J BUSN RES 1986:14:345-354 345 International Cash Management: A Study of the Practices of U.K.-Based Companies L.A. Soenen University of San Diego Little information is available on the current practices of cash and foreign-exchange management by companies+specially outside the United States. The purpose of this survey was to investigate responsibilities and practices of international cash management. Although the survey had a much broader scope, this article addresses six important issues with regard to cash and foreign-exchange management: policy and responsibility, centralization versus decentralization, cash-flow planning and foreign-exchange forecasting, banking relationships and cash management services, hedging translation and transaction exposures, conflicts with other departments. Although the size of the sample is too small to permit statistically significant conclusions, some interesting findings can be drawn from this study. Introduction An increasing number of articles are being published and seminars being organized dealing with the subject of cash management. Although these activities provide a contribution toward a general understanding of international cash management, much less information is available about the actual practices currently used by companies (especially outside the United States) to deal with these problems. For this reason this survey of current cash-management practices was carried out. The purpose of the survey was to investigate responsibilities and practices for workingcapital management, covering both the elements of cash management and foreignexchange management. Although the survey has a much broader scope, this article will address a selected number of important issues with regard to international cash management: 1. Policy and responsibility. The hypothesis assumed is that international cash management constitutes a major financial function in the company and, consequently, the responsibility for it within the company should reside with senior management. In addition, a company should have a formal policy for the management of its cash and foreign exchange. 2. Centralization versus decentralization. It is hypothesized that the increasing Address correspondence to Dr. L.A. Soenen, istration, Alcal Park, San Diego, CA 92110. Journal of Business Research 14,345-354 (1986) 0 Elsevier Science Publishing Co., Inc. 1986 52 Vanderbilt Ave., New York, NY 10017 University of San Diego, School of Business Admin- 0148-2%3/86/$3.50 346 J BUSN RES 1986:14:345-354 3. 4. 5. 6. complexity of worldwide cash management and the availability of telecommunication networks favor a further centralization of the cash and foreignexchange management functions. Cash-flow planning and foreign-exchange forecasting. The preparation of formal cash budgets is as fundamental a cash-management activity as exchange-rate forecasting is to foreign-exchange management. We investigate whether or not companies use some systematic procedure to project cash flows and foreign-exchange rates. To what extent are formal quantitative models used for cash and currency management? Banking relationships and international cash-management services. Banks are an important part of the cash-management system. According to Moriarty, Kimball, and Gay [S], companies show an increasing tendency to concentrate their banking activities among fewer banks. We investigate the number of banking relationships companies have and how many of those can be considered leadbankers. We also investigate the use of cash-management services primarily provided by banks and the degree of satisfaction with regard to the services received. Hedging translation and transaction exposure. The hypothesis here is that transaction exposure should be hedged because it has an impact on the cash flow of the firm, whereas translation exposure is a function of the translation method used and measures the impact of exchange-rate fluctuations on the book value of the company. Moreover, foreign-exchange hedging should involve a trade-off between costs and reduction in risk; that is, selective hedging. Companies can choose among several methods for hedging their foreign-exchange exposure. We investigate the use of different hedging methods and ways by which companies judge their effectiveness. Conflicts with other departments. Effective cash and foreign-exchange management will require information and active cooperation of many departments in the company. The search for profitability, liquidity, and safety can result in opposing interests for different departments within the same company. The survey tries to determine which departments are most likely to be in conflict with those responsible for cash and foreign-exchange management and the means by which these conflicts are solved. All these issues will be discussed Survey L. A. Soenen in the following sections of this article. Design The survey was conducted using a 32-page mailed questionnaire. It included 136 questions, most of which asked the respondent to choose an answer from among several possibilities; other questions asked the respondent to specify other alternatives than those provided and, where appropriate, the respondent was encouraged to write comments on open-ended questions. Because of its length, a copy of the questionnaire is not included in this article. Although the purpose of this study was to approach companies in the major sectors of the economy, financial institutions, public enterprises, and government agencies were deliberately excluded. The questionnaire was mailed to 200 companies in the London area, all members of The Association of Corporate Treas- International Cash Management Table 1. Participating Annual J BUSN RES 1986:14:345-354 347 Companies by Annual Sales (1981) Participating Sales Companies 11% 12% 22% 55% 100% Below $50 million $50-$100 million $lOO-$200 million Over $200 million Total urers. Responses were received from 60 (30%) companies. The breakdown respondents by