Head2Head: A Balance of Economic and Process Efficiency

by Bruce Meuli and Jonathon Traer-Clark, Global Business Solutions executives, Global Transaction Services, Bank of America Merrill Lynch

In this instalment of Bank of America’s ‘Head to Head’ series, Bruce Meuli and Jonathon Traer-Clark focus on the importance of working capital management, and highlight some of the challenges, both operational and strategic.

BM Recently, I’ve spent lots of time with companies to help them improve working capital management. It’s a rich area but rife with varied opinions and practices. For starters there are numerous ways to define it. I think everyone agrees the objective is to make more capital available to the business, to free up and create a pot of money that can be used to support corporate priorities and drive return on capital. In terms of how you get there, some companies use an accounting definition or they frame the discussion around the cash conversion cycle. Few have the ability to define working capital at a process level. By not doing this, they lack sufficient visibility of the causal factors driving working capital, leading to incomplete analysis and missed opportunities.

JTC For me, the first question is whether this is a matter for treasury in isolation. You’re right that working capital management touches the whole company and is influenced by a wide range of factors like seasonality, key business locations etc. so you have to understand the sales organisation and sales patterns. It also has an impact on relationships with suppliers and vendors, and how you manage stock levels. While this is a fantastic area of opportunity for treasurers to extend their value-add, other parties in the supply chain and finance departments have equally appropriate skills, so it may make more sense for these departments to take the lead for working capital.

BM That’s certainly one area of debate. Another is the assumption that good working capital management just equals extending payment terms with suppliers. It’s a real bugbear of mine. Of course it’s appropriate to analyse and segment your supplier base, creating payment policies based on requirements of all parties across the extended enterprise. But I would argue that it isn’t good business practice just to push your payments out across the board. After all, vendors and suppliers are also company stakeholders. If you simply push your cash flow issues onto their plate, this may not be a sustainable long-term solution for either party, creating adverse economic and operational costs to your business. It’s no surprise we’re seeing national regulators now looking at best practice supplier engagement.

JTC There is a subsector of the market in a completely different situation though. Some are still sitting on large cash balances built up as buffers during the worst of the crisis. The low interest rate environment has enabled many firms to access cheap financing too and this year, we’ve seen swathes of US companies issuing bonds in Europe. The pressure to manage working capital is therefore reduced as the company has no real need. At the same time, they can’t ignore working capital management as a function, and in many ways the best time to do it is when you’re capital rich: many options close in constrained times. It’s about achieving the right balance between capital raising and efficiency, the subsequent deployment and associated metrics. Stakeholders – equity investors, debt providers, employees – will have their own views and in some cases be active in voicing these. Being capital rich brings its own challenges.

BM Taking advantage of low funding costs is fine if it’s a targeted policy and companies don’t get hooked on it. What makes good working capital management important is that industry analysts see through short-term measures. They like to see improving financial metrics, but they also want to know how efficiency gains are made and whether they are repeatable, or simply a one-time fix. My message to companies is that you can sustainably improve your working capital position if you look at both short- and long-term issues, understand cause and effect, and focus on economic cost-benefit. Drive near-term gains but also establish an ongoing sustainable programme that becomes an entrenched company-wide discipline.

JTC There’s plenty of help available too, with a number of insight and information sources, and toolsets available to the corporate working capital management council. You can also bring your banks and other relevant third parties into the conversation, but whoever they are, they need to be skilled at taking an end-to-end, company-wide view to maximise the opportunity effective working capital management represents, and the subsequent available uses of capital. Ultimately, you need to focus on the measures of economic return as much as the process itself.

The TMI Verdict - by Helen Sanders, Editor

This ‘Head to Head’ feature raises a number of important topics for treasurers and other senior finance managers, not least the discrepancies in definition, and the relative importance of working capital in different organisations, particularly for cash-rich businesses. Increasingly, working capital management is being recognised as a sign of good financial discipline, not a tactic to address or prevent financial distress. Bruce’s mention of supplier payment terms is encouraging. Early working capital optimisation projects in particular tended to be heavy-handed in extending supplier payment terms without considering the consequences, leading to often valid accusations of corporate irresponsibility and arrogance. Secondly, Jonathon raises the important issue of working capital management. Given that working capital is an issue that affects a range of departments, it is not necessarily clear-cut where responsibility should lie. With increasing treasury centralisation, in conjunction with increasing scope of shared service centres, this is likely to be a frequently debated issue.