Rethinking Working Capital Management As Interest Rates Rise

Drew Hofler

Ouch. I recently started working out again, and my neglected muscles are letting me know it!

Almost 10 years ago, as I was approaching a milestone birthday (never mind which one!), I realized I was quite out of shape and decided to finally hit the gym. Motivated by my impending rollover into a new decade of life, I lost a bunch of weight while getting in the best shape I’ve ever been in. It felt great to have new strategies and practices for healthy living, and they sustained me for quite a while. But in recent months (as yet another decade milestone approaches), I’ve realized that I haven’t been paying as much attention and have taken my physical fitness for granted. Alas, it shows.

Coincidentally, around that same time, a milestone event in the form of the crash of 2008-2009 caused a lot of companies to look in the mirror and assess their working capital health. While working capital management (WCM) has always been important, the radically changing economy brought it to the forefront. Companies scrambled to ensure that their WCM strategies would carry them through a tight-credit, low-rate environment as rates rapidly dropped to near 0% and have stayed there for close to a decade.

Changing interest-rate environment is natural call to reevaluation

Just like with a workout plan, it is natural when things stabilize and a strategy has been working to coast along on past plans and not take the time to evaluate their effectiveness for today. But rising rates should be a call to action, because the certainty of a constant low-rate environment is no more. Old strategies should be reviewed and irrelevant practices changed to fit the new realities and potential risks that come with rising interest rates.

Rising rates may still not yield much on your liquidity

Since the crash, cash on hand in short-term liquidity vehicles has earned next to nothing (and in some high-profile cases, less than nothing). You will need to consider your short-term liquidity investment strategy to determine if traditional vehicles will once again start providing an acceptable return or if you should pursue alternative sources of yield on cash such as dynamic early-payment discounting.

Rising rates and higher borrowing costs may affect your acceptable debt levels

Debt levels in companies are always a concern, but in an environment of historically low cost of credit (to those with investment-grade ratings at least) the price of that debt has not been as much of an issue. As a result, debt levels in many companies have risen. However, as rates rise, so does the cost of servicing that debt, and acceptable levels of debt will likely decrease. When this happens, how will your company fund its investments? Where will it find the cash flow to replace that? Free cash flow from operations and freed-up working capital can provide needed liquidity without leaning on leverage.

Rising rates may impact your supply chain cost structure

Rising rates may not have an immediate major effect on large, global 2000 enterprises, but it certainly does on their supply chains. Suppliers that provide critical components to end products often do not have access to the same low-cost credit that their large customers do. And while waiting to get paid, they likely must fund their cash flow with credit. As rates rise, suppliers’ costs rise, and that increased cost in your supply chain can ultimately find its way to your bottom line.

How can your WCM practices and strategies mitigate the effect of rising costs to your suppliers? One of a number of ways companies are keeping costs out of their supply chains is through supply chain finance (SCF), which lets suppliers access cash flow at their customers’ lower cost of capital.

Rising rates may introduce risk into your supply chain

Not only can costs rise, so can the level of liquidity risk in your supply chain. While many of your suppliers will be able to manage the increased cost of credit, many may not. In some cases, suppliers will find the rising costs too much to sustain the levels of debt they need to carry their cash flow and fund their production at levels you depend on. Sound working capital strategies and tools like SCF and dynamic early-payment discounts can mitigate these risks by providing needed cash flow while freeing suppliers from debt.

Rethinking working capital management as interest rates rise

These are just a few of the many potential implications of a rising rate environment. Has it been a while since you really evaluated your working capital health and strategy? You made it through the great recession and the historically low rate environment, but are you ready for what is coming next? Maybe you should take this opportunity to look in the mirror.

Like me, you might need to hit the gym again.

If you are ready to reevaluate your WCM strategies, please consider attending Treasury & Risk complimentary webinar on August 30. We will explore this subject in greater depth with a panel of analysts and experts who will share best practices, KPIs, and key strategies for this new environment.

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Drew Hofler

About Drew Hofler

Drew Hofler is Vice President for Portfolio Marketing for SAP Ariba and SAP Fieldglass. In this role, he is responsible for developing messaging, creating content and executing global programs to drive awareness and adoption of the company’s cloud-based applications and business network. Mr. Hofler brings over 20 years of technology, operations, and software industry experience to SAP Ariba. Prior to joining the Ariba in 2006, he served as Vice President of Treasury Product Management for PNC Bank and Director of Payment Systems at Tier Technologies. Mr. Hofler began his career at Thrivent Financial. Mr. Hofler has written a number of articles in industry publications – as well as has been interviewed, quoted widely, and speaking extensively – on topics including intelligent spend management, emerging technologies, procure to pay, supply chain finance, and dynamic discounting and payment.