Following a recent survey on working capital levels, J.P. Morgan’s Jasmine Tan and Amy Eckhoff discuss current liquidity levels and popular treasury strategies.

Liquidity and working capital is often referred to as an unsung hero: nobody pays it much attention – until it’s needed. For treasury teams it is always front of mind, and today that means navigating the impact of higher interest rates on liquidity alongside other current trends, like those highlighted in J.P. Morgan’s recent survey of S&P 1500 companies’ working capital levels. It found liquidity has returned to pre-pandemic levels led by an increase in sales and reduction of inventory; companies have begun to deploy funds strategically after a period of cash preservation, but liquidity also remains trapped in supply chains. Treasury Today spoke to J.P. Morgan’s Jasmine Tan, Head of APAC Treasury Advisory, and Amy Eckhoff, Head of APAC Liquidity and Account Solutions, to find out more.

How much liquidity do corporates have on hand at the moment?

Jasmine: According to J.P. Morgan’s analysis of the working capital of the S&P 1500 companies, cash levels are currently at a ten-year high, averaging at around 20% of sales. In normal times, companies typically maintain 3-5% of their top line as cash buffers to manage their working capital. However, as we emerge from the pandemic, we are seeing companies deploy cash on capital expenditure, for pay-outs to shareholders, and for M&A activities after a long period of cash preservation.

Are they more anxious about liquidity now than in recent years?

Jasmine: The pandemic-induced slowdown in early 2020 had compelled companies to build additional liquidity buffers by cutting back on expenses, halting capex and share buybacks, and raising external funding. While the strategy of high cash buffers to manage the uncertainty worked well at that time when the interest rates were close to 0%, we are currently experiencing a period of quantitative tightening, where we are already seeing and expecting more rate hikes in major economies for the remainder of this year. The opportunity cost of this cash buffer – which is sitting in different parts of the business, either intentionally or as trapped cash in different locations – may start to hurt companies. We do expect treasurers to increasingly focus on right-sizing their liquidity buffers.

How is the macro environment impacting liquidity strategies?

Amy: We are seeing treasurers review their debt management strategies and revisit their approach to managing liquidity so that they can mobilise internal idle cash for self-funding and working capital purposes. We also see increased focus on obtaining real-time visibility to their cash positions and the adoption of AI powered cash forecasting tools, in addition to resilient automated rules-based liquidity structures to reduce operating costs and unlock excess cash.

What is the impact of high inventory levels on liquidity?

Jasmine: During the height of the pandemic, supply chain disruptions drove organisations to hold more inventory, resulting in higher days inventory outstanding (DIO) levels that can lengthen a company’s cash conversion cycle. This meant companies were taking a longer time to convert inventory purchases into cash sales. However, as we emerge from the pandemic, we are seeing a reduction in inventory levels due to rising consumer demand. The improvement in the DIO can help in the overall enhancement of the cash conversion cycles and free up working capital.

What key liquidity and cash management strategies are you seeing corporates put in place to safeguard/preserve and have liquidity on hand when needed?

Amy: As external borrowing becomes more expensive, corporates are increasingly looking at self-funding and mobilising idle internal cash to meet short-term payment obligations, optimise debt cost and enhance shareholder returns.

By centralising funds and deploying strategies such as cash concentration, just-in-time funding, multi-currency notional pooling and optimising intercompany position management, companies have an opportunity to release idle cash and reduce the need for costly, short-tenor FX solutions. The result could be real-time visibility and access to a stable source of cash that would otherwise be sitting idle within the organisation.

Jasmine:

1. Multi-currency notional pooling – rather than tap external funding, which is becoming more expensive as interest rates rise, it makes sense to leverage internal surpluses arising from idle balances across fragmented global accounts or maintained at the subsidiary levels due to over-forecasting of their cash needs. Multi-currency notional pooling provides corporate treasury with the ability to self-fund and reduce reliance on external debt. In addition, relying on multiple currencies will provide treasury teams the flexibility to choose the currency most favourable to draw down at any given time.
2. Supply chain financing – the supply chain disruptions caused by the pandemic has made many companies more aware of the importance of maintaining healthy partnerships with suppliers, including smaller players who traditionally have been excluded from traditional supply chain financing programs. J.P. Morgan’s collaboration with Taulia, a leading provider of working capital technology solutions, has enabled the bank to launch a digital trade platform that enables our clients to onboard all their suppliers, regardless of size.
3. Deleveraging – since 2021, we are seeing more companies taking advantage of the normal market conditions to refinance their COVID-19 debt taken in 2020. This trend is expected to continue in anticipation of interest rates heading higher.
4. Revisiting hedging strategies – to get ahead of the rising rate cycle, it pays to do a sensitivity analysis and run financial scenarios using a range of rate forecasts to give you a sense of your company’s exposure to interest rate risks across various future paths. If these forecasts cause concern, treasurers might want to look at various hedging strategies to manage cash flow fluctuations.

Are you seeing any new trends/products emerge around cash and liquidity management? Third party deposits; virtual solutions, distributed ledger, other people’s money?

Amy: There has been a paradigm shift towards a real-time liquidity ecosystem, with significant growth in the use of virtual solutions/accounts to reduce the need for physical accounts, enhance segregation and reporting capabilities, and lower operating costs.

We also see more companies increasingly getting into business activities that involve the handling and processing of other people’s money. This will require licensing, safeguarding and business model considerations and we are likely to see the use of smart contracts to automate and enforce business rules and revolutionise intercompany relationships across disparate systems and counterparties.

Jasmine: Finally, in a rising rate environment, tapping into cheaper internal sources of capital should be a top priority for treasurers in securing liquidity buffers to tide over short-term volatility and risks. Effective working capital management can help to unlock trapped liquidity and can be a vital source of capital for companies. With the treasury’s role becoming increasingly strategic, incorporating ESG into their working capital management through sustainable supply chain financing and dynamic discounting can not only help to optimise liquidity, but also contribute to the supply chain resiliency and ESG goals of the company.