J.P. Morgan’s View: The Treasurer’s Role in Optimising Working Capital
Managing working capital is complex due to the cross-functional nature of the exercise. Handling day-to-day assets and liabilities involves a wide spectrum of departments - treasury, finance, supply chain, sales and procurement who all need to pull in the same direction to deliver working capital initiatives.
Q. How can working capital trends help corporates with benchmarking?
Broadly speaking, companies can improve working capital by managing the cash conversion cycle (CCC). It is important to regularly benchmark companies against industry peers to assess how they are performing, drawing insights and identify potential opportunities for further improvements. J.P. Morgan recently ran a study, observing the working capital metrics of S&P 1500 non-financial companies.
At a macro level, there has been little improvement observed in CCC over the past five years. Analysis of individual components reflects deteriorating days inventory outstanding (DIO) and days sales outstanding (DSO), with increasing days payable outstanding (DPO) offsetting pressure on overall working capital. But increasing DPO alone may not be sufficient to achieve sustained improvement in working capital, hence there also needs to be a focus on reducing collection days and improving inventory turns.
The study found some industry segments fared better than others, these include pharmaceuticals and automakers which showed improvement in inventory days and payable days, respectively. On the other hand, the cash conversion cycles of IT and telecommunications sectors appear to have deteriorated the most overall.
The top 25% of companies that fared the best in working capital optimisation within their industry appeared to convert their cash up to two times faster than average performers. This provided them with an additional cash flow of up to US$50 million per $1 billion in sales.
Q. So what are the key challenges in managing working capital?
Working capital initiatives require change management but some companies may not have the resource or expertise for successful implementation.
As finance and business operations tend to be decentralised, companies often lack the end-to-end visibility required over processes like procure to pay, order to cash, inventory and cash management, that are necessary to benchmark working capital performance and drive improvements.
Educating and encouraging staff to view the business as a whole, as opposed to just their separate functions, can be challenging as non-finance employees are not always able to connect the dots between their activities and their impact on cash flows. For example, optimising cash at hand can often involve delaying payments to suppliers or ensuring faster collections from customers, or both, but corporates sometimes avoid asking for better payment terms for fear of harming relationships with their customers or suppliers.
Q. Are there tips, techniques and tools to optimise working capital?
Working capital management requires continuous planning, discipline and implementation. At J.P. Morgan, we believe there are four key components to successfully managing working capital:
1. Tone from the top
As working capital is impacted by a wide spectrum of business functions, it’s critical for C-suite executives to lead from the top, setting annual targets for businesses to free up cash flows. Including working capital efficiencies in KPIs has proved to produce successful outcomes.
As a rule, the shorter the CCC the better. This can be done by manoeuvring three working capital components: 1. DPO, 2. DSO and 3.DIO. Companies can improve working capital by taking longer to pay suppliers (extending DPO) and speeding up payment collection from customers (shortening DSO). It is important to benchmark these metrics both internally and against industry peers to ensure that these three underlying components are at optimal levels.
3. Leveraging Technology
Managing working capital effectively requires visibility into systems and tools capturing information like receivables, payables, inventory, suppliers / customers, business forecasts and cash levels. Thanks to developments in financial technology, companies can now harness innovation to take on some of the heavy lifting. J.P. Morgan’s data visualisation tool, for example, has the ability to harness data from corporates to provide a bird’s eye view of cash flows and can help determine the best steps forward for optimising working capital.
4. SSC and Payment Factory
Increasingly, companies are looking to centralise accounts payable (AP) and account receivables (AR) functions by setting up shared service centers (SSC). This not only reduces operating costs but also provides central visibility over transactions to drive working capital optimisation opportunities like payment terms alignment, centralised customer credit management, billing automation and faster exception management.
Q. Why is treasury’s role vital?
Working capital has traditionally been a CFO-led responsibility. However, treasurers are increasingly playing a central role due to their expertise in cash management and financial risk management and their banking relationships. They contribute to working capital management in a number of ways:
1. Promoting cash culture
Treasuries are uniquely positioned to build awareness within each business function as to how their activities affect cash performance. Finance and the broader organisation such as sales, operations and procurement need to be educated about the connection between working capital efficiency and generating free cash flow to reduce capital needs or fund business growth.
2. Driving Centralisation
When cash management is decentralised across a company’s subsidiaries, it often results in high operating cash buffers across entities, contributing to funds not being fully optimised. Treasurers can deliver efficiencies by centrally managing cash, funding and foreign exchange for the whole organisation. This not only helps reduce overall cash needs but also drives business behaviour to optimise working capital.
3. Improved Forecasting
Treasury has a key role in promoting best practices in forecasting across the organisation. Regular follow-ups with subsidiaries and escalation of inaccurate forecasts can help to drive better outcomes.
4. Payables and Receivables Strategy
Improving working capital across procure to pay and order to cash cycles requires a payment and collection strategy focused on reducing transaction costs, moving from paper to electronic channels, cutting down the number of payment runs, and leveraging technologies like real-time payments for faster transactions. Treasury has a key role in improving the banking infrastructure required to run efficient account receivable and account payable functions.
5. Supply Chain Finance
Supply chain finance (SCF) programs are gaining traction globally as corporates look for solutions to improve their working capital. SCF can provide suppliers with access to advantageous financing facilities by leveraging a buyer’s credit rating, while buyers can benefit from longer supplier payment terms. By leveraging SCF, many companies have been able to successfully free up cash tied to account payables as they negotiate extended payment terms with their suppliers, effectively lengthening their average DPO.
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