The C-Brief: Managing Working Capital During Volatility

When the economy is volatile, having the right working capital management strategy can help your business thrive as much as possible. However, different times call for different strategies, making a tailored working capital strategy for the moment is crucial.

For example, while the pandemic brought plenty of pain and a touch of initial panic to business owners, the creation of the Paycheck Protection Plan, low interest rates and other government interventions eased the strain on the working capital for many companies. Record levels of loan growth with stable credit risk kept bank balance sheets strong, too.

“Because of the historically low cost of bank funding, business borrowers weren't concerned with yield or holding onto excess cash during the pandemic," said Lisa Bollinger, head of City National Bank's Working Capital Advisory team. “Business owners also weren't concerned with bank risk or with any concentration of operational bank relationships."

Times have changed. First, inflation rose. Next, the U.S. Federal Reserve aggressively raised interest rates to combat inflation.

“Business owners' concerns changed quickly with banking volatility," Bollinger said. “Volatility in the financial markets is a significant challenge for business owners, along with regulatory compliance, the complexity of global operations and cyberthreats."

According to Bollinger, each of these factors are contributing to difficulties with managing capital. However, she says there's ways that leaders can help their companies adapt to these challenges.

“Due to market changes, capital is more constrained, and the cost of borrowing is significantly higher. Working with a bank to utilize new strategies for managing working capital can help businesses adapt to the new environment and protect their business."


How Working Capital Strategies Have Changed

Efficiently utilizing capital is helping some companies navigate a changing landscape and evolve their banking relationships.

“Many companies are exploring centralized operations to help them manage their working capital, which is something we can help them with," Bollinger commented.

When interest rates were extremely low, most business owners paid less attention to the yield on their deposits.

“Now, everyone wants to optimize yield while balancing risk," Bollinger said. “Companies can maximize our earnings credit rate (ECR), which banks provide for operating deposits. This reduces hard dollar fees and taxable interest."

Automation and integration of technology can also help companies manage their liquidity. By implementing services like a hybrid account analysis, deposit sweep or investment sweep programs that can automatically move excess cash balances and maximize interest earned.

Businesses are also upgrading their technology to streamline operations, recognizing that managing cash flow is more important than ever due to the higher cost of borrowing.

“Business can create efficiencies and speed up the time of reconciliation of both receivable and payment data by integrating their accounting software or Enterprise Resource Planning (ERP) systems directly with the bank back-office systems" Bollinger added. “That quicker reconciliation improves cash flow, eliminates duplicate entry and input errors and automates risk controls within these systems."


Managing Cash Flow

The appropriate solutions to overcome challenges vary by business size and industry, but for each company the process of improving cash flow starts with a review of receivables, payables and liquidity, Bollinger said.

“First, we invest in real-time analytics through direct integration to reconcile and turn transactions quicker, to encourage earlier payments and speed up delivery times to make it easier to pay, all of which can improve cash flow," Bollinger said.

Three key metrics that companies can use to help manage their cash flow are the following:

  • Days Sales Outstanding (DSO), meaning the average number of days it takes a company to receive payments.
  • Days Payable Outstanding (DPO), or the average number of days it takes a company to pay its bills.
  • Days Inventory Outstanding (DIO), or the average number of days a company holds onto inventory before selling it.

However, managing each of these metrics might depend on a company's current situation.

Working Capital Management

Often, managing DPO more efficiently can be an ideal strategy. This can help provide more cash on hand to use for investing in opportunities that are important to that individual company.

In a rising interest rate environment, a company's working capital management might evolve in the following ways:

Net Borrowers

Net borrowers can work to reduce loan outstandings by collecting funds faster (decreasing DSO) and paying slower (lowering DSO). The goal is to reduce net interest expenses.

These clients might also look for JIT (just-in-time) inventory management.

Net Long Companies

Net long clients, or companies that have greater short-term assets than they do liabilities, might also look to optimize working capital by reducing DSO and increasing DPO. However, they will also look to achieve the highest possible yield on available cash that their investment policy allows.

In general, companies in both positions often look to reducing DIO as a best practice.


Tailoring Your Working Capital Strategy Is Key

Working out efficient ways to manage your working capital takes a carefully planned approach. Often, having input from the right team can help guide you toward the right management strategy.

“Our goal is to consult with the companies we work with and talk through DPO and DSO, so we can understand the big picture of their cash conversion cycle and short- and long-term goals," Bollinger said.

She's used her experience in the working capital space to help companies optimize their capital management approach.

For example, several of Bollinger's clients have been able to utilize our purchasing card program to extend their DPO an average of 35 days.

“Companies can use a purchasing card program to pay vendors on their terms, and then pay off the balance at the end of the month, providing additional float by leveraging credit with no additional interest expense," Bollinger said.


Smart Practices for Managing Working Capital

In any economic environment, but particularