Working Capital – the Treasurer’s Swiss Army Knife

October 21, 2016
Colin Evans
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When working with corporates, one of the most common issues that cause headaches for the finance team is freeing up additional working capital for the business. However there are multiple ways in which significant cash can be freed up by determined Treasurers.

In today’s environment, when liquidity is often pressurised by factors such as limited access to borrowings, ‘trapped’ cash, slim sales margins, the treasurer can play a major pro-active role in how the organisation manages (and optimises) it’s working capital, and reduces pressure on company liquidity. Other benefits include recognition of good financial management by banks, credit insurers and other agencies, who can identify improvements in annual results.

One of the most important benefits of cash generated by successful internal working capital strategies is that it is cheap liquidity when compared to external funding such as borrowings and equity; when permanent working capital improvements are achieved this can have a significant impact on the finance costs of the business.

Working capital improvement is an area where the Treasurer can demonstrate real strategic management and leadership skills, which can deepen their involvement and recognition for their contribution to managing the organisation as a whole. This is because successful working capital projects involve the co-operation of multiple departments, and will require solutions tailored to that specific organisation, its structure, the products, the markets in which it operates, and the financial information that can be obtained to identify working capital issues and solutions.

All organisations that don’t have ongoing working capital improvement strategies will have opportunities waiting to be identified; the Treasurer (as custodian of the company’s cash resources) is in an ideal position to lead this work. A company’s buying and selling models have not evolved to optimise liquidity, or reduce inefficient working capital; senior management in these areas will not usually have an automatic awareness of how their area impacts company liquidity until they have gone through a working capital project; by owning the project, the treasurer can build a companywide personal reputation for engineering significant changes in the corporate mentality.
How can significant working capital gains be made?

Working capital consist of four key elements…

Cash, Debtors, Creditors and Inventory: these are the Swiss Army Knife tools to drive working capital improvements.

Firstly it’s important to establish an accurate, reliable set of metrics to measure the key indicators of company working capital performance using the well-known measurements of such as days inventory outstanding, days payable outstanding, stock turnover and days sales outstanding. The initial data may not give any strong indicators of working capital performance as it can be difficult to establish what ‘good’ looks like at the start of the project. However, this information sets a ‘baseline’ to measure the progress of working capital improvements once a project has begun, it also can be used to set targets to obtain ‘buy-in’ and support of key departments. The real results will be reflected in reduced borrowings and increased liquidity when cash is unlocked from the balance sheet which is the purpose of the exercise.

Pierre de Corta, Head of Factoring & Supply Chain Financing at BNP Paribas, in his article “Collaborate to Compete”, looks in much more detail at the need for collaborative effort in working capital improvement and using this to reinforce the view that Treasury is the natural focal point for a more holistic working capital strategy. He goes as far as to say Working capital can be the difference between success and failure.

Working capital management is a huge subject that cannot be covered in detail in this blog; however here are some snapshots of tools I have used in challenging environments with great success.

Supplier Management

Matching supplier payment terms to customer payment terms or keeping them shorter. Utilising idle credit / debit notes on the ledger against outstanding accounts payable, reducing payment runs to preserve cash and optimising the timing of disbursements, strict enforcement of supplier payment terms. Permanent improvements can be made by working with procurement to avoid dilution of payment terms in the negotiation process without approval of an FD or controller. Leverage suppliers as working capital providers NOT vice versa.

Pro-Active Stock, inventory & raw material management

To my mind the biggest single drag on working capital in a manufacturing business is that overstocking locks cash in the balance sheet, particularly in seasonal business where sales can dip causing movement of stock to slow dramatically. Revisit ‘safety stock’ levels, rationalise products to eliminate those with low margins, identify customers with ‘unique’ product needs, which can be costly and unnecessary. Review order timing; identify lead times which are too conservative.

Credit & Collection (AR)

Can you improve the aged debt profile of the sales ledger, by better collection efforts and enforcement, consider sending the oldest debts for legal collection before write off. A huge problem is the early payment discount culture, where it’s not uncommon to see 2-3% of an order value lost in discounts; these should be eliminated where possible as the belong to the era of high interest rates. Use account receivable assets as a funding tool (e.g. factoring) if not already being used. Review all disputes to identify common problems and patterns which may indicate internal problems that can be fixed permanently. Leverage Customers as Working Capital Providers NOT vice versa.

Medium Term Cash Forecast

13-17 weeks is ideal depending on the cash cycle of the individual business, though it is important to demand timely refreshes of the forecast and accurate data; once this is achieved the Treasurer has a another Swiss army tool for making tactical decisions and to have early visibility of upcoming cash ‘events’. Identify the Cash Profile of the Business, e.g. understand what cyclicality exists within the typical monthly, quarterly, annual operational period and to understand critical peaks and/or troughs.

Measures which can improve working capital from outside the company include:
• Continuously speaking to new banks, (see my blog about Bank Relationship Management), additional or replacement lenders should always be valued.
• Maximise efficiency of existing finance, particularly asset backed programs such as Factoring, where many corporates fail to reach the anticipated levels of funding due to poor management.
• Use of IT finance that offers full repair and replace leases on a rolling basis – outsourced IT asset management can offer cash disposal of obsolete IT equipment
• Maximise use of Leasing and Rental of vehicles and replacement production assets – attractive alternative to cash purchases which reduces pressure on company balance sheet

All internal measures require a high degree of collaboration, working in mini teams and most importantly educating colleagues about the importance of their role in improving working capital in the business, which make the business and ultimately its workforce more secure and achieve valuable career recognition for the Treasurer.