Working capital priorities

Working capital and cash flow have become vital metrics during the pandemic crisis. As economies recover, the decisions businesses make now will help define and shape strategy for the long term.

Tactical decisions to ensure immediate survival are making way for more medium-term thinking as companies adjust to new markets and reconsider their supply chains, looking in different directions to continue and grow their business – and how to manage their working capital to support this.

The first step for a business is a quick check to see how stable or affected its customers and suppliers are. Consider how demand has changed, recommends Mirka Skrzypczak, NatWest head of working capital and trade products. “Look at how your customers are adjusting. Focus on those that generate most of your revenue as they may be impacted more than you know. And review your suppliers. Do you understand them, their challenges, and the connectivity in your supply chain?”

The profile of many markets has changed over the past few months, and that has a knock-on effect on the speed at which companies need to be paid. This could alter the terms on which other businesses might be willing to trade, adds Lisa Phillips, head of working capital sales at NatWest. “You cannot assume that the contract terms you relied on in the past will necessarily be the same in the future: they made need to be restated and renegotiated.”

Ahead of the times

Through the immediate crisis, the widespread recommendation has been for businesses to draw up 13-week cash flows. Focusing on customer receivables and payables helps give an accurate understanding of the cash position.

Bina Mehta, partner at KPMG, tells clients to prepare a 17-week cash flow, as it includes what you have booked today plus what you see happening in the immediate month ahead. This allows you to look slightly into the future with some accuracy and identify opportunities to manage the cash conversion cycle through improved processes and procedures. Mehta says that having a slightly longer basis period also helps a business make sustainable decisions about how to improve working capital and highlight where certain areas – such as product lines or sectoral sales – are not working. “You can’t go much beyond that if you want an accurate picture,” she says. “Once you go beyond a month, projections become subjective, especially as we haven’t bounced back from Covid-19 yet – and it’s unlikely that we will bounce straight back to where we were before.”

Cash-flow forecasts need to include a number of new issues. Current customers whose business is viable might need longer credit terms. And if a business has new international customers or suppliers, it will need to consider the impact of credit practices in the different countries in which it is now operating.

You cannot assume that the contract terms you relied on in the past will necessarily be the same in the future: they made need to be restated and renegotiated

Lisa Phillips
Head of working capital sales, NatWest

Many firms are less willing to trade on open account terms than they might have been in the past. Invoice finance is a possible solution, says Phillips. “If a business is confident, can show it is on a recovery curve and can forecast this with confidence, then an invoice finance facility can potentially provide flexibility and can grow with that business as it returns to prosperity.”

New ways of financing

What if companies have found new customers? The problem with new trade relationships is there is no basis for trust yet, says Skrzypczak. “How do you trust your counterparties, as you have no idea whether your money will turn into goods or that you won’t be defrauded – and bear in mind that nefarious practices will be on the rise in this economic environment.”

This is where trade instruments such as documentary collections and letters of credit come into play as they offer greater security to both buyer and seller. Through these instruments, banks effectively guarantee that the company’s money is secure, or that goods ordered will arrive or else the money is refunded – effectively confirming that both counterparties are good for the money.

These instruments will play a big part in an economic recovery, believes Skrzypczak. “They will help establish new trading relationships to fill the gaps caused by the pandemic. They also work well with current trading partners when you have no way of understanding how commercially impacted your customers or suppliers have been.”

Another movement NatWest has seen is smaller suppliers opting into larger companies’ supply chain finance programmes. These arrangements are set up by large buyers, often blue-chip companies. The risk and credit limit are marked against the large buyer so that the supplier obtains finance at a much lower price than if they were buying it on their own, with the highest margins currently around 1.5%.

Blue-chip companies have been using this type of finance for their medium-sized suppliers for some time, but now they are extending it to smaller businesses as they understand these companies need it most, says Skrzypczak. “If you’re an SME and know your customer has supply chain finance in place, knock on the door and ask to be part of this,” she says. “Even if only 20% of your sales are to a blue-chip customer, financing that 20% at a lower margin can have a good impact on your working capital.”

Challenges ahead

Lest we forget, the entire UK economy faces a bumpy road to recovery. Companies are having to think about the end of furlough in October and the return of many of their employees to the workplace; this is likely to lead to some hard decisions about the scale of the business and the place of people within the organisation.

Businesses also need to consider how much working capital is tied up in inventory, says Mehta. “The environment has forced businesses to think about their portfolio of products and whether they should rationalise them, with a view of end-to-end profitability and whether they should bring things closer to home or closer to the customer.”

As the transition period after Brexit comes to an end this year, companies will have to consider how to finance any inventory build-up, she adds. “More generally, businesses should consider what the impact of dealing internationally will have on their working capital. And in all this they need to ensure they use solid management information and working capital metrics, producing accurate data and interpreting it well.”

This is a good time for companies to revisit their operating models, says Skrzypczak. “Try to make your business resilient and nimble. Even if you don’t have the answers for everything, start documenting what you have found from this period. There will be more pandemics. Businesses need to learn from this one to ensure they create an environment that will help them survive other serious events in the future.”

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