Companies are emerging dizzied from the economic rollercoaster of the past few years. Despite encouraging signs of recovery, there’s a lingering uncertainty about its underlying strength, and caution about long-term demand. Corporate leaders are preparing for whatever lies ahead.
If there’s such a thing as nervous optimism, we are living through it. It is causing finance and treasury leaders to train a sharp eye on cash flows as they seek to master the near-term imperatives of viability and maneuverability. Working capital management is ‘in’- the exercise of watching accounts receivable (A/R) like a hawk, aggressively managing accounts payable (A/P), and streamlining inventory have risen increasingly to the top of the corporate agenda. Cash is king again.
And long live the king! An extraordinary balance sheet-strengthening exercise has been under way in the past few years. In the US alone, Bloomberg estimates that US$1.18 trillion in excess working capital can be found on US corporate balance sheets – a 20% increase over the previous year. To put it in perspective, this amount is well over the US$700bn earmarked by the US government under the Trouble Asset Relief Program (TARP). Strategic management firm Booz & Co. commented that: “Even for the strongest companies, analysts and bankers are sending a clear message: ‘Plan to meet cash requirements from operations, and don’t count on the credit windows being open – even for you’.
Scrutiny is fixing on money flows in the supply chain and driving demand for a new breed of solutions and providers. Payment discount solutions wrapped around an electronic invoicing (e-invoicing) initiative, supply chain finance, and even traditional solutions such as purchasing cards (p-cards), and factoring are being overhauled. Most solutions are focusing on mitigating the impact of payment term extensions – driven working capital initiatives on the one hand and accelerating A/P collection on the other.
At the best of times, moving payment terms around is a challenging negotiation given the perception of a win-loss outcome. So what are the necessary elements of a properly equipped working capital strategy?
1. Procure-to-pay (P2P) and order-to-cash (O2C)
These technology-based offerings streamline and automate these cycles, reduce legacy and burdensome paper-based systems, increase visibility, and improve efficiency. They are a must-have in the working capital workout equipment list. Properly deployed and configured, the net result is clear: buyers pay smarter, their suppliers see approved invoices faster, resolve disputes better, and enjoy far greater certainty of payment. That’s a fundamental ingredient to a broader working capital effort.
2. Established trading partner networks
Companies are turning to supplier networks to fuel greater collaboration and rapid time to value in their e-initiatives focused on cash flow and payments. No longer in their infancy, supplier networks can deliver far-better value and remove the burden of in-house ‘do it yourself’ deployments. They have the virtue of reducing multiple supplier efforts as well: suppliers can go to one place to reach multiple customers.
3. Working capital management
Armed with a platform that turns invoices into A/P and A/R, trading partners are able to take advantage of new opportunities to remove inefficiency, or create new value in payment flows themselves.
Payment discount solutions allow buyers and suppliers to efficiently manage early payment discounts offered by suppliers to encourage faster payment by buyers. Where buyers seek to leverage third-party funding to mitigate the impact of payment terms extension initiatives, supply chain finance solutions can offer their suppliers payment certainty, days sales outstanding (DSO) reduction opportunities, and faster payment at very low financing rates.
Direct A/R financing can enable suppliers to independently and directly finance their receivables through a panel of independent third-party funders who bid for the receivables offered – permitting a lower finance cost than traditional factoring. Finally, traditional payment solutions such as p-cards round help by offering payment control for buyers, and payment to suppliers at the point-of-sale (POS). Together, these solutions allow companies to optimise cash flow and operations and mitigate supply chain risk.
Optimising working capital within the supply chain involves a close focus on money flows and supplier relationships. In this new mindset, the treasury function merges with the procurement/sourcing role to create new practices and approaches. Success in working capital management initiatives recognises that value calculated on Excel worksheets can only be realised with the help of excellent supplier relationship practices: treasury and procurement need to work together to get it right. Experienced supply chain providers can help them achieve this.
Building the Structure
The best working capital structure can be built in the following ways:
1. Build a foundation
Don’t even think about a working capital strategy unless you have the foundation built or at least planned. Central to any working capital solution deployed on the back of the approved invoice is, well, the ability to approve the invoice quickly. If you can’t do that, you will be setting yourself up for woeful results. In addition, avoid shortcuts.
2. A spend analysis is key
A thorough analysis of your spend file from the perspective of working capital is essential. It will show you what the opportunity is with what suppliers, and is based on assumptions you set.This first stage is just mathematics. Beyond analysis, it’s critical that Excel macros are reality-tested with the knowledge that comes from history and relationship. This is where the procurement/sourcing role is key, for only they are best positioned to know what finally should be targeted for any buyer/supplier trading relationship. More than this, it will likely be the procurement/sourcing team which will be tasked with making sure the target set is actually achieved.
There is no ‘one-size fits all’ for working capital management. Look for a solution that will reflect the various shapes and sizes of your suppliers – as well as your own internal needs.
3. Involve the chief financial officer (CFO)
The CFO is aware of working capital value propositions that impact earnings per share (EPS), days payables outstanding (DPO), working capital, net interest expense, cash conversion cycles (CCC) and expenditure reduction through the conversion of early payment discounts and rebates. These financial ratios and performance metrics are vital in the new economic environment.
Your CFO will not only be a valuable ally, but potentially a co-sponsor of a significant working capital initiative for your company. The right level of attention ensures that resources are secured, IT resources are identified, and the organisation is aligned on achieving the benefit identified. More than that, it helps focus the mind of the supplier, too.
4, Don’t underestimate the importance of supplier engagement
Don’t underestimate supplier enablement. Many brilliant supply chain initiatives have foundered on the shoals of execution. Working capital management, despite its allure, is no exception. Make sure your provider doesn’t adopt a ‘if you build it they will come’ mentality, or worse, ‘we will build it so you can get them to come’. Look for the partner to prove real-life experience in helping you get your suppliers engaged and enabled. You can’t look for them to negotiate commercial terms on your behalf, but short of that, there’s quite a bit they can help with here. Once your programme is up and running, be flexible enough to fine-tune outreach efforts – there will always be something to improve.
5. Consider the process holistically
A successful working capital management programme is more than just technology, a few Excel macros, and financing. It’s about working with you from the start to understand your objectives, design a programme that meets your needs, support your team internally, and stay with you throughout your programme to ensure that you and your supply chain achieve new levels of financial efficiency.
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