To thrive in any economy businesses must create new offerings, optimize existing processes and invest in employees’ upskilling. For this, cash is king, and a strong working capital management strategy is central to growth. However, managing liquidity effectively and strengthening balance sheets is a struggle that businesses face. The ongoing
pandemic has only intensified these challenges.
Traditionally, corporates have been following a singular strategy – maintaining a high credit periods (or DPO – Days Payable Outstanding), where they negotiate longer time to pay creditors and in the interim use any excess available cash for short-term activities. Now, while higher DPO and longer credit period may be seen as beneficial, the pandemic is forcing many corporates to expedite payments to vendors in order to keep them afloat.
According to the PwC research of the largest global listed companies in the last five years, GBP 1.2tr excess working capital is tied on global balance sheets and for two consecutive years a decrease of 3.8% in DPO has been witnessed. This indicates that use of DPO may not be a sustainable approach in the long term. This makes it difficult for cash-strapped buyers who don’t have any ready cash available to pay and hence need a long credit period. The only way to solve this is corporates need to re-look at their entire working capital strategy and cash cycles. .
Supply Chain Financing – An Underutilized Lever
Supply Chain Finance (SCF) is an underappreciated lever to optimize working capital strategies. SCF isn’t a new concept. It’s been around and practiced for more than two decades now. While some corporates have been able to modernize and automate their SCF operations, it still has a a one-size-fits-all approach. This method does not address issues around the lack of liquidity. However, other real challenges such as high transaction costs along with structural barriers such as paper invoices, lack of an integrated data flow that can provide real-time visibility on the end-to-end cash conversion cycle and lack of organizational guidelines are rarely addressed either.
So, while most business leaders understand the value delivered by SCF, the depth of it remains unexplored. Research says that a Fortune 100 company can potentially generate $2 billion in additional cash by simply optimizing working capital management, at par with the performance of top companies in the sector.
To achieve results such as these, every SCF program must align with unique business objectives that doesn’t just ensure business continuity and production planning but also plays a key role in uplifting sales and earning risk free high returns as well.
The key advantages of a well-defined SCF strategy are aplenty. It can speed up sales by injecting capital to the distributors, can create direct bottom line benefit and stretch working capital by extending longer credit periods to vendors who have the capacity to bear the extension, while paying struggling vendors before time. To enable these benefits, corporates need to have a unified supply chain and working capital strategy that is fully aligned with evolving business objectives; and look to modernize practices to achieve scale operations in SCF.
A six-step plan for a holistic SCF strategy
- Set up a 5-year working capital goal that will form the bedrock of the strategy. The goal needs to have a dual lens – profitability for the corporate, and health, resilience and ability to grow for the vendors.
- It’s critical for the corporate to understand their supply chain end-to-end and identify where exactly working capital is trapped and how much is trapped. Often, this occurs in multiple places – delayed payments by customers, early or excess capital made available to vendors, or simply, a slow-moving inventory – a harsh reality of the ongoing pandemic.
- Calculate potential material gains across each of these places, and cumulatively for the organization as a whole. This will help prioritize action areas with immediacy.
- Corporates need to undertake in-depth risk modelling – for this, one needs to deep dive into vendor specifics such as – how many vendors is the corporate working with? Of these, how many are financially strong and how many need support immediately or in the near future. This should also cover vendors and dealers in the second and third tier of network.
- They need to create a data-driven scenario analysis by looking into vendors’ past business performance and relationship with the company, and then create a customized vendor financing program that’s a win-win for both, the corporate and the vendor. Similarly, this needs to be done for all vendors. Here, corporates also need to model the plan in a way that there is flexibility of funding sources, allowing a corporate to dynamically switch between internal and external funds as needed, ensuring overall profitability for the corporate.
- Corporates need to have a contingency plan in plan and periodically assess and re-strategize their approach to suit all. After all, an entire strategy can never be locked into a single course of action – as a corporate’s goals evolve, so must the supply chain financing model.
(The writer is Founder and CEO, CashFlo)