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Working capital. When it comes to the very lifeblood of business, optimisation is essential. From preparing for growth to managing risk and benchmarking success, we explore the metrics of working capital performance.
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FD GAMEPLANSPRING 2014
Contents | 02
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Key contributors | 03
kEy CONTRIBUTORS
Mark Gregory is Chief Economist (UK & Ireland) at EY.
Trevor Williams is Lloyds Bank’s Chief Economist, a Visiting Professor at Derby University and a member of Economia’s editorial panel. Prior to joining the Bank he worked in the Government Economic Service.
Enrico Camerinelli is a Contributing Editor for gtnews, and a senior analyst at Aite Group specialising in wholesale banking, trade finance, treasury management, and payments.
Guy Cabeke is an Associate Principal at REL Consultancy, and specialises in strategic sourcing, working capital and asset reliability improvements.
Simon Fraser is Chief Credit Officer for Mid Markets at Lloyds Bank, leading the Mid Markets corporate credit and business turnaround teams.
Donald kerr is Managing Director, Client Delivery, at Lloyds Bank and leads the team responsible for meeting clients’ working capital needs, including cash management, trade finance, invoice finance and leasing.
Simon Palmer is Head of Strategic Finance, Mid Markets, at Lloyds Bank.
kate Sharp has been Chief Executive of the Asset Based Finance Association since 2003. She is also Vice Chair of the EU Federation for Factoring and Commercial Finance (EUF).
The information contained in this publication is for general purposes only and is not intended to constitute legal or professional advice. You should seek specialist advice should you have specific queries.
This publication is based on information from third parties and is believed to be correct. However, Lloyds Bank plc nor its employees, officers or agents warrants its accuracy or completeness or accepts responsibility for any losses or damages whatsoever caused by reliance on information contained in this publication.
fter several false starts over the last eighteen months, the UK economy is finally getting back on its feet.
The Purchasing Managers Index (PMI) surveys are close to record levels, while a stronger economy and improved job security are helping to create the feel-good conditions that typically drive us to the shops.
And this doesn’t appear to be a flash in the pan. The latest report from the EY ITEM Club is forecasting GDP growth of 2.7% for 2014, with growth then averaging 2.4% a year in 2015 to 2017. While the upturn will be led by consumer spending and increased activity in the housing market, exports and business investment are expected to pick up significantly from 2015, creating the opportunity for a more broadly balanced recovery. It seems that the UK needs a consumer recovery first to create the confidence for businesses to invest over the medium term.
Although most of the survey data in the last few months has been very positive on both exports and investment, the UK is not out of the woods. There are challenges on both fronts and a number of major uncertainties:
• Will the USA be able to manage the exit from Quantitative Easing?
• Can China successfully rebalance its economy from export and investment based to consumer led?
• Will ‘Abenomics’ work in Japan?
• What will be the impact of a fall in commodity prices?
These uncertainties should be seen in a positive light as they reflect a shift in the world economy back to ‘normal’ conditions. The USA is looking to adjust ›
IS YOUR BUSINESS READY FOR GROWTH?
As the UK economy recovers, companies need to re-evaluate options and be resourceful.
MARk GREGORy
EY Chief Economist
This article was first published in CFOWorld magazine, and is
used with their kind permission.
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Insight 1 | 04
to its improved economic circumstances; China is trying to move towards a more sustainable, stable long-term model; and Japan is attempting to address the relatively poor long-term performance of its economy. Yes there are risks, but the overall intent is in the right direction. Commodity prices may fall and this will increase the need for structural reform in countries such as Brazil and Russia. There may be short-term pain but, in the long run, change is required.
UK business investment is currently 24% below its pre-financial crisis peak, but firms have accumulated large cash reserves over the past five years and large firms, in particular, have the funding available to generate a strong rebound in capital spending. The greatest risk now might be that the defensive mentality that has been required to survive the tough conditions of recent years could become a barrier to businesses realising the benefits of an improving economy.
ARE yOU READy FOR GROWTh? The changing economic outlook has four key implications for business:
1. IS CAPITAL BEING USED EFFECTIvELy? COULD IT BE DEPLOyED RAPIDLy? Capital investment has slumped over the past five years so there is a real risk that businesses don’t have the capacity to grow rapidly. Have investment plans been developed and approved so they are ready to go as demand recovers?
UK mergers and acquisitions (M&A) are close to record low levels. After similar lows in 1997 and 2002 transactions rebounded, and so we could see a fight for assets break out. It is vital that target lists are updated and options developed so that companies do not get left behind and see their competitors capture value through first mover advantage.
