Chris Seaman, Global Head of Sales, Benteler Trading International
Being 'ready for anything' is a persistent theme amid ongoing political uncertainty and economic volatility, and it makes for a challenging trading landscape. Recent figures point to a frankly worrying deterioration in working capital performance.
As the UK prepares for its departure from the European Union, China and the US continue their trade tit-for-tat, and protectionism gathers pace in several markets, the resultant uncertainties in the global economy and financial markets are putting unparalleled pressures on companies and their supply chains.
Against this rapidly-evolving backdrop, CFOs and treasurers are under both internal and external pressure to find new ways of optimising the balance sheet and fund strategic objectives, be it acquisitions or dividends.
It’s no mean feat: a third of firms surveyed by Lloyds Bank in its latest working capital index report said that managing working capital in the context of political and business uncertainty was their “biggest concern for the year ahead”. JP Morgan goes further to quantify the problem. Its working capital index suggests that as much as US$460bn of liquidity is trapped across the supply chains of the S&P 1500 companies alone. Releasing this locked-up cash is a priority if firms are to continue to grow their business -- whatever may be happening in the background.
Payables – the first port of call
As a rule, the shorter a company’s cash conversion cycle, the better its working capital efficiency. Companies can improve their working capital by reducing inventory levels, which decreases days inventory outstanding (DIO); extending payment terms with suppliers, which increases days payable outstanding (DPO); or by speeding up collections from customers, which shortens days sales outstanding (DSO).
For most large companies, leveraging payables with suppliers has represented the bulk of their efforts in working capital improvements, and this trend continues. According to a recent survey by trade credit insurer Euler Hermes, based on a sample of 25,000 listed companies across 20 sectors and 36 countries, the electronics, machinery and construction sectors saw payment terms in 2018 reach 89 days, 86 days and 82 days, respectively -- well above the cross-sector average of 65 days.
The growing use of supply chain finance (SCF) has enabled companies to improve DPO, injecting bank liquidity into the supply chain to relieve pressure on suppliers to offer ever longer payment terms to their large customers.
But working capital financing is not a one-size-fits-all, one-stop solution. According JP Morgan's index, the bulk of firms’ trapped capital is not held in payables, (which made up only 19% of the US$460bn figure) but in inventory, which accounts for a considerable 53%. Better management of the other elements of working capital aside from payables is paramount if corporates are to achieve their aims.
Growing inventories present new challenges
As corporates with supply chains spanning the English Channel gird their loins for Brexit, stockpiling has become a serious issue as firms seek to avoid potential cost increases caused by customs delays or tariffs. Analysis conducted by Lloyds Bank shows that over the last three years since the vote to leave the EU, total inventory for the UK-based firms surveyed increased by 29%. This extra inventory carries a cost in terms of working capital that needs financing, as well as logistics and storage charges, putting a company’s cash flow under significant stress – as well as tying up money that could be better spent on strategic aims.
But this is not a uniquely British problem by any means. A recent PwC report, titled Pressure on working capital in the global consumer sector, points to a worldwide issue. “Days inventory outstanding has increased by 4% year-on-year, indicating a deterioration in performance. This could be driven either by a waning of management focus and attention in this area, or by a drive to build up stock,” the report states.
The figures paint an overwhelmingly challenging picture. But just as market conditions change, so, too, can the solutions to some of these new problems. Alternative working capital financing techniques are already beginning to emerge - creating new ways to help companies maximise the efficiency of their balance sheets so they can continue to support strategic objectives -- whatever the trading environment.
One such solution is Inventory Trading, which can be used alone or to complement other solutions such as supply chain finance programmes. Inventory trading involves a trading company buying and selling goods, holding them through the supply chain and delivering just-in-time or acting as an off-taker, thereby optimising the supply chain. This enables companies to unlock cash tied up in their inventories, whether inbound/outbound goods, consignment stock or work in progress, while positively impacting the balance sheet.
I think inventory management may even be the most overlooked area of working capital, and possibly the most strategic measure that a corporate treasurer can take. While the liquidity angle is already very well covered through factoring and reverse factoring, the inventory angle is largely unconsidered due to a lack of relevant options, and as a result, companies overlook the opportunity to free up precious working capital.
With working capital performance universally flat (at best) the potential benefits for corporates of addressing every aspect – payables, receivables and inventory – on their balance sheets may be the key for some businesses to maximising cash flow and shareholder value. I believe this holistic technique can unlock trapped capital that is so valuable -- particularly in times of uncertainty.
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