Procurement has a central role to play in the effective management of working capital, enabling investment, growth and supply chain efficiency.
This article has been written by Neil Ross, Regional Manager, EMEA Trade Credit.
Working capital is the fuel behind any successful mid-market organisation, representing the amount of cash available at any one time. If managed effectively, it ensures the business is able to invest in new products and services, optimising its existing operations, while also shoring up against future risks. Failure to maintain control of working capital will inevitably force companies to rely on borrowing, often through expensive bank finance, putting further pressure on the business.
There are three primary factors dictating working capital – Days Sales Outstanding (DSO), Days Payable Outstanding (DPO) and Days Inventory Outstanding (DIO). Essentially, if DSO and DIO are too high and DPO is too low, then companies will encounter cash flow issues. Simple economics mean money will be going out of the business faster than it is coming in, so striking the right balance between these three factors is imperative.
The Role of Procurement
Responsibility for the day-to-day management of working capital ultimately sits with the treasurer, whose role it is to ensure the company has the necessary funds to operate and meet its objectives for the months and years ahead. But the treasurer cannot work alone. He or she must collaborate closely with numerous departments across the business to ensure working capital is maximised. The procurement team forms a crucial part of this network.
As the primary interface between a business and its supply chain, procurement can make or break an organisation’s working capital strategy. Procurement has numerous factors to consider within its remit, not least management of cost vs. value from suppliers. However, a fixation on costs alone can be a mistake, masking other factors which can also seriously impact working capital.
For example, high logistics and warehousing costs can make working with a particular supplier unviable. Similarly, the ease of doing business with suppliers is a prime consideration – if their contractual terms or the process of purchasing are overly complex, this will eat up hours of administration time that could be better used elsewhere.
Favourable Payment Terms?
But perhaps the most important working capital consideration for procurement is the ability to negotiate favourable payment terms with suppliers, ensuring that money isn’t leaving the company bank account until it absolutely has to.
Extending payment terms is a popular method used by large and increasingly by mid-market companies to maximise their working capital and cash flow. Research by YouGov on behalf of PrimeRevenue and AIG found that over three quarters of supplier businesses have been asked to accept longer payment terms, potentially holding up over £29bn.
A smart move by buyers you might think? Well not necessarily, when you consider the impact this could be having on the supply chain. YouGov’s research found that these longer payment terms are affecting suppliers’ cash flow (55 per cent), leading to additional administration (33 per cent) and putting a strain on client relationships (29 per cent).
The knock on effects can be huge, forcing suppliers to borrow money at a high cost, or to cut costs in production and investment. These issues ultimately drive up prices or impact quality, potentially reducing efficiency and sales, while increasing risk all along the chain.
Supply Chain Finance
Procurement professionals are now waking up to this dichotomy and looking at a more holistic solution to the problem. This means building greater collaboration with suppliers, fostering mutually beneficial relationships, and minimising the risk for the supply chain in the long term.
One key aspect to this more holistic approach is supply chain finance, a financing tool that enables businesses to offer their suppliers early payment, while retaining their own longer payment terms. This is possible through third party financing based on the credit rating of the larger buyer organisation.
Until recently, supply chain finance platforms have been limited to supporting the largest, investment grade businesses. However, innovative online and credit insurance backed solutions mean that it is now an option for thousands of mid-market, non-investment grade companies. This can offer a working capital ‘win-win’, while also helping to streamline processes for all involved.
With the economy on strong footing, many businesses are in growth mode, with ambitious plans for investment and expansion. But these plans won’t be possible without a comprehensive and strategic approach to working capital management. Procurement has a central role in making that happen. The tools and technology now available mean it has never been easier to optimise working capital, across both individual businesses and the broader supply chain.
Supply Chain Finance from PrimeRevenue and AIG frees up significant funding for mid-market (£100m+ turnover), non-investment grade companies and their suppliers, providing low cost access to working capital on both sides of the transaction. More information can be found here.
 AIG and PrimeRevenue research carried out by YouGov. Total sample size was 250 adults with responsibility for invoicing and payment terms within businesses which provide goods and services to large organisations (with revenues of £100m or more).
Businesses were asked how much of their revenue is currently tied up in invoices with payment terms longer than the standard. If these results were replicated across all businesses in the UK which provide goods or services to large organisations they suggest that around £29 billion is tied up in this way.