Cash & Liquidity Management

Question Answered: Working capital

Published: Sep 2018
Silhouette of team building question mark

This issue’s question:

“My business is struggling with working capital and payments are often too slow for our suppliers. What can I do?”

Venkat ES

Head of Asia Pacific Treasury Product, Global Transaction Services
Bank of America Merrill Lynch

Efficient and effective management of working capital is crucial for any enterprise. The traditional definition of ‘working capital’ as current assets minus current liabilities is a very simple concept but it is core to the day-to-day running of a business.

To have sound financial and operational efficiency, optimising the cash conversion cycle (days sales outstanding (DSO) + days inventory outstanding (DIO) – days payments outstanding (DPO)) is an integral part of financial supply chain management. This helps in reducing bank debt but also ensures sustainable and stable links in the supply chain.

The rapid developments in the payment landscape also mean businesses are increasingly looking to payment solutions, both traditional and modern, to unlock hidden cash to achieve effective working capital management. Businesses can explore the following:

Holistic view:

Businesses can adopt a holistic view of suppliers and dealers by categorising them as either strategic or non-strategic partners to gain better payment terms. Deep dive analysis of payment terms has shown that there are opportunities to leverage large dollar value supplier payments to extend payment terms, particularly with strategic vendors. Dynamic discounting is also another tool that can be effectively deployed for working capital management. Providing discounts and rebates to dealer side of the receivables may improve payment terms and cash flows.

Supply chain financing (SCF):

SCF is another option that helps to stabilise financial liquidity by using third-party financing in place of the organisation’s own balance sheet to fund early payment discounts. With an increasing demand for procure-to-pay automation, more companies are showing their interest in SCF to attract and enjoy early payment discounts. Buyers can benefit by reducing spend on goods while suppliers can obtain liquidity and maintain flexibility over receivables.

Corporate cards:

Another great way to accelerate cash flow is through the use of purchase and settlement cards (P-Cards). P-Cards are a traditional fit for financial supply chain management as they combine payments and financing. The benefit of using cards comes from the extended payment dates. Suppliers can receive payments within a few days so they receive money quickly. On the other hand, buyers would have a longer period to pay the bank, enabling them to maximise their working capital for a longer duration.

Going digital:

Effective use of business analytics and intelligence, moving from paper to electronic modes of invoicing, adopting electronic modes of payments, digitalising the reconciliation processes would help the management of working capital and its efficiency.

Effective usage of real-time payment (RTP) mechanism:

The mass adoption of real-time payment globally has contributed to an environment where consumers and businesses are expecting to make payments, settle bills and transfer money securely and quickly. It is all the more crucial for businesses to leverage available real-time payment infrastructure to manage cash flows and working capital.

Nicholas Soo

Director, Regional Head of Payments, Global Liquidity and Cash Management

Like most solutions in life, there is no quick fix and patience, due-diligence and analysis are required – but you can take short-, medium- and long-term actions to rectify the issue for good.

In the short term, you should assess your relationship with suppliers, especially your more strategic partners, to determine if slow payments will pose a significant business disruption risk. If business critical, consider immediate solutions (even if they are likely to be pricier), such as bank facilities (working capital funding, or providing early payment discounts) to ensure your business can continue to operate smoothly.

In the medium term, which could be anywhere from three to six months, you should seek to undertake an end-to-end assessment of your working capital cycle – with a particular focus on the order to cash cycle. Ask yourself: where are the inefficiencies coming from? Many companies face issues in matching and reconciling incoming payments which, if resolved, can free up anything from two days to two weeks cash flow. You should also take the opportunity to consider whether terms with both customers and suppliers can be renegotiated.

From client conversations, we have also learnt that undergoing a stocktake of credit terms across both suppliers and buyers, as well as seeking opportunities for standardisation, is an important step in tackling such issues.

As your payment is someone else’s collection, you may also want to consider speaking to your supplier on their reconciliation challenges and whether you can structure your payment (ie providing the right payment in the right place) accordingly to ease their administrative burden.

Such engagements could benefit you by providing improved chances of discussing favourable terms, or at the very least assist to eliminate some processing float.

Then there’s the long term. At HSBC, we’ve observed that market trends, changing buyer behaviour and enablement via technology are dramatically changing the distribution channels for our clients. These include selling directly online and participating in marketplaces, among other digital platforms. Embracing technology to improve efficiencies is a game changer in the market, and we’d recommend exploring how these opportunities can supplement your business strategy and have a positive direct impact on your working capital model.

François-Dominique Doll

Director, Treasury Advisory Services
Deloitte Southeast Asia

When talking about working capital, it is worth highlighting that it is made up of three main components: receivables from customers, payments to suppliers, and inventory levels of primary or finished goods.

The dynamics of these three components can vary depending on the type of business and/or industry. For instance, retail companies and others in the service-driven industry will not have the same working capital issues as an industrial manufacturing group.

For treasurers, while they may have little direct control over inventory management, they are able to directly influence receivables and payables.

Where collections are concerned, it is about establishing the right level of agreement with the customer, either through open account or letters of credit, to ensure that payment is made on time for the goods and services delivered.

A key index for collections is DSO, whereby the CFO is able to see the status of the payment terms – are they on track or behind? Minimising the DSO involves having the right controls and procedures to reduce any delays in payments and therefore, translating receivables directly into cash.

Utilising electronic collections can help reduce the float on receivables as well. Banks offer a number of solutions to improve working capital, including corporate credit cards, virtual accounts and lockboxes, all of which enhance the collection reconciliation process and identify early any late payments from customers.

On the payments side, recent surveys in Europe show that there is a significant increase in late payments from corporations, which is often not sanctioned. Some companies voluntarily delay their supplier payments to make a gain on working capital. It can be a matter of size where large players take advantage of their smaller suppliers, knowing that some SMEs cannot do without their business.

While it is good practice to minimise payment cycles to once or twice a month to optimise resources, the reduction of bank fees through automated payment method such as ACH makes it possible for companies to support their suppliers by putting in place a number of SCF programmes. These can be done through the banking partner, and suppliers can be onboarded in order to be paid earlier on their receivables and they can also get an extension on the DPO.

SCF is a key topic for treasurers in 2018. Yields on cash invested are still at low levels and treasurers realise that they can better leverage their working capital by offering financing solutions to their suppliers. Over the last few years, a number of fintech companies have emerged to connect directly suppliers with customers. These collaborative tools work by proposing dynamic discounting or by agreeing to a rate for payables based on supply and demand. This tends to be a win-win for both parties where working capital can be optimised in exchange for better returns.

With all these metrics, it then becomes essential for treasurers to use data analytics to regularly measure the value they contribute to the business and justify their importance to their senior management.

Next question:

“To what extent is treasury being changed by consumer behaviour?”

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