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Working Capital Optimization: 3 Things to Avoid

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In my last blog I outlined why you needed to reconsider your approach to working capital and why current programs are limited in their capabilities. In this blog I wanted to outline the things you need to avoid, or at the very least be aware of when approaching a working capital program.

1. Accounting Errors

Where accounting arrangements are concerned, the overriding goal when adopting an early payment program is to make sure that trade payables are not reclassified as debt. While reclassification wouldn’t affect cash flow, money owed to suppliers has to be recorded separately from money owed to finance providers – firstly to avoid confusion, and secondly to avoid breaking the terms and conditions of existing finance arrangements.

For example, reclassifying trade payables as debt could take your total debt over an agreed upper limit. This could, in turn, trigger penalty clauses, such as requiring you to repay long-term finance immediately.

How can you avoid this situation? There are three main points to consider:

  • Structure. As a rule of thumb, the early payment finance provider should not be put in a better position than the original trade debtors were. So an arrangement where the bank could reclaim early payments from suppliers in the event of the buyer’s default would not meet the usual accounting standards.
  • Communication. Reclassification can be triggered if there is a direct correlation between suppliers that have had their payment terms extended, and those that have been offered reverse factoring arrangements. The two strands of the strategy – extension of terms and early payment arrangements – therefore need to be communicated clearly but separately.
  • Offering. It is acceptable to extend payment terms. It’s also desirable to offer suppliers early payment arrangements. But if terms are only extended for suppliers that enroll for the supply chain finance facility – or, indeed, if SCF is only offered to those that agree to extended payment terms – auditors will regard suppliers as being treated as a source of external finance and reclassify trade payables as debt.

2. Managing Relationships and Perception

Fintech providers have much to offer when it comes to providing innovation, scalability and efficiency. But working with a fintech partner on a working capital optimization program needn’t have an adverse impact on your longstanding bank relationships. If your program includes a third-party structure, you should be able to invite your preferred banks to be part of the portfolio of finance providers included within the program.

In recent months we have seen multiple examples of businesses taking a company-centric approach can result in bad press. For example, companies can attract negative coverage when they extend payment terms aggressively without considering the adverse effect on their suppliers. It’s therefore essential to make shared benefits available across the supply chain as a whole. Likewise, adhering to voluntary codes of conduct can go a long way in demonstrating corporate social responsibility towards your supply chain.

3. Legal Issues and Payment Codes

Beyond these pitfalls, companies should also be aware of other industry developments that may have a bearing on their payment practices. For example, governments increasingly expect organizations to treat SME suppliers fairly — and they are using various tools to facilitate this. These range from mandatory practice set out in law to schemes which recognize organizations for committing to best practice in supplier payments.

As such, countries including the UK, Netherlands and Australia have created payment codes for organizations to follow. Companies which sign up to these codes typically make certain commitments, such as agreeing to pay small suppliers within 30 days. While such payment codes aim to encourage best practice, issues can arise if organizations are unaware that their own group headquarters has signed up for payment codes that they are expected to follow – a situation that can arise when a company has recently been acquired, for example.

While payment codes are not legally enforceable, another issue is that companies may be legally required to pay SME suppliers within a set period. In some jurisdictions, such as France, late payment penalties are imposed automatically.

Summary

Over the last few weeks, we’ve set out how you can use a game-changing approach to working capital optimization in order to support the growth of your business, while extending the benefits across your entire supply chain.

Indeed, the benefits of such an approach can be considerable. In today’s highly competitive market, thinking outside the box can enable you to free up working capital while reducing suppliers’ financing costs. And by leveraging an intelligent, data-driven system, you may be able to provide precisely timed early payment opportunities to suppliers.

In order to reap the benefits, it’s important to take a proactive and far-reaching approach to working capital optimization – both while implementing a program, and on a continuous basis thereafter. Consequently, there is much to be gained by appointing an enterprise cash optimization officer who can take responsibility for this area and build a cash-conscious culture across the organization.

Want to become a game changer for your organization? Take the first step by joining Taulia at its Working Capital Summit, in San Francisco on October 10 or Chicago on October 18

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