Maximising liquidity to speed up the recovery

04 October, 2020

As businesses get to grips with navigating the current economic landscape, we expect the working capital position for most businesses to face further pressure. Robust working capital management will therefore be even more critical over the coming months. Optimising the working capital position of your business will not only support liquidity, but also support the longer term capital requirements of the business to support future growth, remain competitive and generate greater shareholder returns.

Historically, most organisations have been slow in realising working capital improvements, with only 12% of companies typically able to generate year on year improvements. However, given the current environment this is likely to change.

The current challenge

The unprecedented situation has presented several unique challenges for businesses in managing their working capital. Understanding these challenges is an important first step to assessing where potential opportunities or risks lie. These challenges include:

A significant shift in customer payment behaviour and credit profile, resulting in an increased uncertainty around the risk profile of customers and their ability to pay on time.
Rapid shifts in demand patterns, resulting in a combination of both inventory build up and stockouts of impacted products and product categories.
Liquidity and capital constraints, resulting in significant operational impacts on projects, employees, third party suppliers, contracts and business decisions in both the short and longer term.

As companies activate their strategic plans for FY20/FY21 and beyond, there are a number of actionable steps that should be considered in order to stabilise your working capital position, manage down working capital investments where opportunity exits, and maximise the use of liquidity to support business recovery and growth.

(A) Managing inventories

Identifying slow moving, obsolete or excess inventory in order to redistribute capital towards the purchases of new materials. Running fire sales or targeted auctions at cost could be net beneficial, if a market can be found. This rapid recycling of capital, even if small, can help fund new sales and could offer a boost in the recovery timeline for companies willing to sacrifice short term margin for revenue gain.
A risk weighted approach based on demand variability should be adopted when prioritising production orders or new purchase orders. Investments in high variability items,unless strategic, are likely to come with higher risk of slow turns or even obsolescence, therefore needs to be assessed against overall liquidity position and risk appetite.
Return to full service or full product offering should be done gradually based on categorisation driven by demand patterns, margin contribution and turns in order to ensure that the limited cash available is invested in products/ service offerings which can offer quicker cash turns and cash margins versus others that might block cash or offer little profit.
Revising the forecast to account for consumer patterns and demand changes or potential shortages due to COVID-19 related impacts and translate it into an updated operational plan.

(B) Cash collections

Where appropriate, consider and implement alternative payment options. For example agreeing or revising payment plans with existing customers.
For overdue customers establish visibility around stock levels and future order requirements in order to influence clearance of overdue purchases of new orders where leverage can be identified. Alternatively, for service based sales maintain strict compliance to credit policy.
Review and tighten existing payment terms for new customers to ensure new payments are received on time to establish payment history. Consider enforcing cash only terms for customers with weak or no credit profiles.
Make use of larger customers’ discounting programs to access cash immediately after a sale or access receivables discounting products from banks where you have existing relations.

(C) Managing the payments

Setup a payment committee to evaluate payments over a certain threshold on a regular basis to ensure cash is deployed effectively and the investment made in cash outflows return cash profitability and do not tie up cash for too long.
For strategic or critical suppliers, consider entering into payment plans with suppliers in order to unlock service levels. Ensure payment plans are adhered to once agreed to maintain confidence and trust.
Establish robust communication lines with all critical suppliers. Open a transparent dialogue to proactively exchange forecast information as well as manage payments.
Explore options with lenders and other non-bank solutions to explore supply chain finance tools to benefit both your organisation and the supplier base.

The COVID-19 pandemic has challenged organisations to do things differently whilst unlocking different strategies and new ways to create value. As companies deliver on their future strategic plans after lifting COVID-19 restrictions, it is important to ensure that the working capital processes are supporting the business, not hindering. The level of liquidity available to the company will have a significant influence on the ability and speed to deliver that plan, and maximising working capital resources is an effective way to mitigate potential liquidity risks and provide the capital needed to fund the rebound as quickly as possible.

Did you know that AED 134bn of excess liquidity was trapped on the balance sheets across the Middle East listed companies? Check out our Working Capital report.