Working capital, at a high level, represents a company’s ability to meet short-term obligations – bills to pay, cash on hand needed to maintain the pace of operations.
From an accounting perspective, the main drivers of working capital are receivables, inventories and payables, which result in current assets less current liabilities. The propagation? Well, it’s the available financing that gives a business the cash to pay employees and suppliers, meet tax obligations, and even pivot to meet unexpected expenses.
Gurang Shahhead of consulting at JPMorgan Chasetold PYMNTS’ Karen Webster that effective working capital requires treasurers and finance professionals to deftly pull inventory, receivables and payables levers to match supply and demand – which is not an easy task given inflation and supply chain issues.
But the impetus is there, he said, given the current macroeconomic uncertainty.
The current challenges are formidable. Shah noted his own previous tenure in automotive design, where shock absorbers (in the form of running gear) help support rough terrain automatically, but there are some that bounce.
And for companies that were previously used to cheap financing, that shock absorption has eroded a bit. Ditto the consumer demand that had been building up as a result of the stimulus programs – that spending firepower has waned a bit, so forecasting has become very difficult for large companies.
“You may have unsold inventory,” he said, “which can significantly affect working capital.”
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The conversation took place in a context where a bank report found that last year working capital at S&P 1500 companies returned to pre-pandemic levels. During this year, several industries have also shown positive impacts on working capital during the pandemic and beyond.
In the pharmaceutical industry, for example, there has been what he called “incredible demand” during the pandemic, where week-long inventory drawdowns were the norm. Also during the pandemic, tech companies such as Apple saw notable declines in inventory, spurred by strong consumer demand. Automakers experienced supply constraints due to semiconductor shortages, and available inventory was quickly depleted.
But with the uncertain macro environment, he said, working capital has become a project. In order to improve this management of working capital, there are two aspects to examine: the process, related to the supply until the payment, or the processes of order to the collection.
There are a number of inefficiencies that exist here, he said, such as battling payment cycles, whether daily, weekly or monthly. On the other side is financing, which can help address supply chain pressures and can help increase DPO. The net impact here is that companies hold on to cash longer.
As a result, he said, “companies that tend to do well are those with strong balance sheets that allow you to seek growth when they see the right opportunity.” These companies are the ones with the cash to increase R&D spending, fueling future growth.
There are also companies that don’t have the luxury of investing in growth because their balance sheets aren’t that strong. Part of the solution to making supply chains more efficient is to integrate more payments into the process, into the interactions between buyers and suppliers.
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The urgency is there, Shah said, because last year when working capital levels were good, finance leaders tended to spend less time improving those processes. The focus now shifts to managing working capital, given the challenges of inflation and the onerous cost of tapping into other sources of funding (i.e. bank loans).
He also noted that many companies are considering environmentally, social and governance (ESG) friendly forms of financing, such as green bonds, and that access to earned wages is also gaining traction – a boon for those of us who live in the paycheck to paycheck economy. But such initiatives will take time.
“When you think about ‘climbing the ladder’ of ESG goals, that’s a vision, but in terms of execution and moving the needle, it gets a lot more complicated,” Shah said.
Looking ahead, he said, companies are extending their scenario analyzes to three years instead of the usual two years, to ensure their working capital processes and buffers are adequate.
As he told Webster, “Right now, working capital is your cheapest source of funding.”
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