Treasury Today Country Profiles in association with Citi

Working capital optimisation: fine-tuning the supply chain

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Corporates are holding onto record amounts of cash to boost liquidity levels in light of market uncertainty. But should businesses be using this opportunity to invest in their supply chain? Treasury Today asks whether working capital optimisation is the better bet for the long term.

When looking to fund the business, treasurers often turn to bank lending and the capital markets. But these options can be unpredictable in such a volatile economic climate. Corporates need to search further if they are to get the best out of their funding potential.

Enter working capital optimisation (WCO). Not to be confused with simply releasing trapped cash, WCO is a dynamic term that relates to the art of establishing and maintaining an effective financial supply chain. By devoting resources to building a robust and flexible supply chain, corporates can become more efficient, thereby cutting costs and boosting revenues in the short term and beyond.

Working capital management in general has taken on a heightened importance in recent months. According to a study released in April by RBS and Greenwich Associates, 72% of responding companies stated that working capital management was an ‘important strategic component to their overall financial management processes.’

Moreover, 84% of respondents claimed that working capital management has become ‘an integral part of their funding strategies.’ Businesses are now taking notice. By fine-tuning their payables, receivables and inventory processes, corporates can install a more powerful engine when it comes to the financial supply chain.

A whole new world

The troubled global economy is arguably having a large impact on WCO and the financial supply chain. “Credit is in short supply today and capital preservation is at the top of the agenda,” says Michiel Ranke, Head of GTS i-LIM Product Management at RBS. “This is driving the conservative approach to working capital management: corporates want to keep their assets highly accessible.”

“In the past year there has been a complete change in the corporate world with regard to how WCO is being used by treasuries,” agrees John Mardle, Managing Director at CashPerform. A distinct lack of good investment opportunities in the United States and Europe has led to corporates hoarding record amounts of cash. Corporate cash holdings in Europe alone, for example, were estimated to be an enormous €2 trillion in late March.

At the same time, increased awareness among treasurers and sustained advances in technology are expanding the possibilities and potential of payables and receivables to the business. Companies are centralising treasury operations, integrating the trade finance and cash management areas, and automating collection processes. These two developments are joining at the crossroads to create a new trajectory for WCO, one that embeds it within effective supply chain management. The art of WCO now operates in a different world.

And it is a disconcerting one. Volatile, unpredictable markets ensure that even the best efforts of corporates are being stifled. According to research conducted by REL Consulting, a leading working capital advisory firm, a majority of large companies fail to accurately forecast quarterly working capital estimates by up to 23%. In other words, a typical Global 1000 corporate could save up to $600m per annum by optimising receivables, payables and days inventory outstanding (DIO).

Easier said than done, however. The difficult business environment means that corporates are finding their supply chains are running into trouble as small businesses – ie their suppliers – struggle to keep out of the red.

What results for some corporates is a “trade-off,” according to Mardle. On the one hand, they could continue to save for the proverbial rainy day; after all, maintaining liquidity and managing risk are the top working capital management priorities for businesses. Holding reserves of cash make these objectives achievable. But on the other hand, there are companies that realise that the extra cash can be used to bolster their supply chains.

Tuning the machine

Pinching pennies is a good short-term solution. But are corporates not better off investing in WCO? According to some analysts, WCO can benefit the company in the short term and long term. The case for WCO is strengthened by the poor corporate lending landscape. A wave of loan maturities is due between 2013 and 2015, piling pressure on chief financial officers and corporate treasurers alike. Banks are now far more picky about whom they lend cash to.

As a result corporate balance sheets are in the spotlight: in a post-Basel III environment, treasurers will have to clean up their act if they want to tap bank lending. WCO is therefore an attractive option: it sends a message to financial institutions that the company is a finely-tuned machine – and thereby an arguably more reliable debtor – and it allows the business to gain immediate access to trapped cash in the short term.

But how should a treasurer go about implementing WCO? Each corporate is of course unique. And treasurers should judge their requirements on the needs of their business. A case in point is the German company SAP, a leading provider of enterprise application software.

After implementing a number of key performance indicators (KPIs), the front office was able to highlight problematic areas specific to its working capital management processes, improving its days sales outstanding (DSO) correspondingly. “The reduction of DSO, which is the most important part of working capital at SAP, by only one day, improves the cash flow by a substantial seven figure amount and the financial result accordingly,” says Andreas Hartmann, Head of Front Office at SAP.

There is no quick fix solution when it comes to WCO, however. While artificial adjustments to working capital, such as delaying payment to suppliers, may reduce working capital in the short term, they are likely to be countered with price increases later on. Unilateral solutions are not the answer. Indeed, they may be part of the problem: according to research conducted by Bibby Financial Services, the global cost of chasing delayed payments for small businesses amounts to a hefty £1.9 billion. Moreover, additional research by REL Consulting supports this argument: in 2009 payment delays to suppliers resulted in $740 billion in cash being tied up in the top 1000 public companies in America.

Step by step

Treasurers can set about implementing effective WCO measures by first conducting a comprehensive overview of the business. Working capital is divided into three areas: payables, receivables and inventory, and the respective processes for these are, more often than not, source-to-pay, order-to-cash, and fulfil-to-service. A logical solution is that the corporate should tackle the area where problems are located, taking into consideration the area’s share of the working capital, its market position and the business model. REL Consulting, an authority on working capital issues, recently suggested the following measures to get the ball rolling:

  • Ensure that WCO is a firm strategic objective on the ground level of the business.

  • Work around the volatile market to ensure that accurate forecasting processes are implemented as much as possible – a difficult, but rewarding task.

  • Integrate cross-functional areas of operation processes effecting working capital management.

