Adapting to the Times: The Critical Role of Real-Time Working Capital Management

In today’s current interest rate climate, finance teams are well aware that investing surplus cash can significantly contribute to the company’s overall financial performance. Many companies establish an investment policy and negotiate with their banking partners to maximize interest rates that they get on various products – from money market accounts to term deposits, and even funds held in their checking accounts. Yet, the interest rate is only one part of the yield equation, the other part is the amount that’s invested.

In an earlier blog post, we explored various ways to optimize buffers and manage cash across multiple accounts. The focus of this post is on another highly effective but often overlooked method for maximizing invested cash – proactive working capital management.

Working capital (defined, for the purpose of this post, as accounts receivable + inventory - accounts payable) is definitely a tough nut to crack. While interest rate negotiations and intercompany money movements fall under the sole control and responsibility of the finance team, working capital doesn’t. It involves other departments and stakeholders: the sales team influences customer payment terms, the operations and supply chain teams define the inventory policy, and various stakeholders influence supplier payment terms. This causes many finance teams to avoid facing the challenge of optimizing working capital. When interest rates were close to zero it didn’t matter that much. But things have changed. Every dollar that can be freed up from working capital and invested in interest-bearing accounts is now translated into interest income that directly contributes to the company's bottom line.

Before initiating any steps to unlock cash from working capital, it’s imperative to understand the potential impact. While working capital can never be zero, calculating the actual value of working capital and monitoring changes and trends over time is key. There are two important benchmarks to consider:

  1. Comparing working capital against your company’s historical performance. This can help the team identify root causes and other key issues that need to be addressed. 
  2. Comparing your company’s working capital to external benchmarks. Public companies that operate in a similar space can serve as a great benchmark. If your company’s WC consistently exceeds that of its peers, that should raise a red flag right away.

After the initial benchmarking, it’s critical to start measuring relevant KPIs on an ongoing basis. DSO and DPO are a good starting point, but these metrics are usually only calculated monthly after the month-end closing (or even worse, quarterly!), rendering them difficult to act upon in real-time. Introducing real-time, actionable metrics such as weighted average days to cash (WADTC) and weighted average days to pay (WADTP) can help finance teams identify issues quicker and respond more effectively.

Once the right metrics are in place and a continuous monitoring process implemented, teams can easily uncover opportunities for working capital improvement and take action. Since working capital is often a cross-company responsibility, it becomes crucial to communicate the KPIs and status with everyone involved to secure buy-in and accountability.

Wrapping things up 

The current market condition, with high interest rates in the foreseeable future, provides a significant incentive for every finance team to streamline its working capital management. Although things can get quite messy at times , defining the right KPIs, monitoring them on an ongoing basis, and communicating the underlying causes to the organization are all critical factors needed to release precious cash from working capital. 

Every dollar that’s freed up can be leveraged to reduce interest costs or invested to generate interest income. Either way, it’s pure cash flow and the moment to take action and act on this opportunity is now.

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