The Need for Efficient Cash Management

With a growing global outlook, businesses today are increasingly under pressure to control costs and reduce financial requirements. Thus, in identifying possible options, it becomes extremely important for corporates to focus not only on short-term resources, but also on ways to optimise liquid resources that contribute to the improvement of free cash flow.

The four basic strategies that are required for a corporate to efficiently manage cash are:

1. Forecasting cash position: Forecasting the short-term and long-term cash position is key for corporates. Having a plan for idle cash at an early stage and the need for safety buffers compensating for forecast errors is crucial. Additionally, this helps a company to make reliable projections on future funding requirements.
2. Maintaining less idle cash: Visibility in terms of cash balances becomes a key driver to reduce idle cash. Leaving cash in a local account reduces return and does not make the cash actively available to the group, curtailing optimal utilisation of available liquidity, thereby increasing the utilisation of credit lines.
3. Concentration of collected funds: Consolidation of cash helps a company to have better cash control and cash position visibility. The effect is that surplus liquidity is bundled and required capital is internally financed to the maximum extent possible. This, therefore, reduces the corporates’ external interest expense.
4. Efficient collection of cash inflows and outflows: Effective payment terms and collection procedures, lower inventories, lower replenishment, and longer credit from suppliers are prerequisites for corporates wanting better cash inflow/outflow management.

Effectively managing the above strategies presents a new set of challenges, as well as opportunities, for the treasury and can become the starting point for corporates to build effective working capital management (WCM) programmes.

Corporates Should Focus on Better WCM

The working capital cycle is all about the commercial and financial aspects of inventory, credit, purchasing, marketing and investment policy. Many big innovative corporates have already passed one stage of WCM by reinventing their production and logistics process based on ‘just-in-time’ management.

This revolution has led corporates to reduce their working capital levels significantly. As the next stage, many corporates are now gearing up to focus more on treasury and finance related operational process improvement for fine-tuning the financial aspect of WCM.

The three aspects of WCM are:

1. Achieve operational reduction through efficient collection of cash inflows and outflows.
2. Manage cash effectively through better liquidity management.
3. Introduce electronic invoicing (e-invoicing).

Operational Reduction in WCM

The three key areas that are a starting point or key performance indicators (KPIs) for any corporate to achieve an operational reduction in working capital requirements are:

1. Days sales outstanding (DSO).
2. Days payable outstanding (DPO).
3. Days inventory outstanding (DIO).

While DIO has traditionally been the primary focus of optimisation efforts and is fairly achieved through business relationships, DSO and DPO remain the critical missing link today.

With the changing receivables landscape, cash gets trapped at many places, thus affecting the overall financial performance of the corporate. Iit is therefore very important for corporates to identify the weakness on the DSO and to take proactive approach for the management of receivables. Few other operational challenges faced today are the decentralised process with no single point of trapped cash, disjointed systems and disintegration of the information management infrastructure.

Efficient DPO management for any corporate is to self-fund its operating or production cycle, invest surplus balances or use funds to pay down debt. These issues can be addressed through mature automation tools such as purchase order (PO) management, e-invoicing, integrated supplier financing with automated workflow and matching process. Thus, standardising and automating the payments and collections workflow through electronic straight-through processing (STP) will be a lever through which corporates can reduce their working capital.

Streamlining Payment Processing

As mentioned earlier, one of the critical dimensions that results in the improvement of working capital is introduction of e-invoicing. A recent study estimates that in Europe e-invoicing can save up to 65% in operational costs in terms of handling paper and reducing mail float on receivables up to three days¹.

Effective management of order-to-cash (O2C) cycle is required to optimise working capital efficiency. Addressing the automation of order-to-invoice (O2I) and invoice-to-cash (I2C) with account reconciliation and rich analytics unlocks the trapped cash in corporate.

Better Liquidity Management

Visibility on cash balances across the enterprise is crucial for better liquidity management. The near real visibility of the cash flow across an enterprise helps the cash group head from optimising the return on available liquidity and decreases the unnecessary utilisation of credit lines. Also, detailed knowledge of local bank accounts to the cash head helps central division to advise local management on their decisions about cash, paying local vendors, leaving it on the account or depositing cash with treasury.

A reliable understanding of future cash balances reduces idle cash. Furthermore, accurate cash forecasting also improves the standing of the company and can have a positive impact on the company valuation. Understanding the enterprise cash flow gives the following benefits:

• Increased visibility over cash and payments leading to better liquidity management.
• Better foreign exchange (FX) management.
• Structural efficiency to process all intercompany transactions.
• Payment process improvements.

Conclusion

Active WCM brings a reduction in the operating costs of managing inventories and receivables resulting in improved liquidity. This strengthens the balance sheet and reduces borrowing costs, and leads to an effective increase in enterprise value.

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