Managing working capital has always been a high priority for treasurers. However, the recent supply chain stresses caused by the impact of the Covid-19 pandemic and ongoing geopolitical conflict, coupled with rising interest rates globally, have pushed it to the forefront.
According to a recent paper from Citi, the landscape faced by corporates is substantially different from that of 18 months ago. According to the report, the focus on preserving capital is increasingly paramount, prompting corporations to rethink their reliance on commercial paper issuance and revolving credit lines.
According to Naresh Aggarwal, associate director, policy and technical at the Association of Corporate Treasurers, organisations have become a lot more mindful again around working capital in the past couple of years.
“Why were they not bothered so much before? Liquidity was pretty free and easy, interest rates were very low,” he says. “What we’ve seen over the past year, as we’ve headed into a cost-of-living crisis, and higher levels of interest rates and inflation, obviously there’s a greater focus on it. The first thing is most people are doing some good housekeeping, which is making sure that there are no extended terms.”
The Covid-19 pandemic also put a real focus on liquidity, says Sarah Boyce, associate director, policy and technical at the ACT.
“That kind of mood music then starts to drive the behaviour,” she says. “Every sort of five, to seven, to 10 years you’ll see this tightening cycle as people start to focus much more on the importance of cash.”
The research from Citi found that firms which consistently shorten their cash conversion cycles see greater return on investment capital than those who consistently lengthen them. The leading driver of shortened CCC is improved days payable outstanding, and businesses which have consistently shortened their CCC have shown a median increase in DPO of 18 days.
The report went on to say that those companies that consistently shortened their CCC more than the sector median achieved superior cumulative sector-adjusted total shareholder returns compared with peers that extended their CCC.
CCC shorteners achieved a total shareholder return of 143 per cent from 2010 to 2022, with a compound annual growth rate of eight per cent. In contrast, lengtheners only managed a TSR of 44 per cent with a CAGR of three per cent during the same period. The impact extends to return on investor capital, where consistent CCC shorteners demonstrated a 0.4 per cent average increase relative to their sector, while lengtheners experienced a 0.4 per cent decrease. Furthermore, companies with shortened CCCs exhibited superior median annualised sales growth of 7.4 per cent, outpacing lengtheners at 5.9 per cent.
According to Andrew Betts, global head of trade and working capital at Citi’s treasury and trade solutions division, there are three ways to shorten CCCs: shorten DPO, shorten days sales outstanding, and manage days inventory outstanding. The Citi report also highlighted that buyers are negotiating to extend payment terms, while sellers are quickening the pace of receivables collection.
“When we focused on those three areas with group treasurers, what we found was there was a significant focus on dates payables outstanding and working with their suppliers deep into their supply chains, and we saw immediate improvement of up to 18 days over a 10-year period,” he says. “There was clearly a focus across global corporations in standardising payment terms and gaining those working capital benefits.”
Citi’s findings also show that industries with complex supply chains typically have the greatest opportunity for working capital savings. According to an analysis by Citi’s Financial Strategy Group, in 2022 there was a 91-day difference in the CCC of the top-quartile firms compared with the bottom-quartile firms across all industries.
According to Betts, the “early adopters” for shortened CCCs are “typically, those with the largest most complex supply chains”, such as “consumer non-durables, consumer services and industrials”. However, other industries, such as healthcare have seen less take-up, he adds.
The general economic outlook also affects various sectors differently, says Aggarwal. “Anecdotally, during hard economic times, working capital comes up a lot,” he says. However, while the hospitality and construction sectors are currently struggling, oil and gas industries are not, he adds.
Outside industry sectors, Aggarwal also points to generational factors influencing the prioritising of working capital. “Because interest rates were so low, for so long, there’s a whole generation of people” that are experiencing this environment for the first time, he adds.
As part of the research into shortened CCCs, Citi’s global trade working capital advisory division looked at different components of the cycle for S&P Global 1200-listed corporates (representing roughly 70 per cent of global market capitalisation) that shortened their CCC from 2010.
Citi also found that in addition to improving DPO, corporates are standardising payment terms in line with their CCC and industry peers. Many are partnering with banks for supply chain finance programmes, offering early payment of suppliers’ invoices and leveraging the buyer’s often higher credit rating, while extending payment terms. Dynamic discounting can enable the buying company to use excess short-term cash to fund early payment of approved supplier invoices, while letters of credit with extended terms and bank confirmations can mitigate counterparty risk as well as maximise working capital.
