Working capital in focus as interest rates rise

A decline in the return on capital employed of globally listed companies over the last decade has been noted in recent EY and PWC reports.

This is despite businesses taking an increased focus on balance sheets since the financial crisis in 2008.

Research published by PwC in 2016 reported that, despite considerable improvements during the financial crisis, companies’ global working capital performance has “progressively deteriorated” over the past 10 years – although small improvements were seen in 2014 and 2015.

However, in 2017 there were small signs of improvement in the UK. A 3% improvement in the cash-to-cash cycle of UK companies released £8.8bn which was previously tied up in working capital, according to Grant Thornton’s latest UK Working Capital Survey.

Since the financial crisis, UK companies have placed more focus on the health of their balance sheets, partly due to increased scrutiny on working capital by executives and investors.

This focus on company balance sheets will become increasingly important as the US, UK and Europe are all expected to see interest rate rises in 2018 following a prolonged period of historic lows.

“While cash and credit appear to be plentiful, both public markets and private investors now have a laser-like focus on cash and working capital based metrics,” Conor Deegan, director of CashAnalytics, tells GTNews.

“In the past, these metrics were used to gauge the efficiency of a company’s financial operations, but investors now monitor them as an early warning signal for future profitability and balance sheet issues,” he explains.

Grappling with shifting interest rates

In challenging markets, efficient working capital management can be used very effectively to free up cash within organisations. This cash can either be invested or used to reduce the company’s external funding needs.

“Ultimately, all of the facilities supporting working capital and supply chain finance come with a cost that is tied directly to interest rates,” comments Deegan.

“The expected increases in interest rates this year will increase the cost and, in some cases, call into question the viability of current working capital financing arrangements, particularly in lower margin industries where they are most relied upon,” he adds.

However, the current low interest rate environment means that companies have little to gain by investing excess cash in investment vehicles which pay little or no returns.

When struggling with trapped cash in a low interest rate environment, using internally generated cash to fund working capital is always the optimal solution, argues Deegan.

“Working with colleagues in local entities and in other departments such as tax to devise strategies to release trapped or unused cash, with the explicit purpose of funding working capital, will be a key activity in 2018,” he says.

“A working capital cycle that maximises the use of internally generated cash will ensure that the company’s operations are funded in the most efficient and cost-effective manner possible, while also allowing key metrics to be closely managed and predicted,” he adds.

How to monitor third-party working capital

Treasurers will need to stay up to speed with these changes and develop a full understanding of the working capital landscape so that they can provide insight and context to working capital discussions within their organisation.

Businesses not only need to stay on top of their own working capital but also that of suppliers, customers and the market in general when forecasting and building a picture of future liquidity requirements.

“The largest companies in the world have a huge impact on global working capital flows and understanding current metrics and long-term trends is an essential part of effective forecasting and planning,” explains Deegan.

CashAnalytics has launched an openly available online Working Capital Monitor through their website to help treasurers improve both their understanding of the broader working capital market and ultimately their business forecasting.

 

 

The Working Capital Monitor contains 10 years of working capital information on over 350 of the largest companies in Europe and North America. Alongside this, it provides an analysis of close to 50 industries which provides a telling insight into broader market trends in each of the industries.

“We believe that data sits at the core of effective forecasting and planning. The Working Capital Monitor makes some this data easy to access and interpret for anyone with an interest in the area,” says Deegan.

The CashAnalytics Working Capital Monitor is the largest openly available resource focused on corporate working capital data available on the web today, according to Deegan.

The data is designed to be easy to understand and interpret for busy professionals seeking to gain insights to better understand the future cash flows, positions and requirements of all aspects of their business.

 

 

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