Managing Working Capital to Fund Growth

Working capital, the difference between a company’s current
assets and its current liabilities, has always been an important consideration
for corporate treasurers, but the approach to working capital management has
been undergoing a subtle but significant change in the past four to five years.
The year 2009 was one of the worst on record for working capital performance
(according to research from consultancy firm REL), with many companies having
to aggressively follow up their receivables in order to squeeze as much as
possible out of their working capital.

Now, a greater desire to
avoid taking external funding means businesses are on the front foot with their
cashflow to a much greater extent. This more sophisticated approach means they
are focusing on long-term improvements in order to generate extra liquidity,
rather than fighting short-term inefficiencies. Focusing on the ‘big-picture’
helps identify any bottlenecks in the working capital cycle and resolve them
before they become a problem – rather than reacting to issues as they occur,
which can lead to other difficulties.

For example, when a company
conducts a working capital optimisation drive by reducing days inventory
outstanding (DIO), this might result in buyers looking elsewhere while they
wait for items to come back in to stock. Or, if a company increases its days
payable outstanding (DPO), the longer period of time until payment might cause
difficulties for suppliers, negatively impacting DIO. So unless the whole
working capital chain is taken in to account the problem simply shifts
elsewhere, and the whole process becomes a succession of urgent drives to
reduce inefficiency.

Proactivity is Key

The benefits of taking a more proactive approach are clear, with research
from PwC showing that between 2007 and 2011, the most efficient European
performers (in working capital terms) were able to fund their own growth, while
the least efficient performers had to look elsewhere for capital to fund their
growth. According to the PwC paper, the least efficient companies in Europe
fall short of the most efficient companies by over £300m in funding. Overall it
found that, among the European companies surveyed, more than £830bn of extra
capital could be released if all the companies performed as well as those in
the upper quartile.

As businesses are recognising the use of a
strong and proactive working capital process with a long-term focus, banks must
concurrently update their offerings in this area to be able to provide the best
possible service for their clients. Historically, the approach by banks to
working capital management was very product-oriented, matching the short-term
needs of their clients. However, as clients’ demands have changed banks need to
evolve alongside in order to match these demands. At the same time, the
products offered by banks to help clients optimise their working capital have
become increasingly commoditised, meaning it has become harder to differentiate
one from another with a purely product-driven approach.

For this
reason, banks must now be taking steps to immerse themselves in their clients’
working capital management and gain a far better understanding of their
processes, in order to offer more holistic solutions that focus on the big
picture of generating long-term improvements to fund growth. This means that
banks must now take a more end-to-end approach, as their clients do, rather
than simply offering products at one stage of the process. Individual products,
of course, remain important as a means to assist with working capital but banks
must give a greater consideration to how these products link together from one
end of the working capital cycle to another.

A Variety of
Solutions

The solutions that banks offer to assist companies
in managing their working capital is now much more varied than in the past and
can be tailored to suit the needs of an individual company. For example, if a
company is looking to optimise their receivables cycle, a bank might offer
products such as payments solutions (collections, direct debit), export letters
of credit (LC) and export collections, card acquiring, distributor finance,
invoice matching and financing, factoring, foreign exchange (FX) risk
management and inflation rate hedging. At the same time, among all these varied
offerings there is the expectation that a bank will delve in to a client’s
working capital and help them link these solutions together, as this is the
best way to use the working capital cycle to unlock extra value.

This ‘big-picture’ approach to working capital management is currently one of
the major trends in cash management and as more firms see the amount of extra
capital they can generate it will continue to develop. Banks also play an
important role in working capital management and so it is crucial that they
develop their offerings, to match the more holistic view being taken by
treasurers.

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