Why treasurers use working capital management solutions to manage improbable events

What is the working capital cycle (WCC), and why is it important?

Working Capital Cycle (WCC) is the length of time it takes for a company to turn its current liabilities and net current assets into cash. It shows the organization’s effectiveness and capacity for managing its short-term liquidity situation.

Working Capital Cycle= Inventory Days + Receivable Days – Payable Days

The working capital cycle focuses on managing four essential components: cash, receivables, payables, and inventories. To have a well managed and effective working capital cycle, a company must have total control over these four factors. With a shorter working capital cycle, companies can turn stock into profit more rapidly, which is usually better for their finances and operating costs.

How do we evaluate a company’s working capital?

Working capital is calculated by using the formula:

Working Capital = Current Assets / Current Liabilities

The three types of net working capital are discussed below:

• Positive Net Working Capital suggests that a business can meet its existing financial obligations and has funds to spare for investment, operational development or expansion, innovation, emergencies, etc.
• Net Zero Working Capital suggests that a business’s liquidity is sufficient to meet its obligations but doesn’t have the cash flow for investment, expansion, etc. 
• Negative Net Working Capital suggests that a business cannot pay off its current debt and will probably need to get loans or investments to maintain operations and solvency.

What are working capital management problems and solutions?

Common challenges faced by treasurers in managing working capital

Here are some problems faced by treasurers in managing working capital:

• Lack of real-time information: Obtaining accurate data on time may be difficult, depending on the complexity of the firm’s activities. Due to financial constraints, mid-sized businesses use multiple systems dedicated to each department rather than making a valuable investment in modern ERP systems. This leads to various data sources but a lack of real-time data availability and accessibility to the employees. This further creates confusion due to disintegrated systems. The treasury department also needs to update the spreadsheets regularly manually. As a result, the reporting turnaround time increases, and the reports are obsolete by the time they are given to the CFOs. This makes it harder to make timely decisions. 
• Irregular cash flow: Changes in working capital affect a company’s cash flow. Businesses often face cash flow issues due to problems related to the management and streamlining of cash receivables and payments. Irregular cash flow can occur if operating activities don’t generate enough cash to remain stable. This can happen if profits are tied up in accounts receivable and inventory or if a company spends too much on capital expenditures.
• Higher operational costs: Initial costs of leveraging technology are high, so cash-deficit companies often refrain from doing a regular forecast. Most small and mid-sized businesses face an aging workforce, the requirement to generate profit while minimizing operating costs, and demanding customers. Increased inventory levels may also lead to higher operating costs and the risk of obsolete inventory. Thus, these problems have an impact on overall revenue.
• Late-paying customers: Late payment affects companies by causing debt, penalties, and business shutdowns. When a company does not receive payment on time, this negatively impacts cash flow and would lead to severe effects such as :
  • Inability to pay its suppliers
  • Insufficient working capital to run its day-to-day operations 
  • Inability to pay its operating expenses

How can treasurers improve working capital?

Here are some ways in which treasurers can improve working capital:

• Leverage current assets and minimize liabilities: Working capital will be negative if the current liabilities exceed the current assets. So a company should leverage its current assets to obtain positive working capital. Working capital will increase if a transaction improves current assets but does not affect current liabilities. And cash flow will also increase.

  For instance, if a company sells a fixed asset for cash, it signifies an inflow of cash or an increase in account receivables. That, also without affecting the current liabilities. In this situation, increasing working capital boosts cash flow. Using working capital management solutions helps businesses to make the most use of their current assets and generate enough cash to meet short-term obligations. As a result, companies can:

  • Decrease their dependency on external borrowing
  • Expand their business
  • Fund mergers and acquisitions
  • Conduct research and development
• Shorten operating cycles: Shorter operating cycles suggest that a company has enough cash to maintain operations. It helps companies recover their investments and meet their obligations. If a company’s operating cycle is very long, it can cause cash flow issues.
  There are three ways for a company to lower its operating cycle:
  • Speed up the sale of its inventory
  • Reduce the time needed to collect receivables
  • Extend the time to disburse payables
• Increase forecast accuracy: Cash deficit companies focus on tightly managing cash, delaying payables, and borrowing at LIBOR rates instead of overnight sweeps. Therefore, they must create accurate cash forecasts and increase forecasting cadence to prevent overdrawing from their revolver.

  Implementing AI to capture customer-specific variables, using suitable models for different cash flow categories, capturing external data and seasonality, and analyzing the variance between forecasts and actuals can also improve forecast accuracy. This helps treasury teams transition from manual to strategic tasks like reporting and decision-making. Accurate and timely cash forecasts can bring tremendous benefits, such as:

  • Minimizing external borrowing costs
  • Maximizing investments
  • Better management of currencies
• Cut unnecessary costs: Examine the line items to find areas to cut unnecessary costs that deplete savings. So, to escape negative cash flow, a cash-strapped firm must look into new tactical cost-cutting methods. This can be done in the following ways:
  • Eliminate the need to maintain a higher cash buffer to save interest costs
  • Quantify profits by borrowing early to avoid high borrowing costs
  • Analyze costs by dividing them into fixed and variable costs
  • Cut down on payment processing costs
  • Cut down on bank integration costs
  • Automate time-consuming tasks
• Run scenario analysis: The corporate treasury teams may quickly become overwhelmed by the possible outcomes when creating best-case and worst-case scenarios. Finance leaders must prioritize and form opinions on the possible results of various scenarios according to their sales cycle or type of firm (midmarket/enterprise). Using treasury management software helps to identify the degree of impact on cash flows caused by various scenarios. This allows the treasury team to devise solutions to potential financial problems.

Apart from these best practices, companies should use treasury management software to manage their working capital.

How does treasury management software help in managing working capital?

Here are some features of treasury management software that help in managing working capital:

• Integrates with ERP systems, bank portals, and TMS improves visibility and reduces errors
• Reduces borrowing costs and increases investment returns by taking proactive measures
• Tracks scenarios effectively to manage loans and investments
• Tracks budgets and cash positioning
• Improves forecast accuracy by analyzing differences between forecasts and actuals
• Gathers real-time data for accurate reporting
• Helps in reconciling payments automatically

Customer success story with HighRadius treasury software:

A global company with a revenue of $765M was facing numerous challenges in managing its working capital:

• Could not supervise their 63 legal companies due to inaccurate reporting.
• Forecasted for four months: weekly for the first two months, then at a high level for the next two months.
• No proper data categorization: The A/R forecast was done randomly based on conjecture, resulting in many deviations.
• There were many intercompany payments, and the working capital management was poor.

Using the HighRadius cash forecasting solution, they acquired the following benefits:

• Improved A/R forecast accuracy (90%).
• Increased granular visibility (invoice level drill-down).
• Improved forecasting frequency.

Schedule a demo to learn the benefits of HighRadius treasury management software for treasurers.