sales levels is shown in Table 1. The total annual sales turnover of of all the companies who took part in this study is $95 billion. We reserve the term “large company” for those with annual sales in excess of $200 million and “small company” for those with sales less than $50 million. It follows from Table 1 that primarily large companies are represented in this survey. Of the participating companies, 50% are the headquarters of a multinational company. The other half of the participating companies represent either the regional or divisional headquarters or a subsidiary of a multinational corporation. The actual respondents to this survey, in general, all occupy senior positions within their individual companies, as illustrated in Table 2. Where it is considered useful to clarify the analysis, the respondent companies have been classified as either industrial (i.e., manufacturing) or trading and service organizations. Although neither the size and the selection of the sample nor the survey procedure allow meaningful statistically significant conclusions, interesting conclusions can be drawn from this research. The results are therefore indicative of corporate practice rather than statistically significant. The Responsibility for Cash and Foreign-Exchange Management The first set of questions dealt with the responsibility for cash and foreign-exchange management within the company and the type of management policy utilized. The executives responsible for cash and foreign-exchange management are summarized in Table 3. Notice that the sum of the totals exceeds 100% because of multiple answers given by the respondents. Cash-management and foreign-exchange-management responsibility is in most companies assigned to senior executives. This responsibility in more than 60% of the respondent companies is shared among the financial vice-president and the treasurer. The financial vice-president’s responsibility is most frequently (70%) reported to be solely for policy issues. In another study by Smith and Sell [12] the Table 2. Respondents Position by Position Held of Respondent Treasurer Finance Director/V.P. Accountant/Controller Cash/Money Manager Other % of Respondents Finance 50% 20% 15% 5% 10% 348 J BUSN RES 1986:14:345-354 LA. Table 3. Responsibility for Cash and Foreign-Exchange Cash Management Responsibility Vice-President, Finance Treasurer Cash Manager Controller Currency Manager 72% 62% 35% 23% 13% Soenen Management Fore&h-Exchange Management 67% 60% 9% 25% 18% financial vice-president was found to have responsibility for establishing the company’s overall working-capital policy in almost half of the responding firms. Involvement in operational as well as policy aspects is more likely to occur in small companies. The position of the treasurer is recognized as a separate function by large companies, and where this function exists it is involved both in policy and operations. The emphasis of the position, however, is placed on the operational aspect. In instances in which other executives-the cash manager, controller, or currency manager-are involved, their role is mainly operational. These latter positions are more prevalent in large companies, wherein cash management is the joint responsibility of more than one individual. In these cases, however, final responsibility lies with the financial vice-president. In companies with more than one individual responsible for cash management, it appears that in many cases a cash-management committee is formed. Although the development of a cash-management policy can be considered a major responsibility, particularly in the current economic situation, over half of the vice-presidents of finance spent less than 5% of their time on such matters. Treasurers devote relatively more time to cash-management issues. The results of this study show that no formal long-term guidelines for cash management are set. Although 20% of the respondent companies indicated that they have no cashmanagement policy, the contents of the guidelines used by the remaining 80% of the respondents are, in the main, of a very general nature and cannot be regarded as constituting formal policies. This suggests that only informal policies for cash management are set. This finding is not consistent with that by Smith and Sell [12], which concluded that just under 30% of their sample firms (210 in total) had a formal policy for the management of working capital, whereas about 60% of the firms had an informal policy and 10% indicated that they have no working-capital policy. A similar lack of a formal policy is found with regard to foreign-exchange management. As Fitzsimons [3] concluded for U.S. firms, few companies have developed a detailed corporate policy that clearly specifies objectives and procedures that guide the person responsible for foreign-exchange management in making decisions about whether, how, and when to protect currency exposures generated in the course of a company’s regular business activities. Centralization Versus Decentralization Just under 70% of the sample companies centralize their cash-management operations at headquarters level, although evidence was found that partial centrali- J BUSN RES 1986:14:345-354 International Cash Management 349 zation takes place at lower-regional or divisional-levels. A definite trend is seen toward increasing centralization of the cash-management function. During the past five years only 8% of the respondent companies had seen a decrease in centralization of the cash-management function. This trend is expected by the sample firms to continue in the next five years, although not as strongly as in the past. Over 40% of the companies expected no change in their degrees of centralization. It is likely, however, that these companies are already highly centralized and this was confirmed by several of the respondents. The trend towards continued centralization of the cash-management function is in agreement with the findings by Reed [lo], Gitman, Moses, and