The conversation at the April meeting of the WCF focused on how early payment discounts can be used alongside working capital objectives to improve the bottom line.
How can organisations generate cash but at the same time make sure they are making best use of that cash in a low interest rate environment? This was the conversation that developed at the most recent gathering of the Working Capital Forum at The Savoy. Sponsored by C2FO, the discussion brought together treasury and procurement professionals from a wide range of blue chip organisations.
Level 3 invests in its supply chain
At network services giant ??Level 3 Communications, the business has transformed over the last few years from being somewhat cash-poor to relatively cash-rich. Andy Gifford, Level 3’s head of treasury for EMEA, explained in a short talk that while this was obviously good news, it meant that it was important for the board to communicate to shareholders that the company could use that cash to earn a better return than if it were handed back to them.
“One of the areas we looked at was our working capital and how we could use our cash to improve our relationships with suppliers while also generating a P&L return,” Gifford said. An early-payment programme helped the company negotiate discounts with suppliers.
There were three key elements to implementing the programme:
The company is naturally keen to avoid late-payment charges, especially in jurisdictions such as France and Sweden where these are incurred automatically as soon as a payment is late, without the supplier having to do anything.
“In terms of key performance indicators, it’s important to identify and quantify, early on, what the impact will be on working capital metrics such as DPO [days’ payables outstanding],” said Gifford. “We don’t want it to come as a surprise to the organisation when they see DPO drop substantially. And they need to know there is a benefit associated with that. That’s the balancing act.”
The Johnson Controls Experience
Mike Mattacola, talking about his experience in the automotive division of Johnson Controls, said that, in his view, extending payment terms simply adds to suppliers’ costs which then come back as higher prices to customers – and greater financial risk in the supplier base. Instead, Mattacola took the approach that, to get costs down, the business would “physically go into suppliers and work with them to reduce costs”.
On the working capital side, his approach was to find out how long it takes for an order from a customer to get turned into cash. “The quicker you do that the more profitable you’re going to be,” he said.
Mattacola seeks to achieve that by reorganising how different departments collaborate. “I put people together,” he said. He builds teams that have, for example, an engineer, a procurement person, someone from finance and an operations person. “You get this interdepartmental group and they learn from each other,” he said.
One Working Capital Forum participant from a manufacturing business agreed that care had to be taken with regard to how payment terms can affect the financial position of suppliers. “For our smaller suppliers we may actually reduce payment terms. We then get a small reduction in cash but the reduction in risk pays back in spades,” he said.
Another participant explained that they were starting to implement a supply chain finance programme and looking at incorporating working capital targets into procurement KPIs and bonuses.
Colin Sharp, senior vice president EMEA at C2FO, commented that, if not implemented well, this can result in conflicting priorities. “Since 2008, everyone has been focused on working capital. Finance and procurement have increasingly been measured on working capital. But then everyone is focused on ‘How can I stockpile cash?’” he said.
If the goal of the organisation is to make money, however, then excess cash that earns virtually no return doesn’t necessarily help the business. “You can use that cash to reduce your cost of goods sold and earn a higher return.”
Andrew Burns, director business development at C2FO, added that the corporate goal should be to optimise working capital, not maximise it. “People miss the subtlety of the distinction between strategic cash and short-term cash,” he said. Generating cash to invest in the business and grow the business is great, “but on a short-term basis you can optimise that by getting a P&L impact.”