Prepare for financial challenges - improve liquidity through a cash race

In current times of economic uncertainties created by the widespread outbreak of the Coronavirus covid-19, many companies will face financial challenges in the near future. Facing these upcoming challenges – either caused by Coronavirus disruption or any other underlying cause – freeing up cash rapidly to secure access to capital and a good cash position will be key to minimize losses. 

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Foundations of a cash race

All companies have assets on their balance sheet that can be converted into cash. Cash that can cover expenses when credits are reduced, or that can be invested in equipment when bank loans are difficult to come by. Given the current situation where multiple stakeholders are affected, it will be important to consider the whole value chain when optimizing the working capital in order to ensure that suppliers and customers jointly share the burden of working capital to survive a recession. 
 
Now is the time to target specific initiatives that will reduce working capital requirements and put your company in a financial position to successfully weather this economic storm. A cash race is a number of focused efforts within a short period of time – mainly focused on quickly reducing working capital and improve cash flow as well as reviewing the cost-structure. Capacent has experience of supporting our customers during this journey where some of the key success factors are: 
  • To ensure that the management supports the project and is a prioritized initiative with focus throughout the whole organization  
  • To create a cross-functional team which is given the mandate to execute the activities  
  • To secure a high project pace to keep momentum in the project 

 

We present several concrete actions you can take to ensure the minimum of tied-up capital in each interface of your business.

Supplier interface 
Addressing accounts payables, the first action needed is to get an overview of current account payables by understanding to which suppliers the largest spend is related and what payment terms they offer. When an overview is obtained, a negotiation is required to try to increase the payment terms for the largest invoices. 
 
Another action to take is to cancel all non-essential purchases and to lower the order quantities when possible. However, considering the trade-off between the higher purchase price that comes with a decreased volume and the cost of capital for keeping excessive stock. Focus should also be spent on reviewing all indirect purchases by determining the criticality level and see which ones that could be cancelled and which ones where effort could be put on negotiating lower prices. 
 
Facing financial challenges, it is also effective to implement a clear set of rules when approving invoices. E.g. all invoices above 50 KSEK is automatically stopped and any release of payment need to be decided on within the team. This will also raise awareness of payment terms for large invoices. A set of rules should also include a decision around standard terms that should be assigned to all small suppliers, which is an effective way to push payments for the tail of suppliers. 

Risks that needs balancing:

  • Damaged relationship
  • Lost volume higher prices
  • Quality effected negatively

However, all above stated measures comes with some risks to take into consideration. There is a chance that too tough negotiations can damage the relationship you have with your suppliers and by pushing them financially there is a risk that the quality of the products they sell are affected negatively. Given the current situation this should be regarded carefully before taking any decisions. 

 

Inventory management
Regarding inventory there are several measures to take to reduce the inventory at hand and by that reduce the overall working capital. 
 
One action is to initiate campaigns to sell off excess inventory at a reduced price. However, to get a rapid effect of this measure it is essential that payments of these stock-emptying campaigns are paid in cash or with short payment terms. A decision regarding a cash discount should be regarded as a one-time opportunity and the extent of the offering should be analyzed carefully. You must also be aware of the risk of cannibalization of other products and the loss of sales this implies. 
 
Risks that needs balancing:
  • Cannibalization
  • Lost sales
  • Poor customer experience
A review should also be made of the inventory parameters to ensure a proper stock composition in the short term. Another trade-off that should be evaluated in times of low liquidity is whether keep current delivery precision or to temporarily reduce it by lowering the safety stocks. This will reduce the inventory levels, however there is a risk that the relationship to the customer will be negatively impacted by a poor customer experience.

Customer interface
When it comes to accounts receivables effort should be put on the overdue invoices and to ensure that the collection process is accelerated. It is important that the customer responsible keep a tight dialogue with their customers to ensure first and foremost that overdue invoices are paid. Lack of communication is usually the primary reason why invoices turn overdue, and by not understanding the cause there will be limited possibilities to reduce the share of overdue. If the customer is not able to pay it is essential to set up a payment plan including down payments to mitigate the risk. In the discussion with the customer it is crucial to get a realistic view of when they will be able to pay their invoices. 
 
Another measure to take is to offer the customers discounts to get early payments, though it is important that they are in line with WACC (weighted average cost of capital). However, this action needs to be balanced by the immediate risk of these discounts being permanented and expected also in the future when the working capital has stabilized. 
 
Risks that needs balancing:
  • Damaged relationship
  • Discounts to high
  • Discounts being permanented
Actions above should primarily focus on customers and invoices that will make a difference, i.e. those with large volumes. For smaller customers the implementation of standard terms is an effective method to ensure short payment terms for the tail of customers. As of internal structure, it is important to ensure that the invoicing process is accelerated and that there is no delay in sending out invoices. In comparison to actions  mentioned above which demand high attention and work  effort, establishing this process is a one-off effort which will have great impact. 

 

Monitoring

It is essential to set up a structured monitoring of the working capital to understand how actions taken have an impact on the reduction of working capital. This should be done by establishing a detailed way of monitoring the inventory levels, accounts receivables and accounts payables with the possibility to drill-down on specific areas. It is important to ensure proper follow-up of liquidity monitoring payments. The same principle applies to account payables where you are in stronger control, since you control the outflow from the ledger. Capacent has a wide experience of using tools such as Qlik Sense and Power BI for this purpose. 
 
It is important to keep up a good pace of the project which is most easily obtained by setting clear targets on a weekly basis and to ensure clear responsibilities. By having a weekly rhythm, results will be achieved quicker which is crucial in a cash race. 
 
Summary
  1. Key success factors for a cash race includes
    • Management Support and prioritized initiative focus throughout the organization
    • Cross-functional team with mandate to execute activities
    • Secure high project pace to keep momentum 
  2. Actions in each interface
    • Supplier interface: negotiate payment terms, cancel all non-essential purchases, review indirect purchases and negotiate
    • Inventory management: sell off excess inventory, ensure proper stock composition short-term, evaluate if reduced delivery precision is possible
    • Customer interface: review overdue to accelerate collection process, offer discounts in exchange for early payments, assign standard term for smaller customers
  3. We are all in the same boat and share responsibility
    •  Consider the whole value chain when optimizing the working capital order to ensure that suppliers and customers jointly share the burden of working capital to survive a recession