  • Introduce employee accountability to the causes and symptoms of the problems.

  • Incentivise the workforce: incorporate WCO as a permanent component of the reward structure.

  • And train all levels of staff, including the workforce on the ground, to understand the benefits of WCO.

Outside the company’s offices, difficult market conditions are influencing WCO trends. For example, efforts to hoard cash have in many ways led to the rapid emergence of ‘dynamic discounting’ on this side of the Atlantic. Dynamic discounting occurs when a supplier offers a buyer a discounted payment, often in tranches. With more cash in the company coffers in both the United States and Britain, businesses can afford to pay large sums of money upfront.

Take a £10,000 payment for a goods delivery for instance. The buyer says it will pay a total of £9,800 for the items – ie implying a 2% discount – but will pay, say, £8,000 upfront; the remainder paid at a later date.

Dynamic discounting originated in the United States some years back, but global economic troubles are fuelling its popularity. Suppliers are finding it difficult to make ends meet; an immediate payment can be used to relieve strained cash flows. And with many businesses hoarding cash, buyers are in a better position to offer that payment upfront.

But the emergence of dynamic discounting is just one aspect of a ‘new norm’ in WCO. According to Mardle, another is the recent uptake of ‘white labelling’, where a supplier outsources the task of chasing debt to an agency that can operate under that company’s moniker. White labelling is a popular solution for large suppliers; there is no doubt that DSOs have taken a hit, with buyers finding it difficult to pay their clients. By outsourcing the often arduous duty of chasing money owed, suppliers can concentrate on other areas of their function that need improving. “White labelling is one of the key things that is happening in the past 12 months. Outsourcing gets rid of the costs and suppliers are getting a far better return on their money” says Mardle. “In many cases these external agencies are far better at chasing debt.”

“In 2012, WCO best practice is about proper alignment throughout the whole financial supply chain, taking into account the type of sector you are operating in,” continues Mardle. It is no longer enough to view WCO in terms of trade assets and trade liabilities. A two dimensional viewpoint such as this inevitably leads to limitations in the potential of effective working capital management processes.

Instead, corporates should adopt a holistic approach to the financial supply chain, argues Mardle. Think of the importance of maintaining transparent counterparty relationships; think of bolstering the supply chain with innovative payment solutions that make both your business and the supplier see the benefits of working together. For instance treasurers can benefit from a multitude of payment providers, such as Sage Pay, who offer tailored solutions to individual clients.

More knowledge, more technology

But the troubled economy is not the only factor behind the development of WCO. The art of maintaining an effective supply chain has also benefited from the fact that treasurers have become more familiar with the issues. This knowledge has translated itself into a more proactive approach to managing the corporate supply chains, an approach that is honed by the availability of new technology to cement efficiency gains.

“Companies have brought an increasingly forensic focus to the process of daily cash flow management, extending from the initial order to final settlement and reconciliation of the invoice,” says Yera Hagopian, Head of Liquidity Services EMEA, J.P. Morgan Treasury Services. “Few stones have been left unturned, whether during the production or sales process or treasury management of the resultant cash flow, to ensure that internal funding is optimised.”

In March, for example, Bank of America Merrill Lynch launched Trade Pro, a new trade and supply chain portal. Offering an integrated gateway to treasury and trade functions, the tool allows the user to automate processes and manage import and export supply chain activity more effectively. This solution is only one of a range of alternatives that treasurers can opt for.

“The concept and benefits of good DSO/DPO management have been understood for a long time but that understanding is much deeper and more widespread now. In addition technology is making it simpler and more straightforward to calculate metrics more accurately than ever before,” Hagopian adds.

Treasurers are now increasingly taking to setting clear key performance indicator (KPI) targets when it comes to DPO and DSO. Others extend their sights further and use KPIs to reach best possible days sales outstanding (BPDSO), a relatively new term that measures the number of days that all companies take to collect revenue based on the exact payment terms agreed in the sales contract. Treasurers can strive towards reaching the so-called ‘holy grail’ of 100% automatic reconciliation with a number of KPIs set in place.

According to Bank of America Merrill Lynch, straight through reconciliation rates averaged out at 65% across multinational corporates in 2011. Active use of KPIs can allow treasurers to push for a more realistic 85% reconciliation rate, thereby smoothing payables across the supply chain.

But KPIs and bank technology are just two facets of a wide array of changes in optimising a business’s working capital. And underlying all these shifts is the growing ‘dematerialisation’ of the supply chain. By pushing for paperless methods of communication, courtesy of the latest advances in technology, the treasurer can now avoid uncertainty and risk with instant electronic communication. Visibility increases. Speedy reconciliation and exception tracking is assured. And costs are reduced both in terms of time and raw material expenses.

“Automated cross-bank and cross-border cash concentration structures (physical or notional) are taking the strain out of the daily cash management and reconciliation process and crucially avoid loss of value,” says Hagopian.


WCO stands at a crossroads. An uncertain market environment, combined with an upcoming wave of loan maturities and an increasing awareness of WCO among treasurers, has highlighted the growing urgency of investing in the supply chain.

The problem is that the very same market conditions are restricting WCO’s development. By encouraging corporates to hoard cash, the economic crisis is stifling potential investment in the company’s financial supply chain. It is also aggravating unilateral moves to delay payments to suppliers by artificial means. These decisions ripple across the supply chain and can often have severe consequences.

Holding onto cash certainly increases a company’s flexibility in dealing with ‘stress’ events. But this is a short-term strategy to navigate through stormy waters. Treasurers that can extend their sights further by bolstering their supply chains with prudent investment can realise both short-term and long-term benefits by doing so: unlocking trapped cash and securing their financial supply chain for the future.