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Calculum Inc
Calculum Inc
Our media pack is available for download and contains the Calculum logos and company information. If you’d like to receive our press releases, organise an interview, and collaborate on a content piece, please contact us.
Welcome to Calculum’s content series on Working Capital Management: The Forgotten Cash Flow Lever. As part of this series, we hope to provide an overview and foundational understanding of the importance of working capital management and supplier payment terms for your company.
In the world of corporate finance, working capital is a significant player that often goes unnoticed. The third installment of our content series delves into the far-reaching impact that working capital has on companies, the financial complexities it entails, and how strategic working capital management can lead to improved efficiency and growth.
As discussed previously in this series, when we talk about working capital, what we really mean is ‘Operating working capital,’ which means accounts receivable plus inventory minus accounts payable. (Operating Working Capital = AR + Inventory - AP) This is the capital a company must invest in its operating or cash-to-cash (C2C) cycle to purchase goods, hold inventory, and wait to receive payment from customers.
Let’s look at an average $5 billion revenue company. They invest a staggering 20% of their revenue into working capital. That’s over a billion dollars, exceeding investments in property, plant, equipment, and capital expenditures. This significant investment underscores the importance of efficient working capital management.
However, working capital doesn't yield returns like traditional investments; it sits idle, earning no interest. This becomes increasingly problematic in an era of elevated interest rates. A billion dollars invested in working capital without a return is a missed opportunity for growth.
The working capital cycle paints a vivid picture of this phenomenon. Consider the example of a steel box manufacturer; before even creating a steel box, they need to acquire the steel (inventory) —a capital outlay that translates to an investment in working capital. After the steel box is sold, the manufacturer waits for the customer’s payment, continuing to tie up capital and leading to accounts receivable. The cycle also encompasses supplier payment terms, reflecting the intricate nature of working capital dynamics.
The goal for companies is to strike an optimal balance in working capital. Excessive working capital can be detrimental, tying up funds that could be allocated elsewhere. On the flip side, inadequate working capital can lead to operational disruptions and lost sales. It's a delicate equilibrium that requires careful management.
Working capital's impact reverberates across various facets of a company's operations. For instance, growth becomes challenging as companies must continuously invest in working capital to support operations. This siphons resources away from other investment priorities such as dividends, share buybacks, and business expansion.
Working capital optimization aims to increase cash flow without negatively impacting the business. For example, companies can unlock substantial cash flow benefits by extending payment terms to suppliers. A 30-day extension, for instance, can yield an additional $250 million in Free Cash Flow for a typical $5-billion revenue company. This substantial influx of funds can then be channeled into strategic investments, reducing net debt or bolstering shareholder returns.
Despite the potential complexities, companies in various industries have harnessed the power of optimizing working capital. From food and beverage giants to retailers, strategic shifts in payment terms have translated into tangible gains. These gains drive cash flow, which can be utilized for share buybacks, investment in higher-growth ventures, or mergers and acquisitions.
The impact of working capital is particularly pronounced in the context of high-interest rates. Earning zero returns on a significant investment becomes increasingly painful as interest rates rise.
Working capital efficiency, often overshadowed by more glamorous financial metrics, wields immense influence over a company's financial health and growth trajectory. Though largely unseen, the billion-dollar investments in working capital significantly affect a company's growth, capital allocation, and ability to navigate an ever-evolving financial landscape. By skillfully optimizing working capital, companies can enhance not only their cash flow but also set the stage for sustainable growth and financial success.
In this series's next and final installment, we’ll examine the cash conversion cycle and how to strike the right balance with supplier payment terms.
