margins.  Invoice factoring/ invoice discounting/ invoice financing/ sale invoices. 3.9 FUNCTIONS OF CASH MANAGEMENT 1. Inventory Management It deals with forecasting and planning inventories based on the orders from the clients. The usage and storage along with the management of finished goods. It ensures timely completion of the customers orders and prompt receipt of bills receivables and payment of bills payables. 2. Receivables Management A company shouldinitiate its invoices so that sales can be enhanced. The credit period for debtors may range from 30 days to 90 days. The cash management’s function ensures that there is a quicker recovery of all the receivables to stay away from a probable cash critical situation. The company must aware of future contingencies like bad debts etc., and ensure follow-up technique to ensure the speedy recovery of bills. 3. Payables Management 50 CU IDOL SELF LEARNING MATERIAL (SLM)