Working capital management in a post-Covid world
The way that companies approach working capital management has changed considerably during the Covid-19 crisis. When the crisis began, companies took rapid action to ensure they had enough access to liquidity. For many, this meant drawing down on existing credit facilities. But recent months have also brought a major focus on freeing up liquidity sources and tapping into working capital.
For suppliers, this has resulted in significant challenges. Many large companies delayed payments to their suppliers – whether as a way of extending their Days Payable Outstanding (DPO) or due to disruption during the switch to remote working. As a result, 43% of respondents to Taulia’s Covid-19 Supplier Survey reported an increase in receiving late payments. As the report noted, “the main reason seems to be that businesses are conserving their own cash amidst the economic uncertainty.”
In this challenging environment, suppliers are increasingly taking advantage of early payment opportunities. In April, Taulia reported that early payment volumes had surged by 208% month-over month, while new supplier adoption increased by 178% – a clear sign that small businesses were looking beyond traditional bank lending to overcome their cash flow gaps and increase their working capital.
So what will working capital management look like in a post-Covid world – and how can businesses address their own working capital needs without adversely affecting their suppliers?
Reviewing working capital
As the crisis continues, companies will be looking closely at their key metrics of Days Sales Outstanding (DSO), Days Inventory Outstanding (DIO) and Days Payable Outstanding (DPO). By reducing DIO or DSO, or by increasing DPO, companies can reduce their cash conversion cycle and thereby maximize their access to working capital:
- DSO. Chasing overdue payments is more challenging during times of crisis. On the one hand, sudden changes to working practices can delay Accounts Payable processes – and on the other, buyers may choose to delay payments to suppliers to conserve their own cash. In order to reduce DSO, companies should aim to adopt best practices within the collections process to maximize efficiency and reduce the risk of delinquency. In addition, automating the invoicing process through solutions such as electronic invoicing can help to reduce the friction between buyer and supplier, and thereby improve DSO.
- DIO. Knowing what level of inventory to hold has become more challenging as a result of the crisis. The closure of bricks-and-mortar stores due to country-wide lockdowns left businesses holding excessive levels of stock, which means cash is tied up and products are at risk of expiring or becoming obsolete. Conversely, holding low levels of inventory can be a risky strategy, particularly when crisis conditions could result in logistical challenges for purchasing new stock. In the post-Covid world, companies will need to review their inventory management strategies, with a particular focus on gaining visibility over their inventory levels and ensuring effective planning and forecasting processes are in place.
- DPO. While companies may be tempted to pay suppliers later in order to preserve their own liquidity and extend DPO, this course of action places considerable pressure on small suppliers, which may already be struggling to stay in business. Other businesses have been proactive in supporting their suppliers during the crisis by paying small suppliers early, or even paying them in advance – but not all businesses will be in a position to reduce their own DPO during crisis conditions. For many, the solution lies in early payment tools such as supply chain finance, which enables companies to support suppliers without adversely affecting their own working capital.
Alongside these three metrics, companies are likely to ramp up their efforts to adopt accurate cash forecasting in the post-crisis world. Forecasting future cash flows was already challenging before the crisis began – and with customer behavior changing considerably during the pandemic, this has become even more difficult.
Companies can overcome the challenges by taking advantage of an effective real-time cash flow forecasting solution that combines live data, historical data and predictive models. With an accurate forecast in place, companies will be better positioned to highlight any upcoming cash gaps, manage their excess cash effectively and make better-informed decisions.
The Covid-19 crisis has led to major working capital challenges for businesses in many different industries. From managing inventory levels to collecting payments from customers, every component of working capital management has been affected by the disruption brought by stay-at-home orders, supply chain disruptions and economic uncertainty.
But the crisis has also highlighted the role that early payment solutions like supply chain finance can play in supporting both buyers and suppliers during turbulent times. It should come as no surprise that early payment volumes increased significantly as the crisis began. As companies navigate the uncertainties ahead, early payments will be a key tool for companies seeking to optimize working capital – not only for themselves, but also for their suppliers.