Working capital: Why prioritise operational and commercial excellence?

Read time: 6 mins Added date: 26/09/2024

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Over the last 18 months, I have experienced a significant change in the narrative from our corporate customers. Recent geopolitical events and market conditions – especially in the context of higher interest rates – have not only increased the level of working capital requirements, but have also increased the cost of holding working capital itself. In addition, the switch from a ‘just-in-time’ to a ‘just-in-case’ approach to inventory means that treasurers are also facing an extended working capital cycle, while at the same time being required to release cash to grow the business.

As a result, the conversations I have had with our clients have broadened from focusing on direct solutions to working capital challenges, to looking beyond single product discussions. Now, the pendulum has swung more towards implementing operational and commercial excellence; that is, putting in place solutions that will drive the business forward, increase margins and reduce costs. The conversations extend well beyond trade and working capital, and now also delve into the operational aspects of cash management and foreign exchange (FX).

I therefore find myself increasingly engaged with the operational and commercial sides of our customers’ businesses before addressing financial solutions – but what do we mean by implementing excellence in these areas, and how can this be achieved to benefit working capital?

The operational route to optimisation

Recently I chaired a panel session at the Association of Corporate Treasurers Annual Conference 2024, where I was joined by several corporate treasury experts who had overseen this process of optimisation and taken steps – both small and large – to simplify and centralise processes. Alex Spencer, director at Baringa LLP, was one of the experts who shared his experiences in this field:

“I remember looking at one company that had 172 combinations of payment terms, and we got that down to six. It had a really dramatic impact. The procurement and finance teams managed the payables, and you needed fewer people to manage that process. You had fewer errors, and you had a better opportunity to optimise the process because you had a better idea of what your flow looked like.”

Alex Spencer Director at Baringa LLP

Today there is more urgency than ever to optimise such processes, especially in the context of a volatile business environment. When interest rates and inflation were both lower, businesses that held higher levels of working capital had little incentive to create improvements within procure-to-pay (P2P) processes, customer-to-cash (C2C) processes, or inventory management. Today, this represents a significant cost and taking action – such as reducing the time it takes to approve invoices, or centralising payment terms – can deliver real value to an organisation before a financial solution has been overlaid.

Innovation and the drive towards digitalisation have also provided further opportunity for optimisation. Lloyds Bank has worked with our clients and UK government bodies to create the first digital iterations of traditional trade instruments, such as promissory notes, to reduce transaction times from days to a matter of hours. This has helped engineer faster, smoother, and more cost-efficient operational experiences, and create further opportunities to optimise transactional processes as a result.

Parallel chains

Treasurers are key to implementing these processes of improvement, and they are able to do this by embedding themselves in strategic conversations among different business functions. As the custodian of cash within an organisation, it’s critical that the treasurer is able to gain a complete and holistic view of the operational and commercial running of the business, and this can be achieved by managing the physical and financial supply chains in tandem.

Abel Martins Alexandre is a former group treasurer of mining company Rio Tinto and is now head of infrastructure, energy and industrials at Lloyds Bank. He has experience not only as a treasurer, but also in running working capital optimisation projects, as well as a number of divestments where the valuation of working capital featured prominently.

“The role of the treasurer becomes one of sitting down with procurement, sales and marketing, operations, sustainability and IT, and explaining the value of cash, why there is value in optimising working capital, and why it should be everyone’s responsibility – from the bottom up,” Abel says. “Within an optimal and integrated approach, operational efficiency, health and safety, sustainability, and working capital are all part of the same dynamic. Managed together, they form a fundamental tenet of a culture of excellence.”

Abel’s argument is clear – the treasurer should not work in isolation, but instead must become integral to all aspects of the business, becoming the bridge between the physical and financial supply chains, and acting as a trigger to drive forward operational and commercial optimisation. They should also use their role as a catalyst to create a culture of excellence, in which the business thinks of working capital as a process of continuous improvement.

Two business men discussing document in hallway

Driven by data

Access to high-quality data also plays an important role in this process. Gathering data at three levels – operational, commercial, and financial – can provide the treasurer with clear reasons why potentially expensive financing solutions should not be used as a standard default and before the business is operating at an optimal level. Gaining access to such data needs understanding and investment from across the business.

Operational excellence stems from a culture of continuous improvement, and once the business begins operating at an optimal level then financial solutions – such as supplier finance, dynamic discounting, and receivables financing – can further support process improvement. With the foundations in place they can become truly effective, not only benefiting the business itself, but also improving the resilience of the business’ supply chain.

Ultimately, by shifting the initial focus away from financial solutions and towards operational and commercial efficiency, treasurers can gain a more accurate understanding of the true efficiency of the business, including its working capital cycle. This allows them to then choose the most appropriate financial solution to provide effective support.

When he joined me on stage at the ACT annual conference this year, Abel underlined the importance of the ‘loop effect’; “where you start with an operational excellence mindset and then apply a commercial excellence mindset, in which you simplify and standardise payment terms and payment methods, among other measures,” he explained. “Then you overlay the financing tools that support process improvement – that’s the winning formula, and that’s where our clients see value.”

Article first published in The Treasurer, Issue 3 2024