Optimising working capital through treasury transformation

In today’s uncertain macroeconomic environment, companies have more reason than ever to focus on optimising working capital. At the same time, treasurers are increasingly focusing on centralisation structures such as in-house banks to achieve working capital improvements. HSBC’s Andrew Wild, Head of Commercial Banking Europe, Deputy CEO HSBC France, explains how companies are approaching these challenges – and what steps HSBC is taking to support customers in Europe in the current climate.

How important are working capital improvements to your customers in the current economic climate?

In the current economic climate, issues such as increased trade tensions, low interest rates, social unrest in some countries around the world and continuing uncertainties around Brexit are of particular concern as treasurers look at how they are managing their cash.

Against this backdrop, we are acutely aware that our clients are placing considerable focus on working capital improvements. From airlines to luxury goods companies, many different sectors are having to manage reduced margins while looking for opportunities for greater efficiency within their operations. As such, working capital is increasingly seen as a key indicator of companies’ sound management profitability. Certainly when we talk to treasurers, working capital is a topic that is foremost in their minds.

How are companies approaching this task?

Working capital is an area that involves a lot of moving parts. Where treasurers are concerned, the main focus is on reducing days sales outstanding (DSO) and increasing days payable outstanding (DPO) in order to improve the cash conversion cycle without impacting sales growth or disrupting the supply chain.

Corporates can improve working capital in a number of ways. From a DPO point of view, companies might in the past have achieved this by processing payments late, or by negotiating one-sided pricing with some of their smaller suppliers. But today, I think there is a realisation – certainly within the larger corporate space – that this is unsustainable. Companies are therefore looking for innovative solutions to increase DPO, while at the same time supporting their supplier bases.

Some companies achieve this by adopting supplier financing, but what we are also now seeing is an increased focus on corporate card programmes. Many companies that are talking to their suppliers about offering earlier payment than they would normally receive are looking into the use of purchase card schemes, as these enable buyers to pay suppliers immediately while extending DPO. Clients are increasingly asking us what terms we offer on our card programme and how far out we can go to help them manage their working capital more effectively.

Companies are also looking at opportunities to reduce DSO, which is the time taken to convert sales orders into cash. In the past, treasury teams focused on the balances of accounts in order to manage their cash flow. But increasingly, with better data from payment systems and a greater understanding from banks that data is a key driver for corporates, we are seeing more focus on segmentation – in other words, products that can segment customer receivables in different ways.

With virtual accounts, for example, specific customers are allocated a dedicated bank account number. This means that any cash that goes into the virtual account can be posted automatically into the accounts receivable ledger. As a result, credit control teams no longer need to spend hours of their time trying to match outstanding invoices to payments received, but can focus on more value added tasks such as managing slow payers.

Indeed, one of our clients was able to reduce DSO from 60 days to 48 days by implementing such a solution. This freed up a significant amount of capital, and also meant they could carry out better investigations and credit checks on new customers, as well as more effectively chase slow payers.

Should companies be looking at both sides of this equation at the same time?

Absolutely. When companies are looking at working capital, DSO, DPO and other activities that are all happening at the same time, there is no point in focusing only on purchases if your sales organisation isn’t also focusing on collecting the cash as it comes in.

Another important consideration is the need to improve visibility on cash balances. Real-time balance information can enable treasury teams to focus on where they are right now, how they can invest surplus cash, and whether or not they have short-term borrowing requirements that need to be met. This might mean using banks’ liquidity management portals that can drill down into cash concentration structures. Or it might mean taking advantage of automated investment solutions, whereby surplus cash can be automatically invested and taken off the balance sheet to reduce counterparty risk, while also maximising returns.

Treasury transformation is often positioned as a means of improving a corporate’s working capital. To what extent are your corporate customers engaged in this journey, and what are they looking to achieve?

Centralisation via treasury transformation is still the most prevalent topic for the clients I speak to in Europe. Even big multinationals often feel that there is still scope for them to achieve a greater level of centralisation. We’re also seeing considerable focus on this topic from our large corporate and middle market customers, whether they are regional or have disparate business units within a particular country. These companies are now looking to centralise – whether that means putting in place a cash overlay solution to minimise idle cash, or setting up a full-blown in-house bank solution along the lines of the structures used by very large corporations.

The centralisation process allows companies to review their own internal systems and processes. They then look to the banks to complete this process, in some cases by achieving greater integration through their payments or receivables. The main objectives are really to enhance visibility, streamline processes and build efficiencies within the working capital cycle. That is really what the focus tends to be on this centralisation journey.

While it feels like this topic has been around for quite some time, the level of maturity within conversations with our clients is very striking. Some clients have carried out a lot of work over the last five years and have moved to a highly centralised regional or global treasury centre arrangement with an in-house bank.

These companies may have very sophisticated setups, but at the other end of the spectrum there are those that are just starting out on this journey. For these companies, there are plenty of challenges to consider – not least of all the need to get the whole company behind them for what really is quite a fundamental business change. This isn’t just a change to the treasury system, which might be contained to treasury, and perhaps the finance department. It is something that affects the whole company, including business heads, treasury, finance, procurement, operations, sales and distribution functions. So the topic is broad and there is a lot to consider – but there is also a lot of opportunity for companies to get started on that journey.

