Headroom for expansion


Forward-thinking FDs take a dynamic approach to working capital management. SIMON FRASER, Chief Credit Officer for Mid- Markets, Lloyds Bank, considers the key priorities and challenges of keeping pace with change.

Forward-thinking FDs take a dynamic approach to working capital management. SIMON FRASER, Chief Credit Officer for Mid- Markets, Lloyds Bank, considers the key priorities and challenges of keeping pace with change.

During the global financial crisis, a number of businesses came to realise that while trading was buoyant and strong asset markets could often be relied upon to get them out of trouble, they had under-estimated the value of sound working capital management (WCM) practices. Robust WCM consequently attracted greater focus during the downturn.

As the economy recovers, WCM remains high on the corporate agenda – a trend not restricted to one particular sector or size of business. Companies, from SMEs through to large corporates, are increasingly acknowledging the fact that having significant amounts of working capital locked up in their business can jeopardise survival and that taking action to increase efficiency can unlock value and support growth ambitions.

One risk is that as the recovery gathers momentum, lax practices will creep back in. In the current environment the need for a dynamic response to working capital optimisation persists. Funders, for example, are increasingly focused on the effectiveness of a business’ financial management, strategic plans and management’s ability to deliver these plans.

Forecasting future needs 

As any forward-thinking business develops, it requires an increasingly robust and sophisticated financial management structure with strong controls and a well-planned strategy. The senior management team – including the pivotal FD – will define their corporate vision, understand their company’s competitive advantage and how to maximise it, and create a well-articulated strategy for growth that is subject to regular review. An essential component of that process is forecasting future funding needs, including working capital requirements.

Forecasting working capital needs and contingency planning should be key priorities for any FD. For example, as recovery continues we can be assured that, at some point, interest rates will rise. Businesses need to plan for the best and worst case scenarios. For those businesses susceptible to interest rate rises, sensitivity testing, scenario planning and hedging strategies can contribute to mitigating that risk.

The most effective companies stress-test their forecasts, exploring different scenarios to inform their wider planning. This should be part of a clearly articulated strategic approach that is subject to internal challenge and debate.

Managing growth 

Whilst effective WCM is crucial in surviving a downturn, recovery also presents major challenges for businesses. One obvious danger is overtrading. If a business has experienced a prolonged period of low sales income, it can be understandably reluctant to turn anything aside when opportunities increase, but over-reaching brings both operational and financial pressures. Taking measures to ensure that WCM is considered during contract negotiations, for example, when agreeing payment terms and conditions, can make all the difference.

An unbudgeted and unfunded build-up of debtors or stock can place unsustainable pressure on a business’ cash flow and lead to the failure of an otherwise viable and profitable enterprise. Whether it is overtrading, poor debtor collection, lax inventory control or a failure to negotiate suitable payment terms with creditors, the outcome can be equally problematic.

Creating WCM processes that work in both crisis and in recovery is essential, and is an integral element of sound overall financial management. Strong governance and maintaining adequate levels of management information (MI) might seem obvious, but some management teams simply don’t have a clear enough picture of their current and future working capital position. Current MI and an effective IT system are fundamental to providing this visibility.

Diverse financial solutions 

There are numerous tools at the FD’s disposal to optimise WCM as part of their operational and financial strategies. One tried and tested means of accelerating payment is invoice discounting. It offers an ideal way of funding variable working capital for businesses with large debtor books or seasonal swings. Supplier finance – which enables suppliers to obtain early payment of invoices by leveraging the buyer’s credit rating – is also gaining traction across a range of sectors, and is no longer solely the domain of top-tier corporates.

An open discussion with your bank can help to explore the diverse range of financial solutions available and adopt a broader approach to WCM that will support the business in its day-to-day activities and leverage opportunities for growth as they arise. FDs must look ahead to what will be a changing macroeconomic environment, recognise potential risks and create robust, flexible working capital practices in response.

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