Strategic Treasury

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The New Liquidity Paradigm: Focus on Working Capital Since the onset of the economic crisis, liquidity has taken on an importance that outweighs earnings growth to creditors and investors alike. Consequently, treasurers and CFOs have heightened their focus on working capital as an effective lever of liquidity. As access to capital markets dried up, banks began to retool and shrink their balance sheets, and many companies turned to self-funding as traditional funding sources became scarcer, more expensive, and because the impact of forecasting errors became more significant.

Treasurers are more focused on optimising working capital and extracting liquidity otherwise trapped within their cash conversion cycles than ever before. There is growing recognition that actively managing working capital provides flexibility when alternative funding is not available and access to markets is limited.

This article focuses on how corporate treasurers can improve working capital efficiency, advocating a holistic approach in particular, and offers advice on both choosing experienced relationship banking partners and measuring performance once a cash and liquidity optimisation strategy has been implemented.

The New Liquidity Paradigm: Focus on working capital

by Mark Beard, EMEA Liquidity and Investments Head, Treasury and Trade Solutions, Global Transaction Services, Citi

Since the onset of the economic crisis that engulfed most of the world beginning in mid-2007, liquidity has become more important than earnings growth to creditors and investors alike. As a result, treasurers and CFOs have heightened their focus on working capital as an effective lever of liquidity.

As access to capital markets dried up, banks began to retool and shrink their balance sheets. With traditional funding sources becoming scarcer and more expensive and impact of forecasting errors more significant, companies turned to self-funding. Even many highly rated companies which retained some access to external credit sources  during the financial crisis have been opting to fund internally where feasible and fortifying their efforts to improve working capital efficiency.  

Investors have been rewarding this behaviour. Studies show that firms with high cash-to-asset ratios are attracting a 12% equity valuation premium over less liquid companies. Consequently, treasurers are focused more on optimising working capital and extracting liquidity otherwise trapped within their cash conversion cycles than ever before, and recognise that actively managing working capital provides flexibility when alternative funding is not available and access to markets is limited. The benefits of working capital improvements are measurable and substantial. At Citi, we have supported large multinationals in reducing their working capital requirements by up to 30%, translating to an accretion of 2% to 3% earnings per share.

Holistic approach yields greatest rewards  

Despite the potential advantages, many companies miss opportunities to release liquidity by failing to take a holistic view of how initiatives to improve working capital will impact their cash conversion cycle. For example, an exclusive focus on payments efficiency fails to address wider liquidity implications or supply chain risk, while a change in pricing strategy, even if supported by the procurement department, might impact on foreign exchange risk and liquidity.

Once a company starts along a path towards improving working capital efficiency, however, it should choose its relationship bankers wisely. As financial intermediaries, banks help their clients to collect, invest and pay out cash, thereby providing the means to improve processes across the financial supply chain in three broad areas:

  • Procure to pay, from issuing purchase orders through to making supplier payments
  • Order to cash, across all processes which contribute to revenue generation
  • Treasury and cash management processes

By addressing all of these areas on a holistic basis, relationship bankers can provide critical insights into accelerating the cash conversion cycles and enhancing working capital. Looking at each of these in turn, in procure-to-pay there are substantial benefits to be gained by centralising internal processes, technology, and banking arrangements through shared service centres or payment factories. For example, payment cycles can be co-ordinated to improve cash forecasting and liquidity management. By automating payment processing and gaining access to real-time information and analytics, the quality and timeliness of decision-making is also enhanced. For companies with a stronger credit rating than their suppliers, which may be concerned about maintaining the resilience of their supply chain, banking partners can help to establish supplier financing programmes whereby suppliers can access relatively cheap financing through the bank to ease working capital constraints, and secure relationships between suppliers and buyers.

On the order-to-cash side, there are opportunities to centralise and automate processes from the point of receipt of purchase orders to reconciling inbound payments with outstanding receivables. By doing so, companies enable more rapid, predictable cash collection, eliminate float from internal processes and banking procedures and reduce internal process costs and banking fees. Furthermore, by having access to more timely and reliable transaction data, cash management decision-making is enhanced.

Companies that can establish receivables and distribution financing programmes with their banks can support sales growth without extending their cash conversion cycles. With such a programme, the bank purchases selected accounts receivable on an ongoing basis from a company. The company can then offer its customers more advantageous payment terms, which potentially increases the volume of sales, as well as extending their days payable outstanding (DPO). This use of financial intermediaries creates benefits for suppliers and customers alike, helping to strengthen relationships and resilience in the supply chain. For the selling company, it can lead to more sales with satisfied customers, without the working capital strain of maintaining and financing additional on-balance-sheet receivables. Buyers benefit from more competitive payment terms and the ability to continue buying using the liquidity gained between their purchases and payments.

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