Do companies tend to work their way up the centralisation ladder one step at a time, or do some set their sights on implementing an in-house bank from the outset?

We see examples of both approaches. A lot of it is down to the appetite within the broader leadership structure and the level of risk that the company is willing to take at the time. I was speaking to a client a few weeks ago, and they wanted to focus on basic connectivity in the first instance before looking into a payment factory solution – they were not ready to look at other parts of the puzzle yet.

They may equally look to tackle their risk management by centralising their FX exposure and no longer have their business units managing foreign currency transactions at the local level. Even if they are not putting in place an in-house bank, companies may centralise their liquidity in order to have better visibility and access over cash. As a result, they can manage their liquidity more effectively. This might mean using solutions such as notional pooling, which enable companies to offset short-term working capital deficiencies within a certain currency against long positions in other currencies, rather than having to do costly foreign exchange swaps and hedging processes.

Generally companies that do want to aim for a highly centralised structure in the longer term may engage in a phased approach defining intermediary milestones. The question is how much treasuries can afford to do at this point in time and how much they are willing to disrupt in one go, particularly given the continuing uncertainties in today’s macroeconomic environment. This level of uncertainty and volatility has to be factored in when companies are looking at making significant changes to how they receive or make payments.

How can companies use these types of centralisation structures to support their working capital initiatives?

Bringing all these things in-house, reducing the number of bank partners and potentially reducing the number of accounts, without necessarily adopting a full payments on behalf of (POBO)/receivables on behalf of (ROBO) virtual accounts structure, really does help treasury teams manage their working capital more effectively. As a result, they may be able to fund legal entities that would otherwise require expensive overdraft solutions with a non-core bank.

Bringing all of that into play also adds to a company’s purchasing power. If you have one or two regional or global banks, your purchasing power with those core banks will be much better than if you have 56 banks and 300 accounts.

Typically with treasury transformation, companies will also see a level of IT change, which may bring opportunities to drive further efficiencies, increase automation and move away from spreadsheets. All of these factors can help you gain better visibility over where you are in your working capital cycle, where your stock is and who your debtors are.

So the IT change that goes along with treasury transformation is one component. Another is functional change, which may include procurement and finance as well as treasury. It is not just treasury that is centralising – it is often a lot of the processes that are driven or supported by other functions. The end result is a better line of sight over what is going on.

What challenges do your corporate customers face in implementing efficient working capital solutions?

Most important is the need for senior management alignment. There is no point in a treasury team coming up with a fantastic procure-to-pay project, only to realise that IT doesn’t have the necessary resources for the next two years. Likewise, it’s easy to assume that companies will have a defined vision of where they want to be – but in reality, different functions may have different ideas about what they want to be doing in two years’ time.

Strong senior management alignment/sponsorship can certainly help that. Some companies now have working capital committees that can look both at the indicators and at the underlying business below those indicators. We are also seeing a big inflection point for some companies that are growing either through acquisition or through organic growth. These companies may have reached a certain point in terms of their growth and revenue, but in order to grow to the next level they will require further budget and resources, to streamline their organisation and create efficiencies This is where that senior management drive is needed to get the whole organisation pulling in the same direction.

What approach is HSBC taking to support corporate customers in Europe and how are customers benefiting from your investments in European hubs?

For one thing, we have looked to ensure that our clients are given Brexit-proof solutions. While many of our clients have historically been headquartered out of London, in the last few years we have seen a number looking to move their treasury centres out of London as well. We have therefore built out our hubs in the locations these treasury centres are moving to, including France, Ireland and the Netherlands. We have made sure clients can have the same experience in those markets by investing in technology, solutions and talent.

There is no point in having different solutions in different markets, so we have also focused on standardised connectivity. This includes the ability to produce XML files through host-to-host connectivity or through SWIFT. Another area that is getting more and more interest from corporates is the use of APIs – which comes back to the observation that corporates don’t always want to do everything in one go. Some are dipping their toes into being able to access real-time information through their treasury management solutions. Online banking portals can also now provide real-time data that is crucial when it comes to driving decision-making at the tactical and strategic level.

Likewise, SWIFT gpi is making it possible for customers to find out the status of where a particular payment is. We are building that out so that clients can see this information through our digital channels. At this stage, SWIFT gpi is predominantly for outbound payments – but in the future, SWIFT is planning to add information about receivables, which is something that will be of real benefit for treasurers. Knowing when high value payments are likely to hit their accounts will make it easier for treasurers to use those funds effectively. So gpi is definitely going to be a key driver for our treasury teams going forward.

Efficient liquidity management will also impact effective working capital management and is within the bailiwick of treasurers. The ability to manage short-term FX flows can be managed actively or passively within our hubs. We have standardised cut off times and also worked to ensure that liquidity is available for FX settlements and processes. Treasurers are also reviewing passive management by reviewing notional pooling options which again we have made available in most of our hubs.

Last but not least when it comes to working capital optimisation, we have implemented a state-of-the-art Corporate Cards proposition and will continue to invest in the coming months to bring our customers more features and functionalities.