2. ARE BUSINESS MODELS APPROPRIATE FOR A GROWING ECONOMy? Productivity has fallen as companies have substituted labour for capital, hoarded key staff and seen turnover fall. As future rates of growth are now becoming clearer, are business models appropriate? Portfolios may need tidying up and divestments initiated.
A big expansion of the labour supply through immigration and later retirement has kept a lid on wage pressures. However, there is a danger that a war for talent may develop as the demand for labour increases so companies need to be prepared.
3. WhAT IS ThE BEST APPROACh TO EUROPE? The European economy continues to struggle but Europe is a huge market of relatively affluent consumers. International businesses must decide on the correct level of investment in their portfolios. This could involve managing cash and limiting investment. However, there are businesses continuing to prosper in Europe, especially when they invest in assets exposed to higher growth markets and start to benefit from wage restructuring in Southern Europe.
4. RISk MANAGEMENT The economic and political environment remains volatile and there are clearly risks out there. However, many of these are either manageable or are just normal risks that we have become blind to. High growth usually comes with higher risk – the challenge is to manage it, not avoid it.
Challenges remain but, for the first time in a while, there are positive signs. Businesses must continue to monitor developments and ensure they have the options available to respond as opportunities emerge. •
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Insight 1 | 05
High growth usually comes with higher risk
– the challenge is to manage it, not avoid it.
The UK has moved from crisis to recovery, and whilst that is of course very welcome, businesses that aren’t fully prepared can find the current environment just as challenging.
Consumer spending appears to be key to the recovery, driven by increased confidence. The latest ONS figures indicate that retail sales in December 2013 were up 5.3% on 2012, representing the fastest annual sales growth in over nine years, and helping to strengthen prospects for UK economic growth. To embed the recovery further, however, a rise in business investment is also required.
Beyond the UK, challenges exist around growth in our key export markets. Questions remain, as Mark says, about how the US will handle tapering its Quantitative Easing (QE) programme, despite growth in 2013 of close to 2% and expected growth of close to 3% in 2014. And we must remain cautious about the durability of Europe’s post-recession recovery in the context of the need for continuing reform of labour and product markets. Developing economies, such as India and China, are also
facing up to issues around their need for new policies to stimulate further growth. In addition, some emerging economies have to grapple with the consequences of the tapering of US QE, which had buoyed their asset prices.
Forecasting best and worst case macroeconomic scenarios thus remains intrinsic to an FD’s role.
Recovery presents challenges that the FD can directly influence, such as the risk of overtrading. The recession encouraged cost-savings and efficiencies which left some businesses under-resourced and under-capitalised to take advantage of the upswing. Overtrading occurs when a business pushes for sales beyond what its finances or operations can support. It’s often a natural consequence of attrition followed by recovery. Astute FDs will have strategies in place to optimise their working capital and facilitate stable growth. This, along with a focus on understanding and mitigating the risks within opportunities is essential to negotiate the path to recovery.
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Be aware of the opportunities of growth and understand the requirements of your growth strategy in both an operational and financial sense. Ensure this permeates throughout the company to make sure that your business can safely maximise the opportunities that recovery offers.
Strengthen your Management Information (MI) so that you can quickly identify deficits in workforce, capital or machinery that may lead to overtrading. Be realistic about the amount of orders that the company can handle. It’s a forward-thinking approach that brings long-term benefits.
If you identify a concern or a potential stress to the business, take action as quickly as possible. If you find your business overstretched as demand increases, look at operational efficiencies and talk to your bank about ways of managing your debtor book or raising additional capital to support growth.
ANALYSIS
ACTION PLAN
TREVOR WILLIAMS Chief Economist, Lloyds Bank
PREPARE FOR gROWTh
RESPECT yOUR LIMITS
TAKE POSITIVE ACTION
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Insight 1: Analysis & Action Plan | 06
he major components of working capital are: account receivables (A/R), account payables (A/P),
and inventory. Cash is still king and the decisions and actions undertaken to obtain it require the strict reduction of a corporation’s working capital. Sweating your assets in this way, via lengthening or shortening payment cycles, factoring or other measures, can be beneficial to the bottom line but it needs effective treasury management.
Optimising working capital can sometimes lead to unintended negative consequences, and it can be counterproductive to a corporate’s business if it is not handled correctly. Let me elaborate on this concept.
To optimise working capital a corporate treasurer must:
• Reduce A/R.
• Increase A/P.
• Reduce Inventory.
If these actions are performed in isolation, the chances are that the results obtained will dramatically backfire and result in deteriorating relationships with both suppliers and customers. That is to say, it could jeopardise the whole business of the company. In fact, if we look at the techniques frequently adopted by treasuries to increase A/P we find ›
WORKING CAPITAL OPTIMISATION: RISKY BUSINESS
To counter the impact of the current macro-economic distress triggered by the 2008 financial crisis, corporate treasurers have been challenged for the last five years to optimise their company’s working capital. Enrico Camerinelli explores the available
options but also warns against a short-term approach that could damage physical and financial supply chains and introduce risk into a company.
