Working capital under review

A regular review of the working capital cycle can help unlock cash that is trapped on the balance sheet of a business so it can be put to more effective use.

Working capital represents the operating liquidity of a business. It is the money that the business needs to service maturing debts and fund operational expenses. It equates to the sum of short-term assets minus the sum of short-term liabilities. So, in practical terms, working capital translates as cash, inventory and accounts receivables minus accounts payable.

Although working capital can be expressed as a straightforward ratio, the reality of a business’s working capital position can be extremely complex. This is because it is influenced by every stage of the supply chain, from the procurement of raw materials right through to the collection of payment for finished goods.

Working capital is strategically important because companies use it to invest in product development and technological innovation, to expand into new and emerging markets, to fund acquisitions, and potentially to pay dividends to shareholders.

  • Why review?

    Since working capital is often referred to as the ‘lifeblood’ of a business, it is highly advisable to review it regularly. Some of the main benefits of reviewing a working capital cycle include:

    Cash generation. A review of the working capital cycle presents opportunities to free up cash. This cash can then be deployed in ways that generate value.

    Risk mitigation. Businesses can use robust working capital management to mitigate risk associated with their supply chains. They can also adopt solutions that support the sustainability of their suppliers while enabling them to benefit from discounts on goods and services received.

    Cost reduction. Companies that have a firm grip on their working capital can reduce the costs associated with managing inventory, liquidity, payables and receivables.

    Yield optimisation. When cash is freed up by a working capital review, liquidity is boosted, enabling the business to maximise its yield on that liquidity.

    Business viability. Effective working capital management reduces the risk that a business will suffer an unexpected liquidity squeeze at a time when it is in particular need of funds. Treasurers who regularly assess their organisation’s working capital can pinpoint strategies for improving its overall financial outlook.

  • Key considerations

    A review of working capital begins with an examination of the business’s cash conversion cycle – effectively, how long it takes the business to realise cash from sales of its inventory. The cash conversion cycle is a key metric used in assessing a company’s overall financial health. It is comprised of three primary key performance indicators (KPIs):

    Days of sales outstanding (DSO)

    This KPI measures the number of days it would take a company to collect the money owed on sales and recover the entire accounts receivable. Shorter is generally better.

    Days of inventory outstanding (DIO)

    This KPI measurers the number of days it would take to sell a company’s entire inventory. Since inventory is a use of cash, too much build-up can be inefficient. Shorter is generally better.

    Days of payables outstanding (DPO)

    This KPI measures the number of days it would take a company to pay its outstanding accounts payable balance. Longer is generally better.

  • Cross-functional approach

    A working capital review should involve numerous other business functions in addition to treasury. This ensures that working capital and liquidity are optimised across the end-to-end ecosystem of the business. Businesses that allow decisions that impact on cash flow to be made within functional silos, rather than holistically across the entire organisation, frequently fail to optimise their working capital.

    Working capital optimisation is more likely to be achieved when driven at board level and would see treasury working with other key functions within the business, including finance, procurement and sales. It is important to recognise that different functions within the organisation may be pursing competing priorities, however. For example, procurement might be focused on securing improved pricing from suppliers by promising earlier payment at a time when treasury is more concerned about reducing transactional costs and boosting cash flow. Or sales teams might be incentivised to aggressively pursue orders, at the expense of margin and working capital.

    A holistic approach, that balances the competing priorities of different functions, is the best way to optimise working capital while enabling business growth, mitigating risk and preventing internal conflicts from arising.

  • Benchmarking

    Benchmarking against peers is an important part of any working capital review process. Organisations that benchmark their DPO, DIO and DSO against their peer group can identify possible opportunities to further optimise their working capital – for example by collecting receivables earlier, or identifying ways to turn over inventory faster. Barclays can help treasurers to benchmark their companies against peers and highlight opportunities to improve cash flow cycles.

  • Solutions

    Barclays offers a wide selection of solutions that can be used across the trade cycle to support businesses to mitigate risk, make operational efficiencies and improve their working capital. There are many solutions available, ranging from import and export collections, letters of credit, avalisation / discounting of bills of exchange or promisory notes, through to trade loans, asset-based lending, supplier finance and bonds, guarantees and indemnities.

  • Summary

    Treasury is a strategic function that plays a critical role in corporate planning. Efficient management of the working capital cycle is core to corporate planning because it enables businesses to unlock the cash that is hidden in their balance sheet and supply chain so that they can use it more effectively. This can boost the valuation of the business and deliver positive results to shareholders over the long term.

    It is crucial to work with the right banking partner to access the latent working capital within your business. At Barclays, we take pride in having a specialist team that can support you to manage your working capital more effectively. To find out more, speak to your Relationship Director.


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