The past few years have been a rollercoaster ride for companies. The shock of the pandemic and economic lockdowns was replaced by soaring demand as the economy reopened. Almost immediately, prices started to escalate and supply chains ground to a halt, threatening the recovery. At the same time, major central banks started to raise interest rates to curb inflation. Then geopolitical tensions, which had simmered for some time, escalated further, culminating in the war in Ukraine; energy prices have jumped in response.
For corporates of all types and sizes, the rapidly changing environment has tested their resolve as never before. While each company has unique challenges and opportunities, recent years have reinforced the importance of a number of principals at the heart of all firms. Chief among these is working capital. While working capital has long been described as the lifeblood of companies, it is now the pivotal issue for treasury. Improving working capital efficiency is therefore at the top of the strategic corporate agenda.
How companies view of working capital has changed
Historically, many companies have tended to look at working capital in a narrow way. For instance, large corporates seeking to improve their working capital efficiency have sought to extend their payment terms for suppliers, without worrying about the consequences.
But the past few years has shown the risks of such an approach. During the pandemic, the sharp economic downturn meant that extending terms for suppliers was impossible without jeopardising the stability of the supply chain. And for many companies, their buyers also needed support as the crisis threatened their ability to access finance.
The supply chain shortages that have accompanied the economic recovery as COVID-19 has receded have highlighted different but equally important vulnerabilities. In the automotive sector, OEMs have struggled to secure access to crucial components, most notably semiconductors. Strengthening relationships with suppliers as businesses move from a just-in-time model to a just-in-case one is therefore critical if supplies are to be secured: extending terms in such circumstances is simply not an option. Similarly, production slowdowns as a result of the shortage of semiconductors have put pressure on other suppliers working with OEMs, which also need support.
By looking across a company’s payables and receivables it is possible to find solutions that address a wider variety of needs and can deliver significant working capital improvements across the board.
The key is to take a product agnostic approach and carefully map working capital throughout the organisation, considering buyer, offtaker and supplier relationships and the potential working capital benefits from a range of working capital solutions.
A fresh look at working capital solutions
Just as the pandemic and its aftermath has made companies more aware of the interdependence of their operations with those of their suppliers and buyers, so it has also prompted many to reconsider the nature of working capital within their organisations and find strategies to improve it.
Over the past decade, there has been an increased interest in solutions such as supply chain finance, which enables companies to extend payment terms for suppliers in return for them getting paid early in exchange for a discount (which, as it is based on the buying company’s credit rating is attractively priced). Such solutions can be critical. However, looking at working capital from a solution-specific perspective – rather than considering how it can be improved more broadly – can be short-sighted.
For instance, many supply chain finance providers tend to focus on a dozen or so of the largest suppliers that constitute the bulk of a company’s payments. While this can deliver significant working capital benefits for both the buying company and a handful of leading suppliers, it necessarily excludes the many other suppliers that a buying company works with. Other solutions may have the potential to reach a wider variety of suppliers, strengthening relationships with them and ensuring greater stability across the strategic value chain.
By looking across a company’s payables and receivables it is possible to find solutions that address a wider variety of needs and can deliver significant working capital improvements across the board. Receivables discounting solutions might be used to reduce concentration risk, enabling companies to increase sales, while for another group of debtors, factoring might be more appropriate. The key is to take a product agnostic approach and carefully map working capital throughout the organisation, considering buyer, offtaker and supplier relationships and the potential working capital benefits from a range of working capital solutions.
Preparing for emerging challenges and harnessing new opportunities
The dramatic change in the business environment will have important working capital repercussions for many companies. While the supply chain shortages that defined the economic recovery are slowly lessening, companies have decisively shifted from a just-in-time to a just-in-case model. This requires them to hold more inventory, which ties up working capital.
Similarly, the inflationary environment will put pressure on companies that are unable to pass on higher costs to their buyers, requiring them to hold more working capital. In both cases, firms will therefore be looking for solutions to improve the efficiency of their cash conversion cycle. More broadly, working capital programmes have a crucial role to play in mitigating risk, which is expected to increase as the global economy slows. A working capital programme can also help to reinforce banking relationships through the distribution of programme assets via syndication to a company’s banking pool.
At the same time, there are a number of longer-term trends that are prompting a reassessment of working capital at many companies. For instance, sustainability is increasingly a key focus for companies given the potential for reputational risk, and many now report annually on their environmental, social and governance (ESG) initiatives and progress. Companies can work with their banks to map not only their working capital and strategic value chain but also their sustainability ecosystem. Working capital solutions can then be developed that incentivise suppliers (via improved pricing) to improve specific ESG KPIs (which are vetted by independent rating agencies).
A working capital solution can be used as a spur to digitalisation, streamlining internal payment processes and harmonization of payment terms. Greater efficiency and transparency, achieved through automation and improved integration with a company’s ERP system and banks, can ultimately reduce missed or late payments, penalties, and double payments, as well as improve a company’s negotiating position and maybe even lead to lower banking costs.
The coming year is undoubtedly going to be challenging for many companies. But by reassessing their working capital, companies have the potential to mitigate risks and enhance resilience, generate significant financial efficiencies, strengthen supplier and buyer relationships, increase sales, reinforce banking partnerships and even further their sustainability objectives. For treasury and the broader organisation, working capital solutions that take a broad view of the strategic value chain can be truly transformative and have the potential to create a competitive advantage: there has never been a better time to investigate the opportunities available.
Want to know more about the latest developments in the area of working capital management? Read the following article: “Working capital is a C-suite priority… the goal is to create a stable strategic value chain ” – BNP Paribas Netherlands