Part 2 in a 2-part series. Read Part 1.
In the first blog in this series, we examined the traditional methods used to measure working capital. But once we’ve gathered the data, ratios, and benchmarks, what do we do with them? How do we assess the data, select a path forward, implement that path, and sustain it? This blog answers those questions.
Treasurers have long had access to a variety of tools to achieve this.
- Best practices
- Bank products
- Financial technology; treasury management systems; and supply chain finance solutions
- Working capital assessments and programs
The age-old issue still exists: change is hard, no matter whether it is across a global enterprise or a small business.
The good news is, as new technology continues to mature and integrations between workflow tools, enterprise resource planning applications, and banks become easier and more sophisticated, the power of the tools available has increased. And, in part, they have become easier to implement and sustain.
Let’s not overlook the fundamentals of best practices that treasurers use to improve the cash conversion cycle when working with internal stakeholders, vendors, and customers.
- Extend days payables outstanding (DPO). Extend terms with suppliers. This used to be a one-sided strategy, with buyers demanding extensions that smaller suppliers couldn’t combat. Reverse factoring and dynamic discounting are not new ideas, but the level of technology sophistication and integration makes putting them to work much easier than ever. These tools can be easily integrated with ERP, treasury management system, and other AP automation technology.
- Reduce days sales outstanding (DSO). Adjust credit terms to shorten the number of days receipts are due from customers. But this trend has been escaping most companies as customers try to extend their own DPO at the expense of sellers.
- Review the credit approval process. Being smart about who credit is extended to can help a company avoid slow payments, no payments, and other administrative issues that tie up capital and time for the collections staff. In practice, we know that some sales are just not worth the credit risk.
- Track AR aging. Invoicing customers accurately and on time and sending friendly reminders before payments are due is another way to reduce DSO creep.
- Get control of days inventory outstanding (DIO). Involve demand planning to find the right product mix and levels of inventory on hand for sale. We know that too much capital tied up in inventory could reflect poor planning, weak demand, or obsolete products. However, too little inventory could put the enterprise at risk for losing sales that cannot be fulfilled. Treasurers have long relied on their partner banks for products to improve the cash conversion cycle.
Treasurers have long relied on their partner banks for products to improve the cash conversion cycle.
- Companies can reduce DSO by performing a proximity study to ensure customers are issuing checks to the closest lockbox, or have invoices paid by ACH to eliminate check float. Accepting purchase card payments and negotiating reduced interchange fees will also increase cash throughput.
- Card programs or supply chain financing products such as reverse factoring can extend DPO by allowing a buyer to pay vendors using the bank or finance company’s funds. This extends the original payable by nearly a month, with the added bonus of card payments providing rebates to the buyer. As we’ll detail next, supply chain solutions are also available from fintechs in partnership with banks as funders.
Fintech can be a confusing landscape, but at its core, the tools are relatively the same, just better and easier to use than before.
- Simplified, electronic payments and cash accounting in a treasury management system: Processing efficiencies from inbound and outbound electronic payments, such as ACH or card, can easily be captured by a treasury management system to automatically clear AP, AR, post to the ledger, and relieve operations of manual posting and reconciliation functions. SaaS-based treasury management systems with connectivity to banks make this implementation much easier than in the past.
- Procurement and AP automation: Companies can also achieve fulfillment efficiencies by using procure-to-pay SaaS solutions to manage the supply chain vendor base, complete the three-way match of approved invoices, and govern the approvals and release of outgoing payments (and then couple with supply chain finance for dynamic discounting, or reverse factoring). Similar to treasury management systems, the configurable nature of these SaaS platforms simplifies the implementation.
- Visibility into cash position and forecasting in a treasury management system: OTC transactions that move working capital can be captured and aggregated into global balances by a treasury management system. This gives the treasurer 360-degree visibility to consider along with debt positions and foreign exchange (FX) exposures (again, coupled with supply chain finance to release excess cash or extend terms via reverse factoring to create cash flow). A lot of treasurers are beginning to see the power of a supply chain finance technology platform embedded in their cash position and forecasting workflow tools – i.e., the module for reverse factoring is integrated with the module for cash position.
- Supply chain finance solutions connected to procurement/AP and treasury management: As previously stated, this is coupled with a procure-to-pay/AP automation solution, as well as enhanced knowledge about cash position and forecast via a treasury management system. It used to be that these functions were not part of one integrated workflow. In the SaaS environment, that is no longer an issue. The workflows can be integrated across platforms.
Working capital assessments and programs
The biggest challenge companies face when looking to achieve success in a working capital program is time and access to information. For example, reviewing the supply base in depth to determine applicable suppliers for a term extension and the risk to the base, then creating a program to make it successful, are not tasks most companies are not built to absorb. And even with technology solutions easier to implement than ever, it can be difficult to understand the players, the landscape, and which tools will help for each piece of the newly designed, integrated workflow.
It is a well-documented anecdote that most working capital programs fail because of lack of supplier adoption (in the case of a DPO extension). Mostly, that comes down to supplier segmentation (gathering data and assessing it) and selecting a strategy, a method to implement that strategy, and the arms and legs to tactically execute that strategy. In essence, it requires muscle to deploy a program that includes a lot of change and implementing new technology.
In summary, the age-old strategies and subsequent challenges to increase working capital are not new, but enhanced platforms and products are changing the landscape by increasing interconnectivity and visibility, making it easier for treasurers to manage and grow cash flow. It’s worth looking at your working capital program now more than ever since there are several clear paths to increased performance.
To learn more about the best working capital and treasury management strategies, watch our webinar: The Power of True Liquidity Positioning and Forecasting with a Treasury Management System.