CENTRALISATION V DECENTRALISATION. The Optimum Financial Management Structure. 3 Phases of Company’s Financial Structure Evolution.
A simplified company growth profile could be represented below:
Stage 1: DOMESTIC (Local Manufacture)
Stage 2: NATIONAL (Exporting Abroad)
Stage 3: MULTI NATIONAL (Subsidiaries Manufacturing Abroad)
As a generalisation, at each stage the company’s structure would evolve and develop, from probably being entrepreneurially based initially to being led by a management team at the multinational stage. During the process of evolution the emphasis will have swung from production to sales, marketing and so forth as guiding forces. However, throughout each stage, and in increasing importance as the company structure grows more complicated, there is the finance function.
CENTRALISATION V DECENTRALISATION
Financial management can be decentralised or centralised, or a combination of the two. Again, the optimum solution will be prejudiced by the type of company and the state of its evolution.
Domestic, single product
In the first stages of development, a company will be highly centralised. This will reflect the requirements of the founder or founders to be in control. They will be controlling direct, in an entrepreneurial fashion, the production, sales and marketing aspects of the business. Finance too will be centralised, and the financial arrangements simple. The company will deal with a single banker; indeed, personal guarantees may be required from the founder(s) to secure finance for the business. In any event, finance is likely to consist of part equity from the owner and working capital from the bank.
If the company is operating at a single location the situation will again be highly centralised, in the first instance. If, however, it has grown to be multi-locational there will be elements of delegation. Local site managers will be appointed to oversee production. Purchasing and sales could still be centralised in order to retain the benefits of bulk ordering and customer contact. Finance, like production control, could be delegated in part. A local plant accountant would be appointed, to be responsible for recording activity of the plant in financial terms. A local bank account might be required to facilitate payment of wages and local bills. This may introduce another banker to the organisation.
At some stage the company is likely to begin sourcing its raw materials abroad, requiring financing and currency exposure management.
National, single product
If the company is manufacturing one product, which it sells at home and abroad, control is likely to be central, though production may be multi-locational. At this stage sales abroad may be direct, but more likely will be through a local agent familiar with the local customers. Sales may be invoiced to the agent in base or local currency. An efficient funds collection service will be required to ensure good value as soon as possible. This may imply multi-banking. In order to receive funds quickly (unless paid direct on open account terms) the company will need a local bank account for the clearing of cheques and drafts. The bank chosen should be a member of the local clearing system and have good correspondent bank links with the lead banker to the company. Such rationality will ensure that funds will be passed swiftly along the chain to the company’s own account in the base currency.
The situation of the national, multi-product company is similar to the preceding situation, though since there is greater variety there tends to be growing complexity. In this instance more control is likely to have been delegated from the centre in all areas.
The central finance function will monitor funding activity, but the local financial manager may be responsible for raising finance, buying and selling foreign currency, and local banking relationships. This could lead to anomalies in financial control. One subsidiary could be selling currency while another is buying it, and one subsidiary could be borrowing from a bank while another has surplus funds to invest.
Multinational, single product
A multinational company has overseas subsidiaries which manufacture the company’s products. The products may be parts, which will be assembled in a single location; or the entire production process, through to a finished product, may be involved. Delegation of responsibility is likely to be more in evidence in the latter example than in the former because if there are problems at the assembly plant, the production plants may have to cut back. This level of integration on a multinational basis needs tight cohesion and monitoring, probably involving the financial control aspects as well. A central finance team will probably monitor the buying and selling of exchange, etc., on behalf of the overseas subsidiaries, subject to local exchange controls and controlled company legislation. In some instances regional treasury centres are set up in tax-favourable locations to ensure the efficient handling of the funds of the multi-national.
Where the overseas subsidiary is an integrated one, the finance is likely to be organised at local level. This will again create a multi-bank situation, with subsidiaries setting up their own contacts. The operational difficulties in the group context noted in the preceding section could occur. The system may not be efficient.
Multinational, multi-product is the final stage of company growth complexity. Overseas there will be fully integrated operations, sub-holding subsidiaries, cross-border holdings and so forth. At this stage the management structure is likely to be highly decentralised in order to retain local management motivation – as well as being the most practical arrangement. Finance will probably be decentralised as well, with the various aspects of the finance function being replicated at the country holding company level. The group will be multi-banked, with a complex network of banking and financing arrangements.
Where local subsidiaries are of sufficient size and strength, decentralised treasury management would tend to be the most efficient if the overall financial scheme is overseen by a central point to ensure no conflicts with group financial policy. If local companies cannot support themselves or it is costly to replicate the treasury expertise at subsidiary level too, the parent may run their finances for them. However, local management would still be responsible for local cash management needs, i.e. paying of bills and chasing receipts. The parent would merely ‘manage’ the consolidated funds only.
In summary, centralisation or decentralisation is more or less efficient depending on the type of organisation. In management terms the structure can be split geographically, by product or by function. The permutations are endless. Within the finance function, centralisation allows the negotiation of financial resources from a position of greater strength. The centralisation may be on a country or regional basis or even on a global basis (there are few instances of a centralised global treasury department). The company is then able to monitor currency and interest rate flows, thus optimising them for the best overall return to the group.
Centralisation is also best in terms of rapid decision-making. As pointed out earlier, this is essential with the high volatility of markets. The shorter and clearer the decision tree, the more efficient the overall system.
It is said that centralisation is a demotivator, but it is the degree of centralisation, not the feature itself. It is more important that the organisational structure be well defined; otherwise managers will find it difficult to achieve high performance.
In many companies the optimum situation is decentralised management control with centralised financial control, combined with a monitoring process to oversee local bank contacts – which will always be required.
With either a centralised or decentralised finance function, the need for a specialised team, responsible for the financing of the company, can be identified. At each stage of the company’s evolution, new financial demands are put on it – either in having to raise capital for expansion, to exchange base currencies for foreign currencies or to arrange day-to-day financing of the business. The financial markets are an amalgam of products which need to be assessed and the most suitable ones chosen. This is the role of the specialist, the treasurer (or cash manager).