ENRICO CAMERINELLI
gtnews Contributing Editor
This article first appeared on www.gtnews.com and is used
with their kind permission.
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Insight 2 | 07
What happens to a company if such collection processes are not executed in a harmonised manner among the various departments? For example, what if a solicitor in the A/R department chases a customer for a presumably unpaid invoice only to discover that the delay had been agreed between the customer and the sales account? Or – after having threatened the client with a legal dispute action – the lawyer has to face the fact that the amount of the late payment is minimal versus the potential revenue sitting on a large contract that same customer is about to sign?
Don’t get me wrong. Working capital optimisation is indeed a best practice that corporate treasurers must strive for, but other factors must also be considered to mitigate the risk of adverse long-term consequences. Principally, attention must be paid to supply chain risk and liquidity management if such practices are to be used. Let’s discuss each separately.
abundant literature (unfortunately) about companies that decided to pay their suppliers late, or even to simply suspend payments until further notice – neither of which are good long-term strategies.
Another usual tactic to optimise working capital is to make the supplier hold inventory and deliver only what is strictly needed for the production cycle. This sometimes unfair practice is often cloaked with an aura of ‘collaborative’ or ‘on-demand’ supply chain management phrases, while in reality it is, in effect, aiming to bluntly push costs back on to suppliers.
Such strategies steadily produce financial distress to the supplier and enhance the risk of its failure and, perhaps, the dissolution of a whole financial supply chain. This ultimately has negative consequences for the buyer. Besides being extremely short-sighted, this strategy is also myopic as it doesn’t consider another important factor: the importance of ensuring supplier loyalty.
In a globalised marketplace a supplier is serving not a single client, but a network of clients that are very likely competing against each other. So if a buyer is forcing that supplier to bear all the costs of the supply chain, chances are that the supplier will opt to loosen the relationship from the imposing client and prefer to work more for others. A disloyal supplier soon will turn into a supplier that will make very little effort to adapt to changing corporate requests. If that supplier provides key components (i.e. it is a ‘strategic’ supplier with a unique product), its lack of agility or effort will make the buyer less flexible and so vulnerable to market changes. And a company that cannot adjust to market changes will soon be out of business.
ACCOUNT RECEIvABLESThe situation on the A/R side is no different, and collaboration should always be remembered as an important guiding factor. One common practice adopted to reduce A/R, is to improve the collection of receivables by tracking ageing credits and soliciting late payments from customers, which again, though, is very short-termist.
• Supply chain riskResponsiveness, reliability, and flexibility are indispensable performance attributes that participants in the physical and financial supply chain must reciprocally exchange to ensure streamlined operations and profitable results. Suppliers, distributors, freight forwarders, import and export agents, warehouse operators, and outsourcing partners are but a few of the many participants and nodes of vast supply networks that are all involved. Before each one embarks on actions to optimise their own working capital ratio, they should look at the bigger picture to avoid likely negative domino effects.
• Liquidity managementPayments are becoming a strategic risk management asset for treasurers. Critical supplier relationships can be resolved by anticipating payments just for the purpose of maintaining the optimal level of loyalty. This decision – while apparently opposite to the dictates of an ‘orthodox’ working capital optimisation discipline – certainly helps to mitigate supply chain risk, ensures business continuity and, finally, represents a tool that implements a powerful and effective supplier relationship management strategy.
The bottom line to remember is not to look at working capital optimisation in isolation. Always remember you are a node of a vast supply network of interconnected and interdependent constituents and treat them as you would wish to be treated. •
A company that cannot adjust to market changes will soon be out
of business.
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Insight 2 | 08
There are clear dangers in considering working capital in a short-term, isolationist way, as Enrico notes. By taking an holistic approach, FDs can significantly improve KPIs and improve the buyer/supplier relationship.
To achieve this, working capital needs to be front and centre within the business, so everyone understands the benefits of optimisation and their own responsibilities in achieving it. For example, performance against sales targets will have implications for cash flow, which needs to be understood and factored into the wider strategic picture.
Enrico is right to highlight the importance of supply chain relationships; it’s certainly an important element of a long-term, holistic outlook, and one that FDs are taking notice of. Understanding, as he says, that all businesses are ‘a node of a vast supply network’ has, for example, helped to drive interest in supplier finance beyond the top tier corporates and across a range of sectors. however, there is a natural ceiling, due to the
required credit standing of the buyer and their willingness to assume risk on their supplier’s behalf. Notably, it is increasingly being recognised as a mutually beneficial financing solution that can help to safeguard the essential relationship between a business and its supplier.