White [4], and Smith and Sell [12]. Another important trend is the integration of the various elements of workingcapital management. Only a fourth of the sample companies believe that the various elements of working capital (cash, accounts receivable/payable, inventories, and short-term finance) can be managed independently by separate departments. Nearly 60% of all the respondent companies believe that they should be managed together by one department. Foreign-exchange management is generally centralized at company headquarters, although one-third of the sample companies did centralize foreign-exchange management at the subsidiary level. As with cash management, in some of the larger companies, partial centralization occurred at regional or divisional headquarters. This high degree of centralization was also reported by Jilling [7], who found an even lower number of companies with decentralized foreign-exchange management. Similar results were also reported by Rodriguez [ 111. During the last five years, a definite trend has been seen toward increased centralization of foreign-exchange management: 54% of the sample companies stated that foreign-exchange management had become more centralized and, by implication, more important to them. This trend will likely continue, and only one company expects centralization to decrease in the next five years. Cash-Flow Planning and Foreign-Exchange Forecasting In all but two companies, forecasts are made of both incoming and outgoing cash flows. Generally, this takes the form of a cash budget. A substantial minority (35%) forecast in conjunction with a sources-and-uses-of-funds statement. For most companies this statement contained the longer-term forecasts; that is, those covering periods of at least twelve months ahead. Relatively few companies (10%) appear to rely solely on the sources-and-uses-of-funds statement. Companies prepare cashflow forecasts on a regular basis, although a wide variation was found in the frequency and degree of detail with which these forecasts are prepared. A similar result was found by Soldofsky and Schwartz [13]. The most common frequency of updating is monthly, followed by quarterly. Several companies, however, stated that the forecasts are updated weekly. This finding is irrespective of the kind and size of the company. Earlier research by Anvari and Gopal [l] into cash-management practices of small firms showed that only 53% of Canadian small firms prepare cash forecasts; this percentage is substantially higher than the 30% figure reported in two similar U.S. studies (Grablowsky [5] and Cooley and Pullen [2]). About 60% of the sample companies think that at least 50% of their incoming cash flow can be accurately forecast in the short term; that is, for periods of less J BUSN RES 1986:14:345-354 Table 4. Information L.A. Soenen Sources Used for Exchange-Rate Forecasting Source % of Respondents Banks Financial Publications Intuition Feedback from Subsidiaries External Consultants Formal Forecasting Model 87% 80% 35% 27% 25% 5% than a month ahead. Cash outflows are regarded as more accurately forecastable than inflows; even more companies believe that a highly accurate forecast can be made. A number of respondents indicated that the accuracy of the forecasting strongly decreases with a lengthening (longer than one month) as well as a shortening of the planning period (e.g., daily forecasts). This might explain why onehalf of the companies see the making of accurate cash-flow forecasts as a serious problem. Several sources of information are used in the preparation of exchange-rate forecasts, but the two used most frequently by companies are banks (87%) and financial publications (80%). The sources of information used in forecasting exchange rates are summarized in Table 4. The sum of the total exceeds 100% because multiple sources are used by some respondent companies. Although the most usual procedure is to use a combination of information provided by banks and financial publications, a substantial minority (35%) claim that they use intuition. Large companies modify the information provided by other sources in light of their own experience or their “feel,” because exchange-rate forecasting, irrespective or whether it is an internal or external forecast, is an indication of the expected direction of the exchange-rate movement. Compared with the findings of Jilling [7], this is an almost doubling of its use. A substantial minority, however, (40%) use a point estimate of the future exchange rate. Table 5 shows the indicators used in making exchange-rate forecasts by the respondent companies. Companies used different combinations of indicators. The two indicators considered to be most useful in predicting exchange-rate movements are interest-rate differentials and inflation. It is interesting to point out the difference in ranking of these indicators found by Jilling [7]. The most important indicators in this study were the trade balance, growth of money supply, and interestrate differentials. The larger the company the more likely it is to use several Table 5. Indicators Used for Forecasting Interest-Rate Differentials Inflation Rate Political Stability Money-Supply Growth Government Budget Deficits Current-Account Balance Overall Balance of Payments Balance-of-Trade Surplus or Deficit Historical Exchange-Rate Movement Trading Flows Exchange Rates 7X% 60% 42% 37% 30% 23% 23% 20% 13% 12% J BUSN RES 1986:14:345-354 International Cash Management 351 indicators, primarily interest-rate differentials, inflation, and political stability. The smaller companies tend to rely on interest-rate differentials and inflation. No company forecasts exchange-rate movements further than twelve months ahead. Half of the companies have a time horizon of twelve months, whereas the horizons of the remainder are equally divided between six months and less than three months. Cash-balancing models have received extensive scrutiny in the financial literature (see Homonoff and Mullins [6]). The majority of the companies (80%) reported that they are not familiar with the mathematic models that have been developed to optimize cash of foreign-exchange-management decisions. However, 17% of the sample companies are actively researching the construction of optimization models for cash and foreign management, and some of them have successfully introduced such models. The companies involved in this field are primarily large trading companies. The conclusion by Petty and Bowlin [9] that the use of advanced financial-decision models “appears to be growing even at a fairly slow rate” also holds for our research, although the emphasis is more on planning models than decision models. International Cash-Management Services The number of banking relationships maintained by companies varied widely, with trading companies tending to have more banking relationships than the individual companies. Nine of the large companies had over 50 banking relationships each, with one of them claiming more than 600. Small companies restrict their banking relationships to only one or two. This finding is in agreement with the results of the study by Anvari and Gopal [l] showing that 69% of the respondent small Canadian firms dealt with only one bank and 24% had only two banking relationships. All companies have at least one leadbank; half the companies restrict themselves to no more than two such bankers, the majority of them U.K. banks. On the other hand, the nine large companies referred to earlier all had at least ten leadbanks. Although the number of banks offering cash-management services is increasing, and a greater awareness of the existence of these services is being generated, only 18% of the companies used such services. In the relatively few companies in which such services are used, the services most frequently used are balance reporting, funds transfer, and consultancy. The cash-management services are generally those offered by banks of U.S. origin, although there is insufficient information to enable any one particular bank’s service to be identified as being the most demanded. Companies using a cash-management service expressed themselves as generally satisfied with the service in regards to efficiency, accuracy of the information available, and the extent of the service network. We found, however, less satisfaction with the facilities offered. Hedging Translation and Transaction Exposure A distinction is usually made between translation and transaction companies can concentrate their efforts on one or the other. The respondent companies concentrate on both types, although they arately. This is in agreement with the findings by Rodriguez [ll], exposures, and majority of the are treated sepwho reported a 352 J BUSN RES 1986:14:345-354 LA. Table 6. Methods of Hedging Foreign-Exchange Method of Hednine Soenen Exposure % of resoondents Forward Contracts International Money Market Currency of Invoicing Extending Credit Terms Leading and Lagging Adjustment of Inventories Commodity Futures Market 83% 47% 42% 37% 35% 23% 5% shift from translation exposure towards transaction exposure as the most relevant exchange risk. Only a few companies concentrate on either transaction or translation exposure alone. Transaction exposure is more likely to be hedged than translation exposure. More than one-third (38%) of the sample companies do not hedge their balancesheet exposure at all, and this proportion holds for both industrial and trading companies. Where hedging is used for translation exposure, it is most likely to be some form of selective hedge (55% of sample companies) rather than a full hedge (only 8%). Trading companies are more likely to use a full-hedge strategy than are industrial companies. Selective hedging is the most used strategy (67% of sample companies) when dealing with transaction exposures, but full hedging is also more frequently used (19%). In this situation, however, industrial companies are more likely to use a full hedge. That a complete cover against foreign-exchange losses is not worth the cost is a strong belief of 75% of the respondent companies. Those companies believe that exchange risks should be minimized first, before deciding whether or not a hedging transaction should be made. When hedging foreign-exchange exposure, companies use a combination of methods (see Table 6), but the most frequently used method (83%) was the forward-exchange contract. Forward-exchange contracts are considered by respondent companies to be the most effective method of hedging against short-term foreign-exchange risk; over 60% of respondents rated them as very useful. In contrast to this finding, Rodriguez [ll] reported that U.S. multinationals were reluctant to use the forward market because many considered it speculative. The most used tools by these multinationals were leading and lagging and the international money market. The only other hedging instrument rated as nearly as effective as forward-exchange contracts is the specification of currencies for export/import transactions. The commodity-futures market is the least useful method of all, with 80% of those using it rating the method as having a low degree of effectiveness. Conflicts with Other Departments The interests of other departments may have an impact on cash-management decisions and vice versa. In our survey, the departments most likely to come into conflict with cash-management are purchasing and sales, whereas the ones least likely to conflict with cash management are production and personnel. Although the degree of conflict is likely to be higher with the sales department than with purchasing, the overall degree of conflict was found to be fairly high. If a conflict arises it is generally (80% of sample companies) resolved by mutual agreement. International Cash Management J BUSN RES 1986: 14:34S-354 353 In the remaining instances, the decision is made in favor of cash management. But a general belief (607 