Managing Working Capital in a Low Interest Rate Environment

gtnews: Let’s begin by asking how you would describe the current business environment and the role that working capital management plays within it.

Jim Graves:
It continues to be one in which we’re seeing unprecedented levels of corporate cash. Safety is still a main priority for our clients, who are mainly looking for government-backed securities and are keen to know what their funds are being placed in.

But there are very clearly pent-up frustrations about the prolonged low returns – ‘when are they going to improve?’ is the question we constantly get asked. So while we might be emerging from the crisis at long last, conditions are still tough. The short-term rate markets have certainly been spiky recently. These days, a five basis points (bps) change counts as a major event.

The meagre returns on offer from safer investments has seen some of our clients willing to take on a little more risk, if there is more reward as the trade-off. What they need to ask when investing is whether they are looking to the future, or are still fixated on the rear-view mirror. We encourage our clients to ensure that their policy stays fresh, that it reflects reality and is appropriate for what they’re trying to achieve.

Recently, there has been some concern over the economic prospects for some of the emerging markets, but despite reports of investors pulling out we haven’t seen much evidence that clients are overly concerned.

So cash is still king?

Yes, certainly that holds as true as it ever did. It’s a cushion and a safeguard against a rainy day. Here at the bank we have weekly discussions on where we think the tipping point might lie and what it might take to drive corporates to move their normal usage of cash.

What do you regard as the pros and cons of the current low interest rate environment?

Frankly, there is only one main ‘pro’, which is the stability that is provided by a prolonged era of low interest rates – and even that is offset by several ‘cons’. It does, of course, take out a whole level of noise from the market but it doesn’t encourage lending and there is a strong case for arguing that it acts as a hidden tax on consumers.

When you start looking at the cons, they include the impact on earnings power, the low investment returns and the deployment of cash. It feels rather like an artificial environment and in many ways it is. There are daily readings on when it’s likely to come to an end, but the date is continually being put back a couple more months.

The benefit of hindsight is always great when looking back at the financial crisis and how it came about. Everything you see now is much tighter as a result. With the exceptions of a few opportunistic environments, even if the Federal Reserve was to raise rates by 25bps or 50bps, earnings wouldn’t move in step.

What are the basic components of a good working capital strategy and have they changed because of today’s interest rate environment?

In brief, the answer is ‘no’ the basic components haven’t really altered, so it’s essential not to take your eyes off the ball but to keep to these fundamentals. However, a stable environment also presents you with a great opportunity to reassess your policies and procedures to see if any need adjusting. Otherwise, once things start moving once again you risk getting left behind.

An investment policy that is built on a ‘rear-view mirror’ environment can leave you open; for example if your investment is in a three-year vehicle providing very low returns and interest rates start to move higher. So now is a great time to carry out some tidying up, while still remaining focused on the fundamentals.

An effective working capital strategy comes down to a basic question of discipline. It’s too easy to adopt a lazy attitude when the company is cash-rich. Maintaining that strategy and focus is essential. Now is a good time to try out some new or different tools and if you haven’t exercised discipline in the past, it’s time to start doing so. Ask yourself whether you are moving the business forward, or simply looking back.

How do organisations maintain or adjust a working capital strategy in a cash-rich environment and what impact does unused cash have on the balance sheet?

The question of unused cash and its impact on the corporate balance sheet is a fascinating one. I tend to think of it as opportunity cost and there are various ways in which you can break it down and examine each of the individual elements.

We do see some examples of companies that aren’t using their balances to cover expenses as they regard the balance simply as a safety net. You should be asking whether there are ways in which you can earn more than five, 10 or 15bps by means such as reinvesting, share buybacks or increased dividends.

What role does cash forecasting play?

We’ve always been firm believers in its importance. You need to know what’s going on with your cash, its future uses and the opportunities that are available for redeploying it. Now isn’t the time to start taking your foot off the pedal – if you’re not already doing so it’s the ideal time to deploy active cash forecasting.

It shouldn’t be forgotten that amid the talk of growing corporate cash piles, there are still many companies that are not cash-rich. Yet it’s critical to have a cash fund if you’re operating in a sector such as retail, where profit margins are particularly thin.

What considerations should an organisation make before investing?

First of all, a company should ask itself some fundamental questions, such as how long it wishes to invest for, what its risk tolerance level is and to assess both the level of risk and the level of return. In a low interest rate environment, many companies may not be optimising their returns because they are hesitant on investing.

This can make for a very difficult discussion with some clients. It’s always good to continually review your investment policy and reassess it where necessary.

How much is too much or too little liquidity and how can a business optimise both liquidity and yield?

Your view on the correct level of liquidity is very individual, as one treasurer’s opinion may differ significantly from another’s. At some point it all comes down to how much money is ‘under the mattress’. It’s easier to decide how much liquidity is too little – it will become very obvious that you don’t have enough if you’re running low on cash on a regular basis, if you’re using minor credit drawdowns or are paying overdraft fees. There are many good tools available for assessing if you have too little.

Optimising both liquidity and yield is perhaps not a blanket approach but one that is based on internal forecasting policy. Are you adaptable and are you making maximum use of returns? Ask yourself whether you’re willing to consider new options. A cash-rich environment is one that raises some difficult questions.

So how can organisations prepare themselves for when interest rates eventually rise?

The essential thing is to be ahead and to have good forecasting tools, whether these are in-house or provided by your bank. Reach out and tap your partners – ask them what alternatives they are able to offer. Check whether you’re employing tools such as automated investment features and have all of your cash management toolkit in place.

What else does the future hold for working capital management?

Looking ahead, the crystal ball might still be clouded but it is beginning to clear. It’s certain that we’re going to see some changes, particularly as Basel III starts to impact on liquidity ratios and affects the relationships that companies have with their banks. We might see a change of direction for excess cash.

Investment company rulings and new guidelines on what needs to be held short will also have a material effect. You’ll start getting into areas such as whether the 40 year earnings credit to pay for your fees continues. It will certainly impact on the fees that banks charge for their services.

Will all this change the basic fundamentals of working capital management? Not really, although it may change where the cash actually ends up. After all, it was legislation that brought notice accounts into being. Talks with customers on why the legislation is beneficial are likely to yield some interesting discussions.


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