Supporting the undeniable move amongst businesses to embrace the opportunities of the digital world, supplier finance solutions that incorporate e-invoicing solutions can also help to optimise working capital performance by speeding up payments even further and creating efficiencies in administration.
The rapid uptake of digital payments amongst consumers will certainly be replicated amongst businesses. Appropriate systems and controls allow clear benefits – cost reduction, faster payments and greater security. The holistic FD can play a key role in creating a progressive culture that supports such opportunities.
01 02 03
Working capital is not just about the numbers. Ensure that it’s high on your company’s list of strategic priorities and considered in operational as well as financial terms so that you can make informed decisions and meet short and long-term business needs.
Whether as customer or supplier, encourage and maintain a more open dialogue to get the best out of your relationships. This can open avenues to supplier finance arrangements or improved payment terms that increase efficiency and mitigate risk.
Working capital optimisation requires a willingness to explore new strategies and solutions. Be alert to market forces and product/technology developments, for example, that might affect your planning – your bank can assist with this. If your programme requires external or internal changes, getting all stakeholders on-side will be key to its success.
ANALYSIS
DONALD KERRManaging Director, Client Delivery, Lloyds Bank
ThINK hOLISTICALLy
BUILD STRONg SUPPLy ChAIN RELATIONShIPS
BE OPEN TO ChANgE
ACTION PLAN
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Insight 2: Analysis & Action Plan | 09
urope’s largest publicly traded companies are sitting on €762bn in excess working capital. To put
that figure in context, it is roughly equivalent to 6% of the European Union’s entire gross domestic product (GDP). This level of inefficiency will inevitably have a negative impact on the bottom line – and working capital optimisation is a challenge that affects companies of all sizes and sectors.
In order to assess the level of inefficiency in a company’s working capital cycle, internal
benchmarking is invaluable as a first step. Typically, the three components of working capital – days sales outstanding (DSO), days payable outstanding (DPO) and days inventory outstanding (DIO) – are used as basic KPIs. External benchmarking goes a step further, allowing FDs to determine how well top companies in their industry manage their working capital, as well as accessing benchmarks for the best (upper quartile), and worst (lower quartile), performers in their peer group. ›
BENCHMARKING WORKING CAPITAL: OBJECTIVITY MATTERS
FDs are increasingly using scorecards and key performance indicators (KPIs) to benchmark their company’s working capital performance internally – and
the benefits are clear. Peer-to-peer benchmarking is another valuable tool for finance professionals looking to achieve working capital optimisation.
GUy CABEkE
Associate Principal, REL Consultancy
E
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Insight 3 | 10
PERFORMANCE IN CONTExTAlthough peer group members may actually have very different business models and different commercial footprints, this kind of comparison allows an organisation to see its performance in context – and across each of the three elements of working capital. What is more, the company can analyse not only their current performance, but also look at what their best past performance has been. Sometimes, their best past performance might even have put them in the upper quartile. It’s also possible to calculate the theoretical optimal performance for each element of working capital given the company’s strategy and footprint. This insight can assist with setting working capital objectives going forward.
AN OPERATIONAL ISSUEBut working capital optimisation is not just a question of analysing the numbers. Many companies still see working capital as a financial issue, when it is really an operational issue. This means that corporates need to instil a culture of working capital optimisation across the entire organisation, making sure that it encompasses every individual that affects working capital performance.
Putting in place a working capital sponsor from the financial area (as they manage the balance sheet) to be the flag bearer for working capital within the organisation can assist in achieving this objective. Bringing together a team of people from different areas across the business to lead the change is another positive step: in many cases FDs can be a little reluctant to make their mark on the inventory, for example, because it is primarily in the hands of the supply chain or procurement team. But inventory is a significant piece of working capital, so it is critical to have financial co-leadership over that, too. In short, a holistic and objective working capital approach is the best path to performance improvement. •
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Many companies still see working capital as a financial issue, when it is really an operational issue.
Once an analysis of the company’s performance within its industry, and perhaps also its region, has been performed, potential gaps and issues need to be identified, creating a significant opportunity for the FD to pinpoint possible improvements in processes, practices, skills, and KPIs, for example. There are a variety of complex issues to consider. Is there one element of working capital where the company is falling down? Are invoicing issues or errors affecting your receivables performance? Is the company’s credit risk management perhaps insufficient? Is overall corporate performance affected by one specific geographic region, business unit or operating unit? Are the KPIs that are being used too high level? These are all important questions to address when developing a cohesive strategy to improve the company’s working capital performance.
