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Calculum Inc

Uncovering Free Cash Flow: How Treasury discovers hidden Working Capital

March 11, 2022
Read time:
15 min

Calculum Inc

Press kit

March 5, 2020
Read time:
1 min

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Uncovering Free Cash Flow. How Treasury discovers hidden Working Capital

Many businesses have significant amounts of working capital locked up on their balance sheet. By improving their company’s cash conversion cycle and enhancing operational efficiency, treasury can sustainably increase profitability and company value by discovering free cash flow.

Unlike previous episodes of market disruption, businesses increasingly face the reality of disruptions across their value chain – from procurement through to manufacturing and distribution, causing a knock-on effect on cash flows and broader working capital.

As a result, the importance of discovering hidden working capital to increase shareholder value, maximize margins, generate free cash flow, and reduce risk has never been more critical to any business.  For treasury unlocking working capital is as critical now as it ever was, because of changing market conditions, and increased competition among supply chains. Treasury is required to make real-time adjustments based upon ever faster-changing market events that will impact their organization and their trading partners alike.

Uncertainty related to ever faster-changing market events that impact the organization and their trading partners alike is having a notable impact on cash management practices across industries and requires treasury to make real-time adjustments on their working capital

Beyond the uncertainties in the physical supply chain, challenges in the financial markets such as raising interest rates, and inflation also create a strain on working capital and require increased liquidity buffers moving forward. Furthermore, strategic suppliers or trading partners with financial constraints are also increasingly seeking to re-negotiate contractual payment terms.

This intensifies the need for treasury to focus on working capital. Achieving sales or revenue growth in this environment could very well entail longer credit terms and heightened customer and supplier credit risks.  

When considering these changes, treasury professionals are intensifying their focus on financing new ways to discover hidden free cash flow opportunities within their corporate organization.

3 Key strategies of leading treasury organizations gaining competitive advantage

1. Driving behavior and cross-functional focus on improving the cash conversion cycle across the organization.

While each department within the company wants to achieve overall company goals, they will push to ensure that their specific objectives and needs are met as well. This can cause conflicts between various departments, as their individual drivers do not always align, especially if the benefits of the program are not properly communicated to each department. Thus, they may be reluctant to alter their processes if the reasons for the changes are not clearly understood or if the benefits do not seem to pertain to them.

For instance, treasury may understand and recognize the value of unlocking free cash flow. However, for example for procurement, these benefits are less clear, including the impact on their relationship with suppliers. As such, the overall push on optimizing working capital must be clearly communicated, or else some departments such as procurement may be skeptical or even outright against such changes.

2. Identify working capital opportunities based on data analytics.

“Data is the new oil”, as per British mathematician and Tesco retailer mastermind, Clive Humby. In other words, with advances in digitalization across businesses and their supply chains, vast amounts of data generated in these ecosystems present a huge opportunity for treasury. Harnessing vast amounts of business and supply chain information enables smart insights, competitive advantage, and most importantly finding new ways to unlock working capital.

3. Investing in emerging technologies - especially in artificial intelligence (AI) and machine learning (ML).

These buzzwords may have some treasurers worrying about machines taking over and replacing corporate treasury. However, the data analytics and AI are at the core of successful treasury management and support their department, pushing treasury to a new level of importance with their organizing because of the following:

  • Visibility. Treasury needs data and information to draw conclusions among financial related data across the organization’s entities and financial supply chains.
  • Data Quality. Treasury management is about having the right, reliable information at its fingertips to make the right decision when it comes to managing effectively cash flows.
  • Timing. Having access to real-time information is crucial. Old data is as good as no data. This is why treasury needs data in real-time to make decisions and adjustments ahead of the market and competition.

Using the power of artificial intelligence, treasury executives can more effectively add more value to their organizations - they can validate data, better forecast and plan, find insights, and as a result, allow them to be a more strategic player. Artificial intelligence and machine learning can expedite data analysis and have faster access to decision-making data. Instead of having many people manually collecting and analyzing biased information, advanced data analytics systems can provide insights faster - in seconds rather than months, and far more accurately.

Why is treasury focusing on Working Capital Management?

Working capital management is a broad topic with commercial and supply chain touchpoints. Treasury plays a crucial role in making good decisions between often competing financial and supply chain objectives and incentives.

One of the main reasons why companies turn to the treasury department to play this important role is that often it’s the treasury team that is responsible for sourcing, validating, and analyzing the disparate data sets and inputs to this complex task of how to improve working capital.

Why is unlocking working capital so important?

External financing can be tough to find in an economic downturn. On the other side in an upturn, high-interest rates can make external funding expensive. And even if interest rates remain low, unlocking working capital is cheaper and less risky than setting up external financial liability, other debt instruments, or equity.   Thus, compared to the other primary source of internal financing, optimizing working capital is way less painful than cutting costs, or generating vast amounts of additional sales revenue.

However, it is crucial to wait before undertaking a working capital efficiency drive as economic disruption starts to bite. Working capital needs to be an everyday undertaking and commenced in the most benign environment- squirrels collect acorns in autumn not when the first snow drifts start to appear; I’m sure you get the point.

Therefore, internal funding is essential to building corporate resilience, no matter the economic environment and its free cash flow that is unloc

This additional liquidity can be used by a company to build resilience for a downturn, reduce external financing or take a bolder step such as focusing on acquisitions, investing in research, development and new technologies, or simply having the ability to overprice its competition.

Improving working capital also increases the return on the capital employed, a key measure of how efficiently companies are utilizing their invested capital, which translates into higher equity valuations.

In addition, it can positively decrease financial leverage and thus increase headroom in financial covenants for many debt-financed and private-equity-owned companies, as unlocking free cash flow can reduce external borrowing. This, in turn, can increase return on capital and send positive signals to the capital markets.

But it doesn’t stop there. Improving working capital goes hand in hand with improved profitability and EBITDA.

Unlocking working capital and profitability improvement require rigorous enhancements in core processes and operational efficiency, therefore, both improve when either one is explicitly addressed. A transformation program to enhance EBITDA that requires investments can even be funded by the free cash flow by unlocking working capital.

So, what is the new frontier for treasury to discover ways to improve working capital and the cash conversion cycle?

It’s the active use of new financial technologies harnessing the power of advanced data analytics being an integral part of the treasury organization. Especially given the new opportunities for value creation offered by big data and access to digitalized information, in today’s environment, it’s arguably the most important way to increase a firm’s profitability, liquidity, competitiveness, and overall company value.

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