August 05, 2015

Less Pressure, More Capital

by Treasury Optimization, Finance Centralization, Point-of-View

Originally published in OpusCapita Journal.

Working Capital Management (WCM) is currently losing its priority position in numerous German businesses. This is evident not just from academic studies, but also from informal conversations with treasurers. But it's hardly surprising: interest rates are at a historic low and several German companies are paying penalty interest on their bank deposits.

Many CFOs and treasurers are therefore asking themselves why they should bear the expense of making working capital available, when it would hardly bring in any money anyway? Even if a business wants to finance its expansion with a new flow of cash, the attraction of self-financing is fading: bank loans are currently available at unbeatably good terms in Germany.

Furthermore, German CFOs are optimistic about the future, despite the euro crisis and increasing political risks: in FINANCE’s biannual CFO questionnaire, 42% of respondents were looking forward to improved business growth over the next six months when polled in the spring 2015, while only 16% of them feared worsening conditions. In this context, businesses prefer to build up stock levels in preparation for an upturn in production when demand starts to grow once more. They are likely to offer their clients more generous terms of payment, while not exhausting their own. Furthermore, business consultants and software providers are offering more solutions for businesses to pay their suppliers earlier – and not later, as textbook working capital practice would demand. This is how it works: If a treasurer can see from his liquidity forecasts that his business is likely to be cash rich over the next few weeks, he will offer to pay his suppliers earlier. Discounts are dynamic: the earlier he pays, the higher the discount he will expect to receive.

So therefore, at the moment, businesses at both ends of the business success spectrum are optimizing their working capital: companies with a high level of debt, exiting a crisis, are using WC programs to reduce their debt. This issue also often gains in importance after large acquisitions. On the other hand, first class rated companies will want to free up their working capital in order to maintain good credit ratings with rating agencies.

However, the large number of businesses will need to ensure that working capital does not grow out of control. This is due, among other reasons, to the fact that the effectiveness of WC programs can be greatly improved, as shown by a study run by FINANCE Research in August 2014: although 60% of 122 European treasurers polled for the study had installed a WC program, the Cash Conversion Cycle, which is one of the most important working capital parameters, had declined in no more than 20% of their companies. Should interests rates rise again and the pressure to optimize grow, this lack of effectiveness could easily become problematic.

Desirée Backhaus is an editor for FINANCE, a magazine published by FRANKFURT BUSINESS MEDIA GmbH – der F.A.Z.-Fachverlag.

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