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.