Cash & Liquidity Management

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Putting Working Capital to Work-Releasing Capital by Accelerating the Cash Conversion Cycle For the past year, firms around the world have been intently focused on preserving capital and reducing their reliance on external funding. As a result, managing working capital has become a key priority. In this report, Citi’s Financial Strategy Group analyzes recent trends in working capital management and the value creation potential from improving cash conversion cycles. Additionally, they lay out specific areas where banks can help firms improve their cash conversion cycle including changes to business processes and systems, options for vendor and supply chain financing, and liquidity management solutions.

Putting Working Capital to Work- Releasing Capital by Accelerating the Cash Conversion Cycle

A report by the Financial Strategy Group, Citi Investment Banking Division
by Carsten Stendevad, Anil Shivdasani, Shams Butt, Dan Pakenham and Alfredo Bequillard

Executive summary

For the past year, firms around the world have been intently focused on preserving capital and reducing their reliance on external funding. As a result, managing working capital and accelerating cash conversion cycles have become a key strategic priority. Yet most firms have seen their cash conversion cycle lengthened over the past year. This reflects the difficulty of improving cash conversion cycles during severe economic downturns where firms recognize the need to support important suppliers and customers who may need working capital relief to survive.

To understand the long-term potential of accelerating cash conversion cycles, we undertook an in-depth analysis of 22 working capital-intensive industries, covering 828 of the largest global firms. Our main findings are:

  • Almost half of the firms kept stable cash conversion cycles across five years, with only a quarter of firms improving their cycles by more than 25%.  
  • A small portion of firms saw dramatic changes to their working capital usage: 10% of firms shortened their conversion cycle by an impressive 81 days, a 50% improvement. Conversely, 10% of firms lengthened their cash conversion cycle by 83 days, a 124% deterioration.
  • Improving the cash conversion cycle had a direct and positive impact on Return on Invested Capital with an increase of 84bps for the average firm. The top 10% of firms in terms of working capital improvement were able to outpace their peers in investment, sales, and earnings growth, and experienced a remarkable 30% excess stock return.
  • Industries with complex supply chains and global operations typically have the largest potential for working capital savings. But even within industries, there is a surprising degree of disparity in working capital practices, suggesting large improvement potential for many companies.

Improving the cash conversion cycle requires firms to collect receivables faster from customers, keep inventories as low as possible, and get better payment terms from vendors. The main benefit of these actions is to reduce the need to fund working capital from bank lines or other external capital sources. An optimized cash conversion cycle enables firms to better manage complex supply chains, strengthen relationships with key vendors, distributors and clients, optimize purchasing processes to achieve larger discounts, and minimize invoicing and collection errors.

We found a highly statistically significant relationship between working capital improvement and improvements in interest coverage ratios.

Because relationship banks help firms collect, invest and pay out cash along the financial supply chain, they can be valuable partners in accelerating the cash conversion cycle, both in streamlining cash processes and extracting liquidity from the supply chain. Few firms have achieved daily visibility into cash positions, accurate cash flow forecasting, and efficient cash repatriation on a global basis. Many firms have fragmented internal processes and too many banks, which are costly and ‘trap’ cash in the system. Finally, many firms have yet to centralize investment processes for managing excess cash. By adopting best practices, we estimate the working capital improvement potential to be up to 30% for the typical large multinational firm, which translates into a 2–3% EPS improvement.  

In today’s market, achieving such capital release while boosting earnings is invaluable.

Working capital as a strategic priority

Faced with a prolonged economic slump, firms have preserved capital by sharply curtailing non-essential capital expenditures, by reducing capital distributions at the fastest rate in fifty years1, and by making deep operating cost cuts. Although financial markets have stabilized, most companies face a higher cost of capital and bank lines have become scarcer and more expensive. The turmoil in the commercial paper market has reminded firms of the liquidity risks embedded in short-term financing.

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