Beware of the Working Capital Safety Net

Regardless of where an organization sits in its response to the COVID-19 pandemic—ranging from crisis management to growth mode to something in between—effectively managing working capital will likely continue to be paramount for finance and other leaders as long as uncertainty persists around the pandemic’s continuing impact on businesses and their liquidity.

According to a recent poll, 33% of C-suite and other executives responded that their organizations are currently in crisis mode or recovery mode, making unlocking cash from working capital an immediate priority. Another 56% of polled executives say their organizations are now in stabilization or growth mode, presenting them with an opportunity to leverage the current environment to create leading practices in working capital to better position them for an uncertain future

As liquidity impacts continue, the pandemic environment makes the present an ideal time to rethink working capital management approaches, especially for the 49% of polled executives who report they have increased the frequency of updating their working capital management efforts this year.

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But, not every organization is focused on strengthening its related processes or understands the opportunity around doing so, with many finance teams instead focused on short-term fixes such as delaying vendor payments or focusing on collection efforts, both of which may not be sustainable improvements.

As the pandemic and its impact on business persists, CFOs will inevitably need to build working capital management processes that can more sustainably respond to challenges in the future, while working within and across their organizations.

Two key reasons are likely driving a false sense of security around working capital management today.

First, the provision of government business loans in the U.S. via the CARES Act and potentially the forthcoming HEALS Act could lead some organizations to adopt a safety net mindset.

Considering that more than one-third (38%) of polled executives say that access to cash on hand—both liquidity (18%) and accounts receivable (19%)—is placing the greatest strain on their organizations’ working capital management efforts, it’s easy to understand how government stimulus lending can be an easy and attractive short-term solution.

Unfortunately, some organizations are using stimulus money to buy more time to explore their options, and not taking action now to improve areas within their control, such as working capital — a dangerous game, especially when there is still no end in sight to operational stressors caused by the COVID-19 pandemic.

Second, despite the uncertainty that persists for businesses, most responding organizations seem confident they will be in a better state of operations 12 months from now, resulting in a “why fix it if it won’t be broken forever” mentality.

Nearly half (45%) of polled executives report they expect their organization to be in growth mode 12 months from now compared to the 13% who currently report they are in growth mode, an increase of 32% from today. Similarly, only 3% of respondents expect to be in crisis mode 12 months from now, a decrease from 11% today.

It’s possible this could be the case in a years’ time, but no one knows this for certain. Regardless, this optimism could be creating yet another false safety net barring companies from seeking more sustainable updates to their working capital management processes.

As the pandemic and its impact on business persists, CFOs will inevitably need to build working capital management processes that can more sustainably respond to challenges in the future, while working within and across their organizations.

For some CFOs, this will require recognizing that there are more sustainable ways to manage working capital beyond just uniformly delaying vendor payments across all vendors or increasing the focus on collecting aged receivables.

For example, shifting invoice payments from a 30-day cycle to a 90-day cycle may give the business a longer runway of cash on hand for the short term, but it could also cause significant supply chain disruptions if impacted vendors refuse to continue business under those new terms. There are a number of internal processes, including speeding up billing cycles to issue invoices faster, reducing invoice errors, and managing disputes that can ultimately help drive lasting changes and have a real impact on securing future cash positions—now and in years to come.

Processes aside, advanced analytics and other technology accelerators can also help CFOs evaluate the opportunities to strengthen working capital, including:

• Reviewing invoice data at the transaction level to identify “leakage” such as finding invoices that are being paid early or identifying vendors with multiple payment terms in the system. Often, CFOs may not realize that some invoices are being paid early — or whether their IT system is starting the payment aging clock based on the date on the invoice versus the date the invoice was received by the company. During times of crisis, understanding how to reduce or eliminate certain processes like early payments can increase cash positions while correcting the start date for invoices can gain several days of cash for the balance sheet.

• Analyzing elements within the order-to-cash cycle to pinpoint issues and trends in collection processes and receivables management, such as the frequency and root cause of collections disputes with vendors. There are often a number of actions companies can take to reduce their days sales outstanding that are within their control, without relying on collection pushes.

Importantly, analytics can also help significantly with forecasting efforts, which is critical considering that 32% of polled executives indicate that difficulty forecasting has put the greatest strain on their organization’s working capital management efforts. For CFOs, forecasting disbursements is generally easier than forecasting revenue, and the latter is where analytics can offer truly meaningful insights.

While serious focus to manage working capital has typically been reserved for companies in distress, the COVID-19 pandemic has made those efforts relevant for virtually every organization. For CFOs and other leaders, it’s important to focus on working capital efficiency despite the distraction that U.S. stimulus funding and other temporary safety nets may offer. Now is the time to create better processes and gain better visibility as uncertainty continues.

Anthony Jackson is a Deloitte Risk & Financial Advisory principal in corporate restructuring, Deloitte Transactions and Business Analytics LLP.