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Insight 3 | 11
Effective working capital management is crucial for both cash-poor and cash-rich organisations, not least when we remain in a low interest rate environment. Seeing a clear path to improving working capital performance
can be tough, however. This is especially true in small and mid-market companies where resources are often stretched and technology budget can be scarce.
As guy outlined, benchmarking – both internal and external – is a great place to start. What follows, i.e. addressing any inefficiencies and working towards optimal working capital levels, is often where the real challenge arises for FDs. Whatever gaps the benchmarking analysis unearths in the company’s working capital performance, it is important to focus on creating sustainable improvements. Quick fixes, such as delaying payments to suppliers, may well improve working capital performance in the short-term, but could
lead to supplier relationship issues, price increases, or supply disruptions farther down the line.
Fortunately, there are often many internal measures that can be taken to improve working capital performance in a sustainable manner. In addition to guy’s suggestion of taking steps to ensure that working capital is front of mind for the entire company and not just the finance department, points to consider may include the way that invoices are produced and delivered; how payment reminders are sent; and whether discounts are being used to best advantage.
Strategic working capital management considerations should also include the efficiency of pooling and sweeping arrangements, and a review of the financing solutions that the company has available to it. your bank will be able to assist in determining the optimal set-up for your particular needs.
ANALySE AUTOMATE COMMUNICATE
01 02 03
As the old adage goes, you cannot manage what you do not measure. Benchmarking against internal KPIs and within the company’s peer group is therefore an essential first step on the journey towards working capital optimisation.
The level of automation in receivables can significantly impact DSO. Consider whether e-invoicing would be appropriate for your company and the benefits that could be derived from dematerialisation throughout the financial supply chain.
A successful working capital optimisation drive relies not only on solutions and systems, but also on people. Clearly identify working capital targets, incentivise employees to achieve them, and keep them informed of progress against objectives and external benchmarks. Also ensure that suppliers/creditors are made fully aware of any changes to processes that may affect them.
ANALYSIS
SIMON PALMER head of Strategic Finance, Mid Markets, Lloyds Bank
ACTION PLAN
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Insight 3: Analysis & Action Plan | 12
s economic confidence continues to rise, the focus of many businesses is now
moving away from survival and on to growth. However, there is a danger that cash flow projections and other working capital forecasts will be relegated behind unlocking growth potential on business agendas. If working capital management is not on the immediate business radar, it will limit the company’s ability to seize the opportunities of a growing economy.
Any business seeking growth soon discovers how cash-greedy this ambition
is, with the extra staff, stock and materials needed to fulfil growth in orders. The more business that is coming in, the greater the funding requirement – especially when delivery times and 30-day credit terms add additional time between an order being placed and final payment.
For those businesses looking at growth, the first issue that needs to be addressed is securing a sustainable cash flow, to get through the initial rise in productivity and support sustainable growth. Asset based finance has been increasing in popularity as a funding solution that addresses these needs. ›
WORK YOUR ASSETSEffective working capital management remains the cornerstone of any successful business – and, with cash still king, asset based
finance is proving to be an increasingly popular tool.
kATE ShARP
CEO, Asset Based Finance Association
A
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Insight 4 | 13
CAPITAL EFFICIENCIESFinancial institutions are recognising the growing importance of asset based funding, and not just because it’s an effective product to support the long term ambitions of its clients. As banks need to hold higher liquidity ratios to meet Basel III requirements, asset based finance has proved to be a very capital efficient product.
With banks valuing asset based finance as a way of managing prudential and liquidity requirements, whilst still supporting the funding needs of its customers, I foresee the UK market replicating the US economy by increasingly offering this as an initial solution to working capital requirements. American bankers often look to answer as much of the funding requirement as possible using asset based finance, and only when this has been exhausted will mezzanine finance with equity demands be sought.
Part of the appeal is that it’s a low-cost route to finance. The capital efficiencies that help banks keep abreast of liquidity regulations are reflected in the costs of asset based finance solutions, which, as a secured form of finance, tends to be the one of the most cost-effective options available to customers.
The benefits of asset based finance are becoming more widely appreciated by banks and the business community in the UK, and I predict significant growth of this solution over the coming decade. Its
›
Asset based finance has proved to be a very capital efficient product.
growing importance can already be seen in post-crises lending figures. Whereas the Bank of England M4 lending figures have been steadily reducing since 2009, asset based finance has been growing and will continue to grow until such time as the UK lending requirement reaches maturity. Which, in my view, will only happen when all businesses seeking working capital use asset based finance as part of their funding mix.
INvOICE FINANCE: ADDED vALUE AND INSIGhTThe business benefits of some asset based finance solutions extend beyond the capital efficiencies. The way invoice finance is set up, for example, means it offers a good overview of certain management disciplines.
Invoice finance is linked to the quality and quantity of the goods or services being sold. The amount of funding available grows
as the invoice inventory grows, and so the rise and fall of available cash reflects the rise or fall of a business’ sales.
If orders are rising, but available cash flow does not rise to match the growth, then invoice finance immediately flags up an issue to an FD. This could be, for example, that a certain customer is not paying its invoices, and so the funder becomes reluctant to release cash on invoices to that customer warning the business of potential danger ahead. It could also flag an issue with the quality of the goods a business is supplying if its customers don’t wish to pay for them. In both instances, the early notice given by the invoice finance solution means that any issue can be rectified quickly, often more timely than through traditional approaches.
ASSET BASED FINANCE AND ThE BUSINESS COMMUNITyAsset based finance will continue to grow as an efficient working capital tool, as much through positive feedback and recommendations from business peers as anything else. As increasing numbers of quality businesses use asset based finance solutions, so old prejudices about the product are being erased.
The solutions will form part of the vital funding mix now needed by businesses. It will not replace all forms of funding: for example, leasing can be an ideal way to fund new machinery, and commercial mortgages the most effective form of funding for new or improved business premises. However, the limited availability and higher interest rates associated with overdrafts, and the fact they can be recalled by the provider with little notice, mean that this facility is better suited to low and temporary funding requirements. Furthermore, while many businesses do rely on overdrafts for everyday trading this practice impacts on the availability of such facilities for unexpected expenses, and can in fact mask a broader cash flow issue that actually requires a more strategic response.
Asset based finance offers a sustainable and cost-efficient solution to many working capital requirements, and, I would argue, should be the first thought for any FD reviewing their strategy. •
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Insight 4 | 14
Asset based finance is very much a client-led approach to financing, offering bespoke solutions that support growth. Kate is quite right in describing an increase in its use; it’s something we’ve certainly witnessed over the last
five years. That’s not, as some might suggest, a result of the financial crisis but rather part of an historic trend, and what’s driving that trend is two-fold.
Firstly, businesses are becoming increasingly sophisticated in their financing requirements, focusing on funding that meets specific needs, whether that’s for cash flow or equipment finance, for example. Asset based finance also allows the client to track the cost of finance against their asset types and, in many cases, offers greater flexibility.
Secondly, growth in asset based finance is occurring across the board, from large global corporates right through to SMEs, because the general business
community is increasingly alive to the opportunities these types of finance offer. Far from being a last resort, asset based finance is increasingly recognised as a viable, effective funding solution.
While the US asset based finance market is more mature, there’s no doubt that in the UK companies are increasingly using it as part of a broader funding package. There are multiple client benefits, including funding that can grow with the client and greater visibility over the cost of funding assets, allowing businesses to more easily identify their return on capital.
Moving from crisis to recovery, a blended funding solution offers businesses flexibility to grow, with the control and visibility over their working capital and assets necessary to ensure that growth is sustainable.
PRIORITISE CASh FLOW MANAgEMENT
SEEK ADVICE FROM yOUR BANK
REVIEW yOUR gROWTh STRATEgIES
01 02 03
Cash flow is not just crucial during tough times, but can mean the difference between success and failure for businesses looking to grow. Asset based finance offers greater visibility over capital returns for individual projects and can support cash flow management as part of a wider strategy.
Early discussion of your plans could help to establish a funding structure that can maximise the value in your assets and create a blended funding package that closely meets your needs. This can deliver flexibility, control and scalable funding for a growing business.
Consider the pace and scope of your plans and how your cash flow needs and funding requirements may change over time. Forecast and then compare actual MI to forecast to create a more holistic view of where the business is and where it is heading.
ANALYSIS
DONALD KERRManaging Director, Client Delivery, Lloyds Bank
ACTION PLAN
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Insight 4: Analysis & Action Plan | 15
- 43%
Improvement opportunities
TRENDS: WORKING CAPITAL
The media sector reported the best improvement in DWC performance by industry, with a 43% decrease.
The survey findings reveal that top performers operate with less than half the
working capital of median performers, hold less than half the inventory, pay suppliers
two weeks later on average, and collect from customers more than two weeks sooner.
Europe’s largest publicly traded companies have €762bn tied up in excess working capital, according to REL’s 2013 Europe
Working Capital Survey – a 12% increase over three years. This amount is equal to 6% of the European Union’s entire GDP.
€762bn
The biggest opportunity is in accounts receivable. Approximately €272bn is tied up in this area, representing 36% of the total working capital opportunity.
6%improvement
Days working capital (DWC) improved 6% year on year to 40.8 days.*
Days inventory outstanding (DIO): 3.1% improvementDays sales outstanding (DSO): 6.4% improvementDays payable outstanding (DPO): 4% deterioration
*Figures reflect 2011-2012 comparison.