o) was found among companies that efficient cash management should, where necessary, be subordinated to commercial interests. When action is taken to reduce a company’s foreign-exchange risk, the possibility exists that a conflict can arise with another department in the company. Three departments-sales, purchasing, and finance-are identified as the departments with whom conflict is most likely to occur. The incidence of the conflict is not high, and most companies stated that when a conflict is involved, the degree is low or moderate. Any conflicts that do occur are likely to be resolved by mutual deliberation; that is, the resolution of the conflict depends on the specific circumstances involved. In instances in which deliberation is not the case, the conflict is likely to be resolved in favor of exchange-risk reduction. No company is likely to resolve the conflict in favor of the specific department. Conclusions The thoughtful manner in which most of the 60 financial managers responded to the survey is impressive. Many narrative comments made on the questionnaire convinced us that international cash management is considered very seriously. This is also reflected by the fact that the responsibility for this financial function is in almost all companies assigned to senior management. A general lack of formal policy making with regard to cash and foreign-exchange management, however, was found. Effective (financial) management requires a corporate policy that clearly specifies objectives and procedures that guide the person(s) held responsible. A continued trend towards centralization of the cash and foreign-exchangemanagement functions was noted. Another significant trend is the integration of the different elements of working capital preferably managed by one overall department. All sample firms (except for two) prepare cash budgets, usually on a monthly basis. Making accurate cash-flow forecasts is seen as a major problem of cash management. Exchange-rate forecasts usually imply prediction of the direction in which the currency is expected to move. They are based essentially on interest rate and inflation-rate differentials. The companies surveyed are not familiar with the cash-management models that received much attention in the financial literature. Some (17%) companies, however, are actively researching the construction of optimization models for cash and foreign-exchange management. This finding illustrates the need for quantitative tools for managing the cash balance of the company. The number of banking relationships is related to the size of the company. All sample companies have at least one leadbank; one-half of them do not have more than two leadbanks. Few (18%) companies surveyed make use of cash-management services provided by banks. These services include cash-balance reporting, funds transfer, and consultancy. Users are generally satisfied with the services received. Translation as well as transaction exposure is considered by companies in hedging their foreign-exchange risk, although transaction exposure is more likely to be hedged. Companies make a trade-off between costs and risk reduction by following a selective hedge strategy. Forward contracts are by far the method very much used and considered to be most effective in hedging foreign-exchange risk. If the financial manager is to be effective in managing the company’s cash balance 3.54 J BUSN RES 1986:14:345-354 L. A. Soenen and foreign-exchange exposure, he or she needs the informed and active cooperation of fellow executives representing other departments in the company. The survey has shown that the purchase and sales departments are most likely to conflict with cash management. The same departments and the finance department were found to be most likely to have a conflict of interest with those responsible for foreign-exchange management. A general belief exists that international cash management should be subordinated to the commercial interests of the company. In summary, the major weakness with regard to international cash management is that many of the companies surveyed appeared to manage their cash and foreign exchange on the basis of ad hoc opinions of management rather than based on a soundly conceived cash-management policy. References 1. Anvari, M., and Gopal, V.V., A Survey of Cash Management Practices of Small Canadian Firms, Journal of Small Business Management 21 (April 1983): 53-58 2. Cooley, P.L., and Pullen, R.J., Small Business Cash Management Journal of Small Business 17 (October 1979): l-8 3. Fitzsimons, Euromoney 4. Gitman, R.B., Exposure Management (March 1979): 103-112 L.J., Moses, Management Practices, is Too Important to be Left to the Treasurer, E.A., and White, I.T., An Assessment of Corporate Financial Management 8 (Spring 1979): 32-41 5. Grablowsky, B.J., Management of the Management 16 (July 1978): 53-58 Cash Position, 6. Homonoff, Journal R.B., and Mullins, D.W., Jr., Cash Management: Limit Approach. D.C. Heath, Lexington, Mass., 1975. 7. Jilling, M., Foreign Exchange Research Press, 1978. U.M.I. American Practices, Risk Management of Small Business An Inventory Control in U.S. Multinational Corporations. 8. Moriarty, R.T., Kimball, R.C., and Gay, T.H., The Management of Corporate Relationships, Sloan Management Review 25 (Spring 1983): 3-15 9. Petty, Models, W.L., and Bowlin, O.D., The Financial Manager Financial Management 5 (Winter 1976): 32-41 10. Reed, W.L., Profits From Better Cash Management, Cash and Quantitative Financial Executive40, Banking Decision (May 1972): 40-56 11. Rodriguez, Lexington, R.M., Foreign Exchange Management in U.S. Multinationals. D.C. Heath, Mass., 1980. in Practice, In Readings on 12. Smith, K.V., and Sell, S.B., Working Capital Management the Management of Working Capital, 2nd ed. K.V. Smith, ed., West Publishing Company, St. Paul, Minn., 1980, pp. 51-84 13. Soldofsky, R.M., and Schwartz, D.R., Review 13 (January 1973): 59-61. How Companies Manage Cash, Management
