How to get working capital working harder

Read time: 6 mins Added date: 20/05/2024

This year’s simplification of tax laws is likely to mean that some firms will have less capital on their balance sheet. As a result, the issue of optimising working capital is rapidly becoming even more important. Lloyds Bank has spoken to PwC’s working capital experts to look at the issue and potential solutions in more detail.

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When building resilience and maintaining the financial health of the business, cash is undoubtedly king. But HMRC’s Basis Period Reform, which came into effect for the 2024/2025 tax year, changes how certain businesses calculate their profits, moving from basing them on the accounting year ending in the tax year, to basing them on the tax year itself – regardless of their accounting date. Ultimately this will leave these firms with less capital on their balance sheets.

This comes at a time when firms are facing multiple headwinds; from higher interest rates to inflationary pressures and an increasingly challenging commercial environment. As a result, how firms optimise their working capital is fast becoming an issue on the minds of CFOs.

The reforms affect firms that draw up annual accounts to a date different to the 31 March or the 5 April. Predominantly these businesses will be partnerships and other unincorporated entities, many of whom will operate in the professional services sector. The first affected year is the ‘transitional year’ of 2023/24, with the first significant payment being 31 January 2025.

Putting working capital high on the agenda

“Basis Period Reform essentially accelerates tax payments for affected firms, and the professional services sector will be particularly affected,” says Jessica Armstrong, Head of Professional Services at Lloyds Bank. “As a result, businesses will no longer have the same level of member reserves on their balance sheet to fund working capital.” This leaves affected firms with a key decision: either find a source of alternative funding, for example bank debt or capital call from partners, or unlock liquidity by optimising their working capital cycle.

The latter should be the primary focus for any firms operating at a sub-optimal level. “Indeed, PwC’s 2023 Law Firm Survey suggests that the number-one priority for business support functions this year is to improve the performance of working capital – also known as lockup in the sector,” says Dan Wicks, Director at PwC.

“However, the average lockup days for law firms between 2021 and 2023 has generally worsened in the top 10 firms (+7 days to 152), top 11-25 (+9 days to 145) and top 26-50 (+3 days to 142). On the other hand, the top 51-100 firms have slightly improved (-4 days to 140), he adds.”

The drive to optimise

Recent economic turbulence has increased the cost of capital, which has meant that the optimisation of working capital has become even more crucial. In the 2023 PwC Global Treasury Survey, 37% of CFOs cited working capital (incl. supply chain finance) as one of their priority treasury topics – the first time that working capital has appeared among the most commonly cited list of topics.

“While working capital has always been important, we have not seen firms compelled to take action like they seem to be doing this year,” says Stephen Tebbett, Partner at PwC and PwC’s Working Capital Practice lead. “Strong top line performance and profitability mean that working capital has not been a priority over the past few years. However, over the last 12 months we’ve seen a significant increase in focus by clients in response to the backdrop of higher interest rates and economic uncertainty.”

This is even more crucial for businesses whose primary commodity is time. Businesses in the professional services sector, such as legal, accounting, or consulting firms, heavily rely on human capital and receivables to generate revenue and cash flow. As a result, professional services firms can’t rely on using tangible assets or inventory as collateral, or selling them to raise funds. These firms are almost entirely dependent on clients paying invoices in a timely manner. Delays can cause issues in terms of cash flow and constrain the financial health of the business.

Given these circumstances, combined with the impact of the Basis Period Reform, it’s crucial that professional services firms take steps to ensure a healthy level of working capital. So which solutions are available to affected businesses?

Tips on making working capital work hard:

Harnessing the power of technology

As PwC’s 2023/24 Working Capital Study highlighted, large corporations are deploying tech-enabled management capabilities to optimise working capital. However, most small and mid-sized companies are still behind the curve. The PwC CEO survey found that 41% of organisations surveyed are investing in external partnerships to better access and deploy technology capabilities.

Lloyds Bank can offer a range of solutions to accelerate client invoicing and optimise internal processes. The automation of processes through technological solutions such as Application Programming Interfaces (APIs) can speed up payment processes and improve visibility of the movement of funds.

Lloyds Bank’s Embedded Payment solutions offer the ability to remove friction from the payment journey. Our PayFrom Bank service makes it easier for your clients to pay you and helps to accelerate the receipt of funds, while our PayTo service allows businesses to automate outbound payments. Other solutions, such as Event Driven Notifications, for example, can provide push notifications of credits and debits to an account, allowing the business to be faster and more agile when managing cash flow.

“Automation is the engine of efficiency,” says Brian Owens, Director, Cash Management and Payment Solutions at Lloyds Bank. “Lloyds Bank’s Embedded Payment solutions can help businesses in the professional services sector remove the manual operations from their payment processes, increasing speed and reliability and reducing their working capital cycle.”

Diving into data

By strategically using data and analytics to assess different business functions, a firm can increase visibility, anticipate payments, identify easy ways to further optimise working capital, diagnose cash flow challenges, and benchmark the business’ financial health against that of its peers.

Instilling a cash culture

Part of optimising working capital falls under human responsibility, therefore implementing a culture of rigour and timeliness can help to maximise liquidity. On the receivables side, ensuring that there are processes in place to monitor collections, track slippage and identify emerging trends can help to guarantee that the firm receives payment for its invoices in a timely manner. On the payables side, effective actions include overhauling internal supplier payment processes, improving the timing of supplier payments and ensuring that the most efficient payment methods are used.

“These solutions are only effective if you have people with the right skills and sufficient time to implement them,” explains Stephen. “At PwC, we know this is a challenge for many organisations that we work with, and that’s where clients have come to us for support; either to provide surge capacity for a defined period of time, or to deploy a managed service for the longer term. We can bring together technology, people with working capital expertise and operational teams to run these processes for them.”

Finding financing solutions

To help unlock working capital and improve liquidity in situations where cash flow is constrained, Lloyds Bank offers a range of financing solutions. These range from overlaying financing on select portfolios based on invoicing, through to the extension of supplier payments with early pay solutions. These not only support suppliers, but also allow the firm to unify supplier payment terms, potentially increasing liquidity.

Lloyds Bank also offers a range of Commercial Card solutions that extend Days Payable Outstanding (DPO) by up to 60 days, maximising cash flow within the business. By changing your current invoice payment method to a Commercial Card solution, you can enhance your working capital position, increase efficiency and improve compliance with your preferred supplier’s policies. It’s also possible to earn your organisation an annual rebate.

“Lloyds Bank’s working capital-focused financing solutions provide firms with faster access to the money they’re owed,” says Jessica. “This reduces the risk posed by late payments or non-payments, and provides firms with greater flexibility. Our solutions can help firms meet their short-term needs, while ultimately supporting their long-term growth.”

While Basis Period Reform will accelerate tax payments and put pressure on working capital, there are technological, data-driven, cultural, and financial solutions available. For more information on Lloyds Bank’s solutions, speak to your Relationship Director, Brian Owens, or Jessica Armstrong. To learn more about PwC’s available support, contact Stephen Tebbett or Dan Wicks.