Chapter 2 Understanding working capital management
At the heart of any company’s activity
is its control over working capital. Every
company needs to ensure it has sufficient
cash available to continue to finance its
short-term obligations. These include
making debt repayments and paying
suppliers and employees.
Within this context, the first challenge
for the treasurer is to ensure sufficient
funding is available to meet the short-
term obligations as they arise. This
means working closely with the accounts
payable personnel to establish what these
obligations are, before arranging any
funding required from external sources,
from both bank and non-bank sources.
The second challenge is to ensure all
available cash, including cash converted
from sales, is recycled back into the business
as quickly as possible. For an international
company, this may involve sophisticated
cash and liquidity structures to enable the
cash to be collected from the customer and
repatriated to the home office. By working to
ensure that cash is recycled more quickly via
improvements to the efficiency of the cash
and liquidity management structures, less
external funding will be required.
In the past, the treasurer’s role in
managing working capital might well have
ended there. Today, companies recognise
the importance of managing the cash that is
tied up in the whole working capital cycle, or
internal supply chain. Broadly speaking, the
working capital cycle describes the processes
within the company, from making the decision
to produce a quantity of products or to
provide a range of services, paying for all
the raw materials and other inputs, through
manufacturing the products and delivering
them, to taking an order from a customer and
collecting the payment.
Alongside this physical process there
is an interrelated financial process. This
recognises that cash is needed to pay for all
raw materials and other inputs. Moreover,
these funds remain tied up in inventory and
receivables until such time as the receivable
is converted back into cash as a result of a
completed sale.
Treasurers increasingly have a role in
trying to finance the working capital cycle as
efficiently as possible. This means ensuring
that assets are appropriately financed. For
example, raw materials (which can often
be more easily sold, in the event of a ‘fire
sale’) may be purchased using specialist
commodity finance, and sales invoices,
once raised, can be discounted to speed the
conversion into cash. Relatively expensive
overdraft facilities can then remain free, to
be used only for emergency shortfalls or very
short-term peak funding requirements.
To be able to accomplish this, treasurers
need to understand how the business as a
whole operates. Only on that basis can the
treasurer identify at what stages funding
is required, and how different funding
techniques may meet these needs. As with
many aspects of the treasurer’s role, there
will probably not be one ideal solution. Rather,
there may a number of different funding
strategies, all of which might help to make the
use of working capital more efficient.
The first stage in this process is to
understand the working capital cycle.