Through good times and bad

10/30/2022

This month, the World Bank warned that the world is in for one of the worst periods for economic growth fueled by uncertainty and high inflation. Amid the gloom, Nicky Burridge finds out the steps chief financial officers and treasury managers are taking to manage the risks and whether the current economic outlook creates opportunities for treasury management

Illustrations by Gianfranco Bonadies



The World Bank recently warned that a global recession could be on the cards in 2023, as central banks across the globe increased interest rates in a bid to combat high inflation. It pointed out that central banks were raising interest rates with a degree of synchronicity that had not been seen for the past five decades, but these rises and other policy actions may still not be enough to bring inflation down.

“Global growth is slowing sharply, with further slowing likely as more countries fall into recession. My deep concern is that these trends will persist, with long-lasting consequences that are devastating for people in emerging market and developing economies,” David Malpass, World Bank Group President, said.

The situation creates significant challenges for treasury managers as they position their companies to withstand the economic volatility that lies ahead.

Chief financial officers and treasury managers currently face a highly challenging combination of high inflation, rising interest rates, foreign exchange volatility and slowing economic growth. Anna Cheng CPA, former treasury manager of a multinational corporation, explains that rising interest rates are driving up the operating and finance costs of companies. “A global recession would also suppress demand and economic activities, which further squeezes the working capital of companies,” she says.

Dennis Ip FCPA, CFO at Impro Precision, says many companies have already seen a fall in customer demand, leading to lower sales and profitability, which not only creates lower cash flow and liquidity, but also results in higher working capital requirements, due to increasing inventories and a possible rise in overdue receivables.

Meanwhile, Keith Ng FCPA, Deputy Chairman of the Hong Kong Institute of CPAs' Corporate Finance Committee and Managing Director - Finance at Link REIT, points out that as interest rates rise, property and other asset prices are likely to decline, increasing companies’ gearing ratios. This, in turn, increases debt servicing costs, and companies are likely to have pressure on their net profit and cash flow. “For weaker companies, banks may be getting nervous because of asset price declines and gearing ratio increases, making them less willing to lend. The market for high-yield bonds has dried up, so for some companies it is no longer easy to raise money on the bond market,” he says.

Cyrus Wong CPA, Finance Director of Pizza Express Hong Kong, says one of the biggest challenges created by high inflation for the food and beverage (F&B) sector is increased raw material costs. “We order quite a lot of food from Europe. Both food and logistic costs have increased significantly, managing costs and margin is one of the key challenges to our business,” he says.


Weathering the storm

For many treasury managers, preparations for these challenging conditions began some time ago. “When the tide goes out, you learn who has been swimming naked. It is a cliché, but it is very true for treasury management. Preparation must be done when the market is good. It could be very costly if you want to rectify it during a volatile market,” Ng says.

In the current environment, he says treasury professionals must stick to the fundamentals and avoid the temptation of short-term profits or cost savings. For example, he points out that for bank financing, while uncommitted funding may be cheaper, companies should not rely on it too much, as banks may withdraw it at short notice.

At the same time, Ng says companies should diversify their funding as much as possible. “In Hong Kong, bank loans are typically cheaper, so some companies rely on those, and are reluctant to issue bonds because they are more expensive. But bank loans are typically only for three to five years, and if they don’t diversify their debt maturity it could become lumpy, with a lot of loans maturing in a particular year.”

He points out that treasury managers can use bonds or swaps to fix the interest rates for some of their debt, while they should also conduct a cost-benefit analysis on how much of their foreign exchange risk they want to hedge. “If you short sell a high-yielding currency, you pay a premium, but if it is a low-yielding currency you won’t. With the renminbi (RMB), people very rarely do a 100 percent hedge because if they do, all of their investment returns would be gone because it is very expensive. Obviously, hedging costs have recently reduced as the U.S. dollar interest rate went up. But, the U.S. dollar has strengthened a lot already,” he says.

Ip thinks CFOs and treasurers should ensure their company has ample liquidity, regardless of the market conditions, pointing out that when COVID-19 first hit in 2020, many companies ran into problems due to having inadequate liquidity. “We always maintain around HK$1 billion in undrawn banking facilities to ensure ample liquidity, even in extreme circumstances like in the past couple of years,” he says.

