The Imperative to Improve Working Capital: Driving Forces and Emerging Solutions

Improving working capital performance has become increasingly important to companies in recent years, yet few procurement and finance organizations have found truly sustainable, long-term solutions to support this goal.

The problem is that immediate external forces are pushing businesses to make working capital improvements now, while the sound financial strategies to maintain these changes require more than a few “quick fixes” to ultimately succeed.

Beyond the balance sheet benefits that accompany optimized working capital, there are two primary economic conditions motivating procurement and finance organizations to focus on this area: increased M&A activity and rising interest rates.

Following the 2008 financial crisis, businesses found themselves in a “easy money” environment after the U.S. Federal Reserve cut interest rates to near-zero levels. At first, companies fought the effects of the recession by focusing on operating cost reduction, but as the economy recovered, they also began to pursue revenue enhancement through M&A. The availability of debt to finance transactions led to a whirlwind of deal-making.

Deal volume in 2017 rose to 39,968 from 37,484, or about 7%, similar to 2016 and following record highs set in 2015, according to KPMG’s 2018 M&A Predictor report. And this trend is only expected to continue: Deloitte’s 2018 M&A Trends report found that 68% of executives at U.S.-headquartered corporations and 76% of leaders at domestic-based private equity firms say deal flow will increase in the next 12 months, with a majority (63%) saying that deal size will increase compared with 2017.

While this increased M&A activity has helped companies acquire new strategic assets and expand their market footprints, it has also led to higher levels of debt. Compounding that situation is a fiscal environment where, for the first time in years, businesses now expect the Fed to continually raise interest rates. At the same time, however, cash flows have remained comparatively unchanged, leading to steadily declining working capital performance.

To address this challenge, procurement and finance organizations are returning to a well-worn tactic: shifting their working capital burden onto their suppliers by extending payment terms.

Yet while pushing suppliers to accept ever longer payment terms may improve working capital in the short term, maintaining such improvements has proved elusive. According to The Hackett Group’s 2018 U.S. Working Capital Survey, companies tend not to sustain their improved working capital performance. Only a third of companies that improved their cash conversion cycle (CCC) for three years managed to sustain this performance for five years. Moreover, only 7% managed to do so for seven years. These results indicate that while pushing days payable outstanding (DPO) metrics higher can at first improve working capital metrics, this strategy is unadvisable as a permanent solution.

To move beyond DPO-based strategies, forward-looking companies are evaluating two primary methods for improving working capital: investing in accounts payable automation and experimenting with supply chain finance.

While AP automation is the better known of the two, the benefits of the strategy are worth repeating. By replacing manual and paper-based processes with fully digital, automated approaches to invoice receipt and capture, supplier onboarding and payments, businesses can reduce costs, improve operational efficiency and gain deeper insights into their financial performance. These initial investments in software and services that automate the invoice-to-pay (I2P) process in turn can help set the stage for working capital improvements, both from savings due to error reduction and the time gained by eliminating manual check runs.

Alongside these benefits, businesses are also realizing that AP automation solutions (e.g., e-invoicing tools, P2P systems) produce tighter connectivity with suppliers and increased access to useful transactional data. Procurement and finance organizations are beginning to use these new resources as a foot in the door to develop supply chain finance programs.

Research from Demica, for example, found that SCF programs have experienced 30%–40% annual growth rates in SCF programs with banks and businesses of all sizes. A key factor to those consistent growth rates, according to the report, was the continued uptake of AP automation technology and the growing mandate to adopt e-invoicing systems, both of which contributed as significant SCF market accelerators.

Used in tandem, AP automation and supply chain finance can provide both near-term and long-term solutions to businesses’ working capital conundrum. AP automation can deliver more of the “quick wins” sought in typical payment extension initiatives, while SCF can create sustainable, flexible opportunities to keep cash longer while maintaining strong relationships with key suppliers.

To learn more about these and other strategies for improving working capital, get in touch with Corcentric today.

This article was written on behalf of Corcentric by the Spend Matters Brand Studio team and not by the Spend Matters editorial or analyst teams.