The return of inflation over the past two years and the resulting rise in interest rates have elevated global economic uncertainty, causing organizations and their treasury departments to curb costs in anticipation of a worst-case scenario.

“With increasing financial pressures, firms are being forced to trim costs. Fears of recession and other economic uncertainties and interest-rate fluctuations caused more treasury professionals to keep their money close”, according to the 2023 Association for Financial Professionals (AFP) Risk Survey Report, supported by Marsh McLennan.

The 2023 AFP Risk Survey received responses from 408 treasury practitioners from organizations of varying sizes, representing a broad range of industries and geographic regions (the US, Canada, Middle East, Africa, Europe, Asia Pacific, South and Central America).

Dominance of macroeconomic risk on organizations’ earnings in the next three years

With it being clear that economic uncertainty isn’t going anywhere anytime soon, financial risk (credit, liquidity, currency/foreign exchange, etc.) and macroeconomic risk (pace of GDP growth, inflation and interest rates) are expected to be among the most challenging risks for treasury executives to manage, as per the AFP Risk Survey.

Furthermore, nearly half (49%) of all the respondents reported that macroeconomic risk will have the greatest impact on organizations’ earnings in the next three years, followed by financial risk (45%) and business operations interruptions (35%).

It is important to mention here that 50% percent of the respondents from the US and Canada indicate that macroeconomic risk will have the most significant effect on organizations’ earnings. A slightly lower share of survey participants (46%) from outside of the US and Canada hold the same view.

The belief among treasury professionals that macroeconomic risk will significantly influence their organizations earnings is not surprising, given that persistent inflation and interest rate fluctuations have weighed on global economic activity in recent times. Additionally, the divergent approaches taken by central banks worldwide to restore price stability have been one of the key themes that have dominated corporate finance and treasury discussions since 2021.

Seven cost control methods to be used by treasury during periods of uncertainty and inflation

“Organizations’ decisions to reduce costs and curb expenses are driven primarily by fears of recession/uncertainty in the economic environment (cited by 59% of respondents) and inflationary pressures (58%)”, states the AFP Risk Survey report.

Treasury departments are looking to manage external and internal costs to help preserve their organizations’ margins and protect against economic headwinds. To do so, they intend to use seven methods:

Review pricing of treasury, risk and payments products

According to the survey report, “Three-fourths of organizations with annual revenue of at least $1 billion plan to review pricing of treasury/risk/payments products, while 61 percent of organizations with annual revenue less than $1 billion are considering taking the same action.”

It is important to bear in mind that a successful strategy for pricing during periods of inflation and economic uncertainty relies on a comprehensive analysis and understanding of several key factors. These include cash flow, upstream (pre-production expenses) and downstream (post-production expenses) costs, distribution channels, competitor pricing, the industry or sector’s response to inflation, customer behaviour and price sensitivity, and product profitability.

All of these elements and their collective influence must be factored in to drive targeted price adjustments. Such a pricing strategy should be aligned with a company’s long-term strategic goals and a thorough understanding of demand and market structure.

Seek vendors that offer more favourable terms

The survey findings show that nearly half (49%) of organizations with annual revenue of at least US$1 billion intend to seek vendors that offer more favourable terms, while 53% of organizations with annual revenue less than $1 billion are contemplating taking the same action.

During periods of inflation, it is advisable to seek vendors that offer better terms, such as extended payment terms or lower prices. Favourable vendor terms can boost cash flow management by allowing treasury departments to defer payments or negotiate improved credit terms. This can be crucial during uncertain times when cash conservation is essential.

Securing advantageous vendor terms can also provide greater organizational flexibility in managing inventory and production schedules, helping companies adapt to changing market conditions more effectively.

While it’s important to seek vendors that offer more favourable terms, it is equally important to maintain the reliability and quality of the supply chain. Additionally, it is advisable to diversify sourcing and logistics routes, weaning off dependency from one supplier or one region, keeping more critical materials on hand and identifying alternative domestic suppliers.

All of these measures help ensure consistent supply of materials, reduce or eliminate bottlenecks, increase bargaining power and augment overall resilience of the supply chain.

Reduce capital expenditure

Thirty-seven percent of organizations polled in the AFP survey are considering cutting costs by reducing capital expenditure, with nearly a third (30%) of companies surveyed with annual revenue of at least $1 billion planning to do the same.

Interest rate hikes, inflationary pressures and the prospect of an economic downturn are making treasury departments more cautious about overextending themselves, so they are looking to pull back on capital spending.

Tapping brakes on capital expenditure will mean spending less on planned investments, long-term assets and projects. This will help preserve cash reserves, which can be critical for covering operational expenses and managing liquidity during uncertain times. Lowering capital spending also helps organizations reallocate capital to more productive uses (for example, paying down debt or making strategic acquisitions), including better accounts receivable practices, which will mean more efficient use of working capital.

While scaling back capital expenditure can be beneficial, it should be done carefully to avoid compromising the organization's long-term growth and competitiveness. Thoughtful evaluation of which projects to postpone or cancel is critical to ensure that vital investments are not deferred or sacrificed for short-term cost containment.

Extend days payable outstanding (DPO)

Another strategy that organizations plan to employ to reduce costs is extending days payable outstanding (DPO). A third (33%) of organizations surveyed are considering extending DPO to lower costs.  

Stretching the payments cycle can enable companies to hold onto cash for a longer period, given the economic scenario treasury now finds itself in. This can alleviate the short-term financial pressure that comes with rising costs due to inflation, help maintain adequate liquidity, and prevent the need for additional borrowing.

Furthermore, extending DPO means that an organization may have increased negotiating power with suppliers when it comes to price concessions or adjustments in exchange for continued business.

However, it is imperative to keep in mind that extending DPO must be done with careful consideration. Overextending DPO can fray supplier relationships, leading to negative consequences. Striking a balance between optimizing cash flow and fostering healthy supplier partnerships through timely and effective communication is essential for long-term organizational success and for preventing strained relationships.

Reduce days sales outstanding (DSO)

Organizations are considering reducing days sales outstanding (DSO) as the fifth cost-trimming method. Twenty-eight percent of respondent organizations in the latest AFP Risk Survey are planning to decrease DSO as a method to control costs.  By shortening the time it takes to convert accounts receivable into cash, a company can improve its cash flow and make optimum use of working capital.

Collecting payments faster and more efficiently indicates that an organization can meet its financial obligations, reduce its need for short-term financing or lines of credit (lowering interest expenses), mitigate credit risk and enhance stakeholder confidence, which is particularly important during uncertain economic times.

As with extending DPO, reducing DSO should only be executed with thoughtful deliberation. Overly aggressive DSO reduction efforts could jeopardise customer relationships or lead to lost sales if customers perceive stricter or modified payment terms as unfavourable.

Decrease days inventory outstanding (DIO)

Treasury is contemplating decreasing days inventory outstanding (DIO) as the sixth method for cost containment. Thirteen percent of organizations surveyed are planning to reduce DIO as a cost-saving treasury measure.

Having a low DIO means that a company has sped up the conversion of its inventory into sales. A reduction in DIO also indicates that there is less chance that stock will become obsolete and have to be written off.

Lower DIO enables organizations to optimise the balance between inventory, accounts receivable, and accounts payable, leading to decreased carrying or holding costs, reduced borrowing needs, increased liquidity and more efficient use of working capital.

While reduction in DIO is beneficial, organizations should carefully analyse demand patterns and establish appropriate stock levels of goods or raw materials, especially those sensitive to inflation. Otherwise, they could struggle to cope with a sudden increase in demand or with any supply chain interruptions.

Reduce the number of items carried in inventory

The recent AFP risk survey reveals that 12% percent of participating organizations intend to minimize their inventory by reducing the number of items carried as a strategy to control costs. A leaner inventory frees up cash that can be used for necessary operating expenses, reduces storage and holding costs, and allows companies to measure production efficiency.

Trimming the number of items carried in inventory is a valuable strategy to improve cash flow and mitigate risks during uncertain and inflationary times. However, it is recommended that organizations have complete visibility into current inventory and all tiers of the supply chain. This will help them determine the right amount of inventory to keep on hand to meet demand without spending excessive money on storage. It also helps with evaluating potential multi-tier supply chain risk exposure.

To conclude, the 2023 AFP Risk Survey findings suggest that treasury professionals are focused on curtailing expenses to steer their organizations through challenging times.

Implementing the seven cost control methods above as needed will help treasury and risk management executives weather economic uncertainty, take some of the bite out of price hikes, unlock efficiencies and increase profitability.