Ip adds that Impro Precision, a global casting and machined components manufacturer, has also diversified its sources of finance, increasing the number of Hong Kong principal bankers it has from four in 2016 to more than 10. “We do this to maintain healthy competition between the banks so that we don’t rely on one particular bank, in case it is hit by bad credit and reduces its lending.”

Ip adds that the company also maintains banking facilities outside of Hong Kong, in Mainland China and Turkey, so that it can tap additional financing if it needs to. Cheng says: “Treasury management needs to strike a balance between the days sales outstanding and the credit term to optimize working capital. Other sorts of funding from financing or investing activities are also necessary to stabilize the liquidity of companies.” She adds that for short-term purposes, trade discount and factoring are commonly used for the early collection of receivables, although this involves additional financing costs.


“When the tide goes out, you learn who has been swimming naked. It is a cliché, but it is very true for treasury management.”

Wong says he has worked closely with the financial planning and analysis function of the business during the challenges of the past three years to take steps to manage cash and optimize operational costs. “Every time new anti-pandemic measures are announced by the government, we need to assess the potential impact and look at different scenarios, such as a 50 percent drop in sales, to make sure we are prepared,” he says. “We need to project our cash position for the upcoming 12 weeks on a weekly basis based on difference scenarios to make sure the business is self-sufficient in term of cash, whereas this process was done on a monthly basis when the market was stable.” He adds that the frequency and accuracy of forecasting is particularly important during difficult times.

Like many businesses in the food and beverage sector in Hong Kong, Pizza Express’ main costs are labour, food and rent. “In the face of rising food costs, we are constantly adjusting our menu or offering to maintain the balance between food quality and margin. We also need to be more flexible with the cost structure of labour, to enable us to react if sales are expected to drop significantly. Recruiting and retaining our part-time staff pool is the key to building a flexible labour structure. We need to reduce fixed costs and convert some of them to variable costs to manage our cash flow for both the short and long run,” he says.

Dr William Chen FCPA, CFO at Quasar Engineering, a medical device manufacturer, points out that high inflation has led to increased raw material prices. At the same time, following the recovery from the COVID-19 pandemic, some materials are in high demand globally, meaning there are longer lead times for delivery. As a result, Quasar Engineering is ordering higher quantities to ensure sufficient material for production and to make purchases before prices increase further.

“From a financial perspective, it ties up more cash in terms of both unit cost and quantity before we can transfer the cost to our customers. The finance function plays an important partner role by working more closely with purchasing, operations and sales teams to analyse and identify the right balance of material inventory levels, unit material costs and cash flow,” he says.

The strong U.S. dollar is another challenge. “We all learn that FX hedging is like buying insurance, but sometime the hedging cost is high. We do a matching/natural hedge, such as making material purchases in same currencies as sales,” Chen says.



Managing risk

An important part of the role of treasury management is identifying and managing risk. Cheng says foreign exchange volatility is one of the key risks multinational corporations currently face, due to the diversity of their businesses across different countries. “This can be minimized by keeping transactions in local currencies to mitigate the foreign exchange risk, but it cannot be avoided altogether due to the different denominated currencies in different countries within the same group. Therefore, appropriate hedging strategies need to be in place to minimize exposure to foreign exchange fluctuations,” she says.  

Cheng adds that in an inflationary environment, rising interest rates, and by extension increased financing costs, is another risk. “Executing fixed-term instruments or arranging hedging, such as interest rate swaps, can help to stabilize financing cost arising out of short-term increases in interest rates,” she says.

For Wong and the F&B industry, the biggest risk is uncertainty in the market. “For treasury management purposes, we need very accurate forecasts for cash inflows and costs. But it is currently difficult to predict sales accurately, as they are highly dependent on the government’s anti-pandemic measures. We expected the end of hotel quarantine to benefit the market and the business but it turns out the impact is not as good as we expected. We still need to keep managing the uncertainty and build different scenarios to make sure we are not over-optimistic in our forecasts.”

Ip points out that as a precision manufacturer, the biggest risk his company currently faces is reduced demand for automotive and certain industrial goods during the economic downturn. Other risks include higher working capital requirements, high interest rates and volatile exchange rates. To ensure it has adequate working capital, the company reviews its inventory and receivables on a weekly basis. It has also included working capital in its key performance indicators, and built foreign exchange movement adjustment mechanisms into its customer contracts.

