Enterprise-level companies are awash in cash today – but it is not easy to put these reserves to work. Interest rates are at historical lows, alas, some banks are actually charging interest on deposits. Large companies are faced with the recurring question: How do we preserve principal while generating profit? Read on to find out.
While large companies are dealing with a “more money, more problems” situation, their suppliers are lacking cash. Banks cannot lend money like they used to, so smaller companies are running into difficulty trying to access capital. The struggle of the suppliers impacts the larger companies buying from them, causing supply chain risk. According to S&P, just 1% of U.S. businesses hold more than 50% of the corporate cash, while the cash-to-debt ratio has lowered to below 20% for the rest of businesses.
These financial factors can create a particularly complex challenge. But company finance leaders – often treasurers – have a unique opportunity to fulfill the mandate of their executive team and optimize working capital, thanks to the emergence of digital financing services that weren’t previously available. Treasurers now have the ability to help everyone in the value chain manage cash more efficiently and improve business margins, while supporting supplier requirements for cash.
What is Working Capital Optimization?
Working capital optimization consists of strategically managing outstanding customer invoices, outstanding supplier invoices, and the value of inventory to ensure the business has just the right amount of cash on hand.
It requires balancing between the two extremes:
Increasing liquidity and mitigating risk, while decreasing overall profitability due to higher inventory and financing costs
Decreasing liquidity and funding costs, but increasing risk of shortage or moving financial risk down the supply chain to a vendor that is not able to carry it.
Working capital optimization is managed by analyzing company operations through the cash conversion cycle to understand where more cash is needed and where excess cash can be re-invested.
In this two-part series, we’ll look at five ways that treasury, procurement and finance teams can work together to optimize working capital. This post will dig into the first two ways, and we’ll follow up with a second post covering the final three ways.
1. Get 100% Spend Visibility
If treasurers are going to be effective at working capital optimization, they’ll need access to real-time spend information in electronic format, for both direct and indirect spending. This means the organization must leverage automation and a holistic approach to procure to pay to:
Process 100% of invoices electronically (paper, electronic, EDI/XML, PDF, etc. – covering direct, indirect, PO, Non-PO spending)
Achieve 100% user adoption of e-procurement solutions to capture all spending
On-board 100% of suppliers (both small and large), regardless of their level of sophistication.
By maximizing those three areas to build a complete data set and leveraging visibility from Shared Service Centers (SSCs), treasurers can understand the underlying business dynamics and create a payments strategy that enables accurate forecasts for CFOs and CPOs.
2. Support Strategic Procurement and Facilitate Collaboration
Optimizing working capital requires collaboration. Treasury and Procurement can work together to identify strategic suppliers and lower their supply chain risk by offering them supply chain financing at an affordable cost. By extending supply chain finance to the long tail of suppliers, the company can systematically improve their days payable outstanding (DPO), while at the same time offer every supplier an option to get paid early. This meaning that large companies can keep cash off the books for longer, while suppliers can get cash flow right away.
You’ll notice that in each of these first two steps, there’s a focus on win-win. Internal stakeholders get the visibility and accurate forecasting they need to plan, make solid business decisions and invest in the business. In turn, suppliers have options for payment times to ensure financial stability and grow their business.
Want to read more on these two steps and learn about the next three? Download our whitepaper, 5 Ways to Optimize Working Capital from Purchase to Pay.