Working capital management in a low interest rate environment

Working capital management is important for all organisations: effective management in this area can reduce a company’s need for external borrowing and increase the amount of cash which can be invested effectively.

Most companies are aware of the importance of effective working capital management. However, the extent to which companies focus on this area can vary considerably. For one thing, every company has a unique set of challenges and business practices, which can affect the way that working capital is managed. In addition, a company’s approach to working capital can also evolve over time: changes to its business model, geographical footprint and funding structure can all affect the way in which working capital is approached.

While internal considerations will affect working capital management, external factors – such as the current low interest rate environment – can also have a considerable impact. In the aftermath of the global financial crisis, difficult funding conditions prompted companies around the world to manage this area more effectively. As a result, many were able to achieve considerable improvements to working capital.

These improvements have not proved sustainable, however. Research published by PwC found 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. According to the report, working capital performance currently consumes over €300bn more than it did before the financial crisis.

  • Working capital metrics

Defined as the difference between an organisation’s current assets and its current liabilities, working capital is linked to activities such as accounts payable, accounts receivable and inventory.

In order to optimise working capital, companies can introduce improvements in three key areas. They can increase days payables outstanding (DPO) by extending the payment terms offered to suppliers. They can reduce days sales outstanding (DSO) by speeding up the collections process for payments from customers. And they can reduce days inventory outstanding (DIO) by reducing the inventory held by the company. In combination, these steps can help companies reduce their cash conversion cycle (CCC).

Impact of low interest rates

There are several reasons why working capital management performance has deteriorated in recent years. One consideration is that just as a difficult market acts as a catalyst for companies to address this area proactively, less challenging markets can have the opposite effect.

Why is this the case? 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.

This course of action offered obvious benefits during the financial crisis, when funding was scarce and the costs of funding were higher. In the current market, however, low interest rates mean that companies have little to gain by investing excess cash in investment vehicles which pay little or no returns. Similarly, the low cost of funding means that companies may see only a limited benefit if they redeploy excess cash to pay off bank debt. As such, many companies may choose to leave cash in their operating businesses.

However, while companies are likely to have less of an incentive to tackle working capital in the current market, they may find themselves at a competitive disadvantage if they take their eye off the ball. Although the benefits of working capital optimisation may be limited for cash -rich companies in a low interest rate environment, there are still opportunities to use working capital optimisation to drive considerable benefits.

For one thing, the process improvements involved in efficient working capital management have wider benefits beyond releasing cash. For another, not all companies are funded at market interest rate levels. Companies which use more expensive sources of funding, such as asset backed securities programmes or factoring programmes, may still benefit by using working capital improvements to reduce funding costs.

Even companies which are funded at market interest rate levels can benefit from working capital improvements if they approach this area in a more granular way.

The granular approach

In reality, the effects of working capital optimisation can be very individual, based on a company’s core business and internal funding costs. Tapping into working capital opportunities requires a more nuanced approach, which can be achieved by adopting technology designed to identify individual companies’ potential for optimisation.

Tools such as Hanse Orga’s FS2 WORKINGCAPITAL can evaluate the potential for optimisation by taking a deep dive into a company’s specific practices, incorporating both accounts receivable and accounts payable. This process might involve analysing the timespan between sending an invoice to customers and receiving the relevant payment. By doing so at the document level, such tools can not only shed light on broad trends, but also identify which customers have the poorest payment practices.

Sophisticated systems are able to carry out this analysis by country, by company code, by company unit and by other factors, providing a high level of transparency about the costs involved in specific sales. When considered alongside the company’s funding strategy and cost of debt, this approach can give greater insights into the company’s individual opportunity interest rate. This opportunity interest rate then forms the basis for calculating the company’s potential for optimisation.

In practice, most companies do not carry out this level of working capital analysis: they will measure working capital management based on balance sheet and P&L rations such as DSO and DPO. For companies looking to achieve greater insights, the complexity of the exercise means that this level of analysis is be difficult to achieve using a spreadsheet. If a company has millions of invoices and incoming payments, the volume of data involved will be far greater than most spreadsheets or calculation tools can handle effectively.

In conclusion, by leveraging innovative business intelligence solutions, companies can bring together disparate sources of data and thereby gain a far more granular and transparent view of their working capital positions. This, in turn, can provide actionable insights, helping companies to reduce costs and build more efficient processes.


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