€272bnAccounts receivable
€257bnInventory
€232mPayables
Source: 2013 Europe Working Capital Survey, REL
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Trends: Working Capital | 16
uring the global financial crisis, a number of businesses came to realise that while trading was
buoyant and strong asset markets could often be relied upon to get them out of trouble, they had under-estimated the value of sound working capital management (WCM) practices. Robust WCM consequently attracted greater focus during the downturn.
As the economy recovers, WCM remains high on the corporate agenda – a trend not restricted to one particular sector or size of business. Companies, from SMEs through to large corporates, are increasingly acknowledging the fact that having significant amounts of working capital locked up in their business can jeopardise survival, and that taking action to increase efficiency can unlock value and support growth ambitions.
One risk is that as the recovery gathers momentum, lax practices will creep back in. In the current environment the need for a dynamic response to working capital optimisation persists. Funders, for example, are increasingly focused on the effectiveness of a business’s financial management, strategic plans and management’s ability to deliver these plans.
FORECASTING FUTURE NEEDSAs any forward-thinking business develops, it requires an increasingly robust and sophisticated financial management structure with strong controls and a well-planned strategy. The senior management team – including the pivotal FD – will define their corporate vision, understand their company’s competitive advantage and how to maximise it, and
WORKING CAPITAL IN CHANGING TIMES
Forward-thinking FDs take a dynamic approach to working capital management. Simon Fraser considers the key priorities
and challenges of keeping pace with change.
SIMON FRASER
Chief Credit Officer, Mid Markets, Lloyds Bank
D
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Bank Insight | 17
create a well-articulated strategy for growth that is subject to regular review. An essential component of that process is forecasting future funding needs, including working capital requirements.
Forecasting working capital needs and contingency planning should be key priorities for any FD. For example, as recovery continues we can be assured that, at some point, interest rates will rise. Businesses need to plan for the best and worst case scenarios. For those businesses susceptible to interest rate rises, sensitivity testing, scenario planning and hedging strategies can contribute to mitigating that risk.
The most effective companies stress-test their forecasts, exploring different scenarios to inform their wider planning. This should be part of a clearly articulated strategic approach that is subject to internal challenge and debate.
MANAGING GROWThWhilst effective WCM is crucial for surviving a downturn, recovery also presents major challenges for businesses. One obvious danger is overtrading. If a business has experienced a prolonged period of low sales income it can be understandably reluctant to turn anything aside when opportunities increase, but over-reaching brings both operational and financial pressures. Taking measures to ensure that WCM is considered during contract negotiations – for example when agreeing payment terms and conditions – can make all the difference.
An unbudgeted and unfunded build-up of debtors or stock can place unsustainable pressure on a business’s cash flow and lead to the failure of an otherwise viable and profitable enterprise. Whether it is
tried and tested means of accelerating payment is invoice discounting. It offers an ideal way of funding variable working capital for businesses with large debtor books or seasonal swings. Supplier finance – which enables suppliers to obtain early payment of invoices by leveraging the buyer’s credit rating – is also gaining traction across a range of sectors, and is no longer solely the domain of top-tier corporates.
An open discussion with your bank can help to explore the diverse range of financial solutions available and adopt a broader approach to WCM that will support the business in its day-to-day activities and leverage opportunities for growth as they arise. FDs must look ahead to what will be a changing macroeconomic environment, recognise potential risks and create robust, flexible working capital practices in response. •
In the current environment the
need for a dynamic response to working capital optimisation
persists.
› overtrading, poor debtor collection, lax inventory control or a failure to negotiate suitable payment terms with creditors, the outcome can be equally problematic.
Creating WCM processes that work in both crisis and in recovery is essential, and is an integral element of sound overall financial management. Strong governance and maintaining adequate levels of management information (MI) might seem obvious, but some management teams simply don’t have a clear enough picture of their current and future working capital position. Current MI and an effective IT system are fundamental to providing this visibility.
DIvERSE FINANCIAL SOLUTIONSThere are numerous tools at the FD’s disposal to optimise WCM as part of their operational and financial strategies. One
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Bank Insight | 18
ealing with the world’s largest supermarket chains, CeDo aims to be the lowest cost
producer in every segment of the market and drives to be extremely competitive. As a consequence we are constantly re-assessing our working capital management processes and strategy,” says Jamie McComasky, who joined the company as Group Finance Director in 2010.
Having spent the majority of his career working for large corporates in the high tech manufacturing sector, he now heads up the finance team at private equity backed CeDo – a European market leader in the
manufacture of household products such as refuse sacks, aluminium foil and cling film.
