Partner: GCS
One of the main challenges highlighted by the Covid-19 Pandemic was cash management.
A few factors contributed to this. Chief contributors to this challenge were the fact that companies struggled to bridge the gap between consistent demand and the fact that they had to move their business processes online as a matter of urgency. Added to this was the Global Supply Chain Crisis, which made the availability of raw materials a challenge.
Even today, three years on from the onset of the Pandemic, companies are still struggling to come to terms with adjusting to a new cash management system. Cash is king in a disruptive environment. I recently read an article by McKinsey which details some innovative ways to free up cash in businesses.
Analyze receivables and payables
The article points out that many companies treat working capital simply as the cost of doing business. In our experience, few consider the negative impact of extended customer terms, tight payment cycles, and high inventory levels on true economic value. That’s why a thorough analysis of previous years’ transactions usually reveals process gaps, unfavorable and unnecessary terms with customers and vendors, and other near-term opportunities to improve working capital.
By closing gaps caused by slow invoicing, weak collections policies, early payments to vendors, inefficient payment processes, and out-of-market terms, a company can typically reduce its cash-conversion cycle, freeing up cash to make investments, reduce debt, pay dividends, and fund mergers and acquisitions. For example, a global agricultural-products company conducted a transaction-level analysis as part of a broad effort to achieve best-in-class improvements in working capital. The results helped it design new product- and region-specific initiatives to transform its order-to-cash process, as well as various category-specific measures and process improvements to extend the procure-to-pay cycle.
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Reimagine or divest underperforming long-term assets
The article adds that sizable opportunities to release cash may also exist further down the asset ledger. An analytical look at the returns generated by investments in property, plants, and equipment—among other long-term assets—can single out stranded or noncore assets that detract from performance. Those assets can then be sold or repurposed, improving results by freeing up cash through the deployment of assets to higher-value activities and delaying planned capital expenditures.
One North American distribution company eager to reduce its debt-to-equity ratio and deploy its capital investments in a way that would yield higher returns used an ROIC framework to determine which assets and business units were performing well and could deliver more, and which were not and should receive less investment or be divested. An analysis of the relative performance of businesses and assets indicated that there was a wide dispersion around the company’s aggregate ROIC—some were performing better and some far worse. The company identified where to invest and prioritized its list of underperformers by assessing how easily each business could achieve its target ROIC, as well as the ways in which each divestment could adversely affect liquidity or the remaining businesses.
Recover ‘trapped’ cash and accelerate returns from partnerships
The article points out that companies often find that not every dollar on the balance sheet is equal; cash may be sitting in foreign jurisdictions without an operationally or tax-efficient way to deploy it. Regularly reviewing cash balances, requirements, and transfers globally may free this “trapped” cash and put it to productive uses, such as capital expenditure.
The article adds that, similarly, companies may participate in joint ventures (JVs) or other partnerships that deliver cash dividends, but those dividends might not be sent in a timely manner. This is effectively the same as trapped cash: it is cash that belongs to the company but is not truly available. As part of a thorough review of its balance sheet, a global engineering and construction company identified a number of JVs that owed cash payments. Following the review, the company was able to capture the cash it was owed and also establish a regular cycle for collecting cash more quickly in the future.
In addition, better global cash management can reduce business complexity and urgent cash transfers. In a recent review of its global cash and bank account structure, one telecommunications provider realized that only about 50 percent of the cash on its balance sheet was truly accessible because of local account restrictions and other transaction frictions. The company reformed its cash-management practices and bank account structures globally, allowing it to have much greater access to this trapped cash, deploy it to profitable activities, and reduce the provider’s reliance on external funding.
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Manage credit support strategically
The article points out that many businesses require credit support—such as cash collateral, letters of credit, and surety bonds—on a regular basis for a wide range of commercial and regulatory purposes. However, while these tools often soak up precious liquidity, many companies pay little attention to them. A high-performing treasury function, often in conjunction with the legal function, can improve a company’s liquidity position by providing strategic insights into credit support in multiple dimensions.
First, the company should review all credit-support requirements on a regular basis (at least quarterly) to determine if existing credit support is still required. For instance, if a project requiring cash collateral is now complete, the cash collateral should be returned. Second, for the credit support that is required, the company should identify the most capital-efficient way to provide it. For some, this can mean replacing cash collateral with a letter of credit that does not affect revolver availability; for others, it can mean replacing a letter of credit with a surety bond that does not require further collateral.
The article adds that, in 2020, a large, independent power producer undertook such a review of its credit support. It had posted more than $250 million to commercial and regulatory counterparties, and due to ownership changes, credit support had not been a focus. The result of the review was significant: the company was able to recover more than $50 million in cash within weeks and another $50 million within six months.
This is a classic example of how applying change management to your company’s cash management system can free up enough cash to see a company through turbulent times.
Moses Singo is a Partner at Genesis Corporate Solutions and is a Junior Business Rescue Practitioner.
