The Argument for Financial-Chain Management

The U.S. security markets turn over the equivalent of the entire GDP every week. Markets settle using about $1 in cash balances for every $250 value exchanged, most of that in free daylight credit. The real economy turns over the $9.2 trillion in GDP on about $1.6 trillion in net working capital, a leverage ratio of less than six. These are very different markets, but the scope for systemic improvement is nonetheless compelling.

There are only two levers for global working capital optimization:

• First, speed it up. Optimize throughput using information logistics. For example, aggregate figures for the economy suggest an average DSO of about 57 days. Elimination of printing, mailing, and re-keying times should be able to knock DSOs down by 10 percent if invoice data was online. Process savings from dispute resolution, fewer processing errors, and pre-reconciliation are incremental benefits on top of the time value of money from speeding up the cycle.
• Second, get it off your balance sheet. Firms are increasingly selective about the uses to which they put their balance sheets. They want to get out of the business of financing other peoples' working capital.

However, the current receivables securitization technology was really built for funding mortgages and other long-term cash flow loans. It is too cumbersome and expensive for short-term capital loans. If corporations can use information logistics to create greater clarity around settlement and trading relationships, it will be up to buyers to grant that degree of certainty, and the ability to make it visible to finance providers, to their suppliers. This will be a valuable quid pro quo to negotiate better trade terms.

Moreover, by doing so, corporations will be giving the financial services provider a far finer, more granular, forward view of credit, default, and dilution risk. These are the raw materials for leveraging the creativity and appetite of the global capital markets to reduce risk and thereby the cost of financing working capital.

This program for optimizing global working capital is both ambitious and difficult, but the same could be said for the deployment of information logistics in the physical supply chain before the great gains of the last 20 years. Many of the necessary tools are coming into place, but no one supplier can provide the whole solution, and the benefits will be achieved only through unprecedented levels of information transparency and collaboration. This program can be made to work given the will and the focus of leading financial professionals. It is really up to you.

This article is adapted from Bernard De Groeve and Kevin Mellyn's presentation to the annual conference of the Association for Financial Professionals in November 2000 in Philadelphia.

Questions for Your Management Team

First, a simple question of financial efficiency: Are we really making the best strategic use of our balance sheet? Specifically, do we really know how much working capital is tied up in our purchase-to-pay cycle, end to end? How much of this is financial working capital — AR/AP financing?

Second, do we really know the costs we are paying for the lack of clarity in the AP and AR relationships with our trading partners? Are the real costs of disputes, cash buffers, credit risk of buyers, and lost discounts fully understood? What scope for improvement are we foregoing in terms of trade terms and financing costs? Is this more or less than what we would have to invest in order to achieve settlement clarity?

Third, do we have the right technology strategy and initiatives in place to optimize our working capital? Do we have a common framework like global working capital optimization to integrate and leverage our information logistics efforts across key functional areas, including procurement, manufacturing, distribution, and — yes — treasury operations?

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