The private equity world has provided a welcome challenge for Jamie who describes this environment as “far more demanding and dynamic” than that of the traditional Plc, with faster pace, rapid decision-making and a greater emphasis on the responsibility and accountability of individuals. What’s more, shareholders’ expectations are high and pressurised. In fact, Jamie was brought into the business with a demanding three year strategy to work towards, which was successfully delivered within a two-year timeframe. ›
WorkInG CAPITAl sTrATEGy: All WrAPPED uP
In an increasingly competitive and international marketplace, Jamie McComasky, Group Finance Director of CeDo Holdings, firmly
believes that mastering working capital management begins with getting the fundamentals right – and keeping your feet firmly on the ground.
Jamie McComasky, pictured, is Group Finance Director of CeDo
Holdings, a European market leader in the manufacture of a
wide range of household products.
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FD Insight | 19
UNIqUE ChALLENGESJust as the pace of planning and decision-making at CeDo may be very different to some of Jamie’s previous roles, the company’s working capital also presents unique challenges. CeDo has working capital of circa £40m and treats each of the three components of working capital (inventory, trade payables and trade receivables) quite differently, says Jamie.
“Take our inventory levels, for example: we have to ensure that we can put products on the shelves of Europe’s largest supermarket chains as and when they need them. But the largest retailers rarely provide a significant forward order commitment – it’s very normal in our sectors to work with a short term order book whilst our customers expect ‘just in time’ responses to their ever-changing needs. Given that CeDo manufactures in locations such as Vietnam, where it can take up to six weeks for products to reach the UK by boat, we need to be able to predict, with a fair degree of certainty, what our customers are going to
need, and by when. We manage this mainly through sophisticated forecasting and integrated logistics/manufacturing planning.
“In terms of trade receivables, we have a fantastic blue chip customer base across Europe, especially in the UK, France, Germany and Poland. We also have an exciting growth operation based in Moscow – where we distribute branded household products. This involves sending our goods up to 3,500 miles across Eurasia to reach our customers’ retail points. From a working capital point of view, when working with customers in distant locations, it is imperative that we have complete control over our receivables ledger. The key is being close to your customer, and understanding whether they are safe or risky.” For added peace of mind, the majority of CeDo’s European customer balances are covered by credit insurance.
From a trade payables perspective, CeDo has a mix of very large suppliers, who deal in the commodity sectors – mainly oil refiners and aluminium miners/convertors, plus a range of smaller local suppliers. ›
£40mWorking capital level
›
We need to be able to predict, with a fair degree of certainty, what our customers
are going to need, and by when.
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FD Insight | 20
Their size can make supply negotiations challenging, and Jamie therefore has limited leverage to optimise the company’s working capital terms. “The secret is striking the right balance between all three working capital components, from inventory through to trade receivables and trade payables,” he notes. “That keeps us quite busy!”
A DIvERSE FUNDING MIxTo assist in achieving this balance, CeDo has a selection of strategic funding facilities in place across the countries in which it operates. “We have an innovative €30m asset-based lending (ABL) facility in place, provided by Lloyds Bank, which covers us not only in the UK, but also in France and
› our external environment changes. Working capital management has to be dynamic,” stresses Jamie.
To monitor the company’s working capital performance, Jamie uses standard, DIO, DSO and DPO metrics, as well as reporting debts 30 days past due. “Twelve month trends are also monitored – we break down our inventory into raw materials, finished goods, goods and transit. In terms of supply chain management we make great effort, up front, to achieve the best payment terms available in the countries we buy from. We take credit from the supply chain in places like Vietnam, China and Russia by stretching payment terms.” Nevertheless, CeDo aims to
meet all of its supplier obligations and actively manages supplier relationships.
“None of this is rocket science,” admits Jamie, “but where working capital is concerned, the FD’s role is all about getting the basics right. That means minimising risk, knowing your customers really well and being able to predict whether your customers, and suppliers, will be able to survive as global economies return to faster growth. It’s the FD’s duty to keep the business safe – this means keeping management’s feet firmly on the ground, and learning from experience.” •
We adapt to different markets
and update our financing model to suit as our external
environment changes.
Germany. For us, ABL is a cost-effective, scalable and flexible solution.”
Additionally, CeDo has a £10m inventory-backed facility, specifically in the UK, which means that a percentage of the inventory that the company holds is immediately funded by the Bank, which assists with working capital optimisation. In Poland, CeDo relies on more traditional instruments – namely a long-term loan and a revolving working capital facility. The company also has a debt factoring facility in Russia, which proved a good financing model when interest rates in the country were 3-4%, though currently it’s less cost-effective so not in use. “We adapt to different markets and update our financing model to suit as
Jamie McComasky, right, with Tim Newman, Relationship Director, Lloyds Bank
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FD Insight | 21
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THINKING
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