“Whenever there is a significant change, such as a 3 to 5 percent movement in the U.S. dollar and RMB exchange rate, we have an adjustment mechanism under which we can move the sale price up or down,” Ip says.

He adds that the company also has access to financing in different countries to help manage interest rate risk. “In China, the interest rate is currently dropping, so we are borrowing more from there to replace higher cost borrowing in Hong Kong.”

To increase cash flow, Chen suggests working closely with the commercial team to increase the frequency and accuracy of sales order forecasts, and with the supply chain and operations team to closely analyse material and finished goods turnover, as well as unit costs. “Treasury professionals should also regularly review with the supply chain team the payment terms of the top 20 vendors to identify opportunities, as well as increase the review frequency of receivable aging for faster collections, and challenge the necessity and timing of capital expenditure,” he says.



Identifying opportunities

While the current economic environment presents challenges for treasury managers, it also creates opportunities.

Ip points out that as a company that has the majority of its production in China, the RMB’s current weakness has resulted in a HK$26 million exchange gain in the first half of 2022. “We have also taken advantage of the Hong Kong Interbank Offered Rate being lower than the London Interbank Offered Rate and the Secured Overnight Financing Rate to divert some of our U.S. dollar financing into Hong Kong dollar financing in order to leverage the lower borrowing costs of the Hong Kong dollar,” he says.

Ng says: “As interest rates went up quickly, previous swaps’ fair-value gain could be pretty good. I know some companies are considering closing out some of those swaps and taking profits. However, that should only be done within the risk appetite of the corporation.”

He adds that a high interest rate environment is also good for new investments. “Investment-grade bonds are easily yielding more than 6 percent nowadays. It is the right time to deleverage but also a good time to invest in solid businesses and bottom fish,” Ng says, referring to a short-term price action strategy where investors buy assets that have experienced a decline.

Wong points out that the current environment also makes it a good time for restaurants to invest in new premises. “Though many restaurants in Hong Kong have closed, we see that the market rent is lower and the cost of building a new restaurant cheaper than a few years ago. But we need to bet on the recovery of the economy,” he says.

Meanwhile, Cheng thinks the current challenges offer treasury professionals an opportunity to shine. “Previously, companies may have used accounting and finance staff to cover the treasury function, regarding it as a cashier function. As the complexity and diversity of a business grows, we are witnessing an increase in awareness of the need for more sophisticated treasury management, particularly in an environment in which the economic outlook is volatile.”


“We are witnessing an increase in awareness of the need for more sophisticated treasury management, particularly in an environment in which the economic outlook is volatile.”

Being prepared

As treasury professionals navigate the current volatile environment, Ip stresses the importance of staying up to date with macroeconomic developments, and fine tuning the company’s strategy to take account of these changes. “We have to maintain good liquidity, and have good control of working capital. It is also important to have a strong team in place to report the numbers quickly and continuously update financial forecasts,” he says.

Ng suggests treasury professionals should prepare for the challenges ahead by arranging surplus financing and committed revolving facilities and ensuring that debt maturities are scattered. “Formulate your interest rate and foreign exchange strategies and seek approval from your board to ensure alignment.”

He adds they should also keep abreast of the market developments and ensure they have the professional knowledge to understand any products they are offered thoroughly. “Both accounting and finance knowledge is essential for treasury professionals. A lot of treasurers have both CPA and chartered financial analyst qualifications. For every transaction a treasurer does, they need to know exactly what the accounting treatment will be and what the accounting implications are before they act,” Ng says.

Chen advises treasury professionals to be heavily involved in business discussions at both strategic and operational levels, and discuss the implications for cash flow with top management before any decision is made. He adds: “They should also consider increasing the facility line headroom when the business performance and cash flow is still positive.”


Wong suggests treasury professionals to closely monitor their business, not just in terms of cashflow, but also the accuracy of the information they receive across the business, such as figures on projected sales and costs. “Any variant could cause very serious consequences. If we miss 10 percent of the sales forecast then the result could be very different, especially when the fixed costs still account for a significant portion in the business model.” Ip adds: “Overall, treasury managers should always be prepared, no matter whether times are good or bad.”


Recent consensus forecasts suggest that the global economy will experience its steepest decline in growth over the next two years following a post-recession recovery since 1970. Growth forecasts for the United States, Euro area, and China have also been lowered significantly, according to a report released by the World Bank last month.