Chapter 2 Understanding working capital management
invoice stream as security. However, it may
be more cost effective to arrange a longer-
term bank loan, using the building as security,
discounting an invoice stream for regular
finance, whilst arranging a more expensive,
but unsecured, overdraft for emergency
short-term finance. For companies operating
internationally, there is the additional
opportunity to arrange financing in more than
one country. This can include a decision on
whether to take advantage of cheaper funding
costs in one country, whilst accepting a
foreign exchange transaction risk. The overall
challenge is not to see each production
process as a discrete activity that needs to
be financed, but to arrange company-wide
financing as efficiently as possible, freeing the
company’s assets to be used as appropriate
security where necessary. The key is being
able to compare like with like when reviewing
the overall cost of funds.
Second, a key priority, wherever possible,
is to ensure the company is not reliant
solely on a single source of finance. This
applies whether the source of finance is a
committed bank loan, an overdraft facility or
a factoring arrangement. Events over recent
years have shown how banks and other
finance providers can change their lending
criteria at very short notice. This can result
in existing financing arrangements being
withdrawn or not renewed, again potentially
at very short notice.
To avoid this risk, companies ideally need
to enter into relationships with more than one
financing provider. This may mean trying to
arrange credit lines using more than one set of
assets as security, even perhaps when this is
not currently necessary. Circumstances make
it easier for some companies than others.
Larger companies, with good credit ratings,
have the opportunity to arrange commercial
paper issuance programmes, as well as more
traditional bank finance (which may itself be
diversified in the form of a syndicated loan),
without giving security. Companies with
overseas subsidiaries can arrange finance
centrally as well as locally. Smaller companies
are likely to have a choice of arranging bank
loans and discounting invoices or using trade
finance techniques. (See page 117 for more
on invoice discounting.)The treasurer’s challenge is to arrange the
level of finance needed both currently and
into the foreseeable future. At the same time,
this funding strategy must be flexible enough
to ensure that a sufficient level of finance
can still be raised in the event, for example,
of an existing provider changing its lending
criteria at some point in the future. The key
is to identify all possible sources of finance
and find a combination of funding sources
that provides for as much future liquidity as
possible. Using other parties along the supply
chain to help is an increasingly popular and
appropriate tool.
The working capital cycle touches many
different areas of specific management
responsibility, from procurement, production
and sales to accounting and treasury. It is
common to find fostering the necessary multi-
disciplinary teamwork to be an organisational
challenge. The use of key performance
indicators can help, but only if they are
carefully aligned: otherwise objectives across
the company can be different. Whatever
organisational system is used, visible
endorsement from the highest levels of
management will help.Techniques to improve the
efficiency of the working
capital cycleThere are plenty of techniques available
to improve the efficiency of the working
capital cycle. Below are brief examinations
of three particular techniques which improve
the visibility and speed of the collection
of cash, which together help to improve
the efficiency of working capital. First, an
efficient cash flow forecasting system allows
the treasurer to anticipate future cash
requirements. Second, an effective cash
and liquidity management structure supports
the movement of cash around a business,
to ensure cash is where it is most needed.
Finally, electronic invoicing reduces the cost
of processing invoices, whilst simultaneously
improving the collection of information.Cash flow forecasting
Companies seeking to manage their working
capital more efficiently will almost certainly