“There are several triggers in the market that are acting as potential catalysts for change within businesses and treasury departments. Some of these triggers are opportunities for treasurers to harness, notably the ever-more affordable range of treasury technology; others are threats to be managed, not least the volatile geopolitical climate and uncertain interest rate environment”, according to the Association for Financial Professionals® (AFP) Treasury In Practice Guide: Adding Certainty to Working Capital Management, underwritten by Wells Fargo Bank.

Beginning with a review of macro themes that are driving change within organizations, this guide proceeds to explore various tools treasurers can leverage to strengthen working capital management, thereby making businesses more resilient amid financial and geopolitical uncertainties.

“Factors vital to effective working capital management not only include liquidity, but also the funding of the business, the resulting cash flow from operating activities and cash velocity. Importantly the net trade cycle is also a factor. Balancing these various factors – and the relationships between them – is the art of effective working capital management”, as stated in the AFP guide.

Here's how treasurers can formulate a plan to boost their organizations’ resilience through the optimal use of working capital:

Achieve best-in-class liquidity planning

The automation of treasury operations through accessible technology has elevated the significance of forecasting and liquidity planning. Employing liquidity planning to forecast future scenarios equips treasurers with the tools needed to reassess and refine company liquidity management practices, as per the AFP guide.

As organizations embrace automated data processing over manual methods, all departments benefit from real-time access to extensive data points. “For treasury, access to granular data, such as the creation of an invoice or a purchase order, will provide detailed information on actions within the physical supply chain and enable the cash forecast to be updated in real time. Faster payment reconciliation is both an important control and a tool to easily analyze customer payment trends”, notes the AFP guide.

This strategic data-driven information sourcing through automated processes empowers corporate treasurers with timely, relevant, and actionable insights, thereby enhancing the effectiveness of liquidity planning and management.

Furthermore, as mentioned in the guide, achieving optimal internal liquidity also plays a critical role in augmenting liquidity planning. It helps treasurers align operating cash levels closely with the organization's risk appetite, aids the board and CFO in establishing liquidity policy and targets for treasury to follow, improves visibility into cash flows and financial risks, and facilitates effective modelling of “Alternative liquidity management structures,” resulting in more efficient use of internal cash.

Additionally, identifying leading and lagging indicators in the forecasting process allows treasurers to monitor the accuracy of their forecasts in real-time and helps better prepare for future scenarios, improving the overall liquidity planning process. Recognising when forecast data and positions are accurate or not enables treasurers to make necessary adjustments promptly, reducing the risk of discrepancies.

In this regard, the AFP guide suggests that “Having as much warning as possible about any changes to forecasts will help manage any gaps and associated risks. Any changes will also help develop the liquidity planning model to improve accuracy.”

Integration of process disciplines in working capital

Companies aiming to build resilience ought to focus on strengthening operational efficiency and risk management by improving visibility across both physical and financial supply chains. This approach helps in identifying vulnerabilities within the cash conversion cycle.

Streamlining and automating processes is a crucial aspect of increasing operational efficiency. In line with advice from the AFP guide, “Technology enhancements offer the opportunity to streamline and automate many processes and, via the latest payment rails, improve the efficiency of processing payables and receivables.”

When seeking methods to optimise working capital, many organizations evaluate potential improvements in working capital by utilising the components of the cash conversion cycle: days sales outstanding (DSO), days inventory outstanding (DIO), and days payables outstanding (DPO), the guide proposes.

Reducing DSO helps shorten the time it takes to convert accounts receivable into cash. By doing so, a company can improve its cash flow and make optimum use of working capital.

There are various ways companies can lower DSO. The AFP guide recommends automating the invoicing process to speed up invoice delivery and reduce manual errors, facilitating diverse payment methods to accelerate cash flow and reduce processing costs, offering early payment incentives “To get cash onto the balance sheet”, supporting customers' cash flow through credit (customer credit) to enhance supply chain stability, automating the cash application process for better utilisation of cash, monitoring client collection times to mitigate the risk of delayed or non-payments, and shortening contractual payments terms to improve cash flow management.

Decreasing DIO is another method that aids enterprises in increasing liquidity and making more efficient use of their working capital. Having a low DIO means that a company has sped up the conversion of its inventory into sales.

Consistent with the advice from the AFP guide, even though reducing DIO can fortify the cash collection cycle, executive management may be hesitant to shift to a just-in-time inventory policy due to concerns about potential supply chain disruptions.

With the aid of advanced data analytics, “Treasury can work with FP&A to provide insights to help the board and executive management understand how the business holds inventory and to model the impact of different levels of inventory on both cash flow and the financial statements. For example, it may be possible to model the cash flow implications of a short-term disruption to production or to model an assumption that a proportion of customers move to a competitor if a finished product becomes unavailable”, the AFP guide further explains.

This depth of understanding, the guide reckons, will equip the C-suite to make more informed decisions aimed at strengthening resilience across cash, liquidity, and operations management.

Another measure that helps organizations lower costs, maintain adequate liquidity, increase free cash flow, and improve working capital is extending DPO. Stretching the payments cycle can enable companies to hold onto cash for a longer period, given the economic scenario corporate treasury now finds itself in.

Companies have multiple options to increase DPO. The AFP guide advocates standardising payment terms to augment operational efficiency and cash management, offering financing to suppliers to manage inventory risks and reduce costs within the supply chain, automating the accounts payable (AP) processes to minimise errors and fraud, and accelerating payment reconciliation, as well as adopting a mix of payment methods such as same-day and real-time payments to improve control over disbursements timing, and lower processing costs.

Formulate a pivot plan – know when to change course

With expectations of an upcoming interest rate decline from markets and the US Federal Reserve (Fed), uncertainty persists regarding the timing of such a change and the overall future direction of interest rates. Consequently, treasurers must carefully evaluate their funding and borrowing strategies to maintain adequate working capital as efficiently as possible, urges the AFP guide.

In this connection, the AFP guide recommends developing opportunity costs of funding. Amid the uncertainty surrounding future interest rates, treasurers must adopt a strategic approach to fund their working capital needs.

“Doing so provides treasury with as much advance warning as possible about potential funding requirements. The treasurer can then actively plan a funding strategy that ensures access to liquidity when needed, without incurring any unnecessary expense”, the AFP guide notes.

The AFP guide also emphasises that having sufficient planning time for a funding strategy enables treasury to explore diverse finance solutions and sources. This helps in reducing costs while preserving flexibility and ensuring access to liquidity.

Expanding investment opportunities is the second method to efficiently maintain sufficient working capital.

“For companies with surplus cash who have become used to generating a return on short-term cash, any interest rate cut would affect the ability to continue to do so. In anticipation of rate cuts, one option is to sacrifice liquidity to earn a higher return. But doing so is only possible if treasury can accurately forecast its short-term liquidity needs and segment its cash balances accordingly. Short-term operating cash can be placed in liquid instruments, with medium-term cash available to be committed for longer terms”, endorses the AFP guide.

This measure keeps the strategy unaltered, even if interest rates change. Hence, operating cash is held in more liquid instruments, with the amount dictated by the organization’s risk appetite. Then, as outlined in the AP guide, “With the next interest rate movement expected to be downwards, treasurers can respond tactically.”

Treasury’s ongoing evolution to foster working capital resilience                                        

To solidify its pivotal role as a key ally in advancing working capital resilience, treasury ought to remember that its job “Is never done”, points out the AFP guide. It must continuously manage new risks and navigate changing market dynamics.

What’s more, with treasurers becoming an indispensable component in various organizational functions, treasury’s role has grown extensively, benefiting from the availability of new technologies at affordable price points.

Supporting this assertion, the AFP guide states that “By utilizing some of the available tools, treasury can extend its reach within the business by becoming a more efficient department and sharing insights across the organization. And, by engaging more with the business, treasury will become an even more important partner to support the development of working capital resilience.”

To conclude, effective working capital management enables treasurers to increase profitability and bolster their organization’s financial stability and resilience.

The AFP guide wraps up by highlighting that treasury should continually explore opportunities to improve visibility into cash flows, cash positions, and risk exposures, communicate and engage with the business by bringing its financial acumen to support the organization in making more sound decisions, and embrace strategic thinking for enacting and sustaining change.

This will likely add certainty to working capital management during times of fiscal stress, geopolitical and economic uncertainty, and also strengthen organizational resilience to help survive tough times and thrive in good times.