The release of PwC’s annual global Working Capital Study reveals the dangers of not optimising working capital, and warns against squeezing suppliers to try to improve it.
Despite a 10% increase in revenues over last year, companies are still failing to effectively translate turnover into cash. The quest for improved working capital is forcing some companies to take potentially damaging action, cutting capital expenditure programmes and increasing supplier payment terms.
The findings of this year’s PwC annual global Working Capital study, reveal that cash conversion has declined by 6% in the last 12 months. With capex as a percentage of revenues having plummeted during the last five years, it suggests that companies are managing cash flows by cutting investment, potentially limiting market opportunities.
With the current outlook of more fiscal tightening and ongoing uncertainty around global trade, the cost of cash is increasing, the study notes. Regardless of such strong motivations to find improvements, overall findings on companies’ net working capital (NWC) performance disclose only a small improvement this year of 0.4 NWC days. Improving days sales outstanding (DSO) and days inventory on-hand (DIO) performance has improved marginally (by 0.1 and 0.7 days respectively).
Although NWC figures mark the first improvement in five years, such marginal gains signal missed opportunity, notes Daniel Windaus, Partner at PwC UK. He believes that working capital is the cheapest source of cash. Improving its management “by a very achievable degree” could reap sizeable benefits.
“If all the companies in the study were to improve their working capital efficiency to the level of the next performance quartile, it would represent a cash release of €1.3trn for the global economy.” This, he adds, could pay for a 55% increase in capex.
When improving working capital, one of the first places companies turn to is how long it takes to pay supplier invoices. The study shows that businesses currently take on average 68 days to pay invoices, with many sectors continuing to increase their payment terms: since 2016, 11 sectors have further stretched their payable days.
“Extending payment terms often feels like the low-hanging fruit, improving cash flow almost instantly at the stroke of a pen,” comments Paul Christensen, Co-Founder and CEO of fintech Previse. “However, long payment terms are creating significant problems for suppliers, especially for small businesses with weaker balance sheets, stifling their cash flow and forcing them towards expensive credit options.”
In a bid to extend payment terms while avoiding impacts on their suppliers, many companies are turning to supply chain finance (SCF). Adoption rates have increased significantly since 2014, largely driven by increased uptake from companies below £5bn in annual revenues.
The primary motivation for companies to adopt SCF continues to be the optimisation of working capital. This is in line with the study’s finding of a sharp increase in DPO over the last five years. Improving supplier relationships, as well as the overall supply chain stability of the buyer were also key considerations when implementing such a programme.
However, the study also shows that the majority of SCF programmes cover only 20% of overall spend. “Almost half of all SCF programmes cater for just the company’s largest 25 suppliers, meaning that when a company extends its payment terms and uses SCF to buffer the impact on its suppliers, the larger volume of smaller suppliers has to cope with extended terms,” notes Windaus.
Indeed, notes Christensen, whilst SCF can be a useful tool to help a large company manage its working capital, it is ineffective for the smallest suppliers. “These are exactly the suppliers which struggle most with long payment terms. They are also the companies which are most likely to want access to an early payment programme, and which find it the hardest to access finance.”
The temptation for outsiders is to simply demand that buyers pay their suppliers earlier. The reality is that payment processes “can only move so fast”, explains Christensen. Companies still have to check invoices are correct, the right goods are delivered and complete a host of important compliance tasks.
“Getting suppliers paid faster is in everyone’s interest. No one benefits from 50,000 suppliers becoming insolvent each year in the UK alone (source: Federation of Small Businesses),” he notes. “At the same time, there must be an awareness of the limitations finance departments are under, and the pressures they face to improve their working capital.”
To make progress, businesses need to be mindful of how their decisions impact their suppliers. This is where senior treasurers can show leadership in challenging their operational and commercial functions to drive structural change. This would improve working capital as well as relieve the pressure on suppliers.