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John Mardle, author of Working Capital Optimisation and Cash Flow Management, brings you his latest blog which looks at how an efficient Cash Conversion Cycle can help you reduce your need for Working Capital.

by John Mardle

Latest surveys from leading organisations indicate that funding for Working Capital is becoming scarcer as banks and other financial institutions find it more difficult to raise cash on the money markets.

The news that Moody's has reviewed the credit outlook for the UK and indicated that it will have a grading that reflects a negative outlook will add further pressure on the carrying cost of capital with interest payments, exit penalties and administrative costs escalating.

Therefore it is critical for companies to deliver a confident message to investors, banks and financial institutions through business plans and that they support these with real initiatives that tackle the Cash Conversion Cycle. This will reduce the need for more working capital, or at least demonstrate that if funding for working capital is required then it will be fully justified.

Organisations need to demonstrate that they have control over their inventory (Stock and Work in Progress) chains and that their supply (Purchase to Pay) chain is aligned to their demand (Order to cash) chain.

Key objectives around reducing DSO (days sales outstanding), improving DPO (days purchases outstanding) and the DIO (days inventory outstanding) which form the Cash Conversion Cycle (CCC) will need to be driven by incentivised employees.

The solutions to the above conundrum are often complex and will require external interfaces with customers, suppliers, investors and employees. This will require clear lines of communication, careful planning of processes and a timeliness that befits the speed of change required to address any issues that result from delivering efficiencies in the CCC too quickly or not very robustly.

In a business to business environment traditional methods of holding back payments to suppliers are now replaced by dynamic discounting and supply chain finance models that assist all parties in robust cash streams. However this can also lead to 'liquidity gaps' and even the need for short term injections of funding. But these challenges can soon become a thing of the past as the cash streams become hardier and all parties have confidence in the end game plan being pursued.

Furthermore the methods of tackling errant customers by chasing monies due through debt recovery agencies and/or credit control departments, particularly in product, project, service based business to business relationships, are no longer fit for purpose. It is being replaced by internal efficiencies that align receipts to payments to suppliers such that customers are paying not in tranches and not on invoices being sent by post but by contractual commitments. These allow for Direct Debits, BACS , SWIFT et al transfers. Businesses are using electronic invoicing which is fully supported by documentation already authorising payment as the required/requested services, products, projects have been delivered in line with agreed milestone cash payments.

As the CCC becomes more efficient it becomes more effective in allowing less funding to support working capital commitments. This in turn allows investors to use their funding arrangements in a more diverse and portfolio management way i.e. supporting other entities. It also reduces the carrying cost of capital for the entity concerned. This in turn could be reflected in more attractive pricing of products, projects and services and therefore higher profits, dividends and internal investment like R & D, marketing and so forth.

In other words the case for going to banks and financial institutions for more funding of working capital should be purely based on the fact that the company wishes to fund new growth and not invest in antiquated, old fashioned practices that just fund inefficiencies in the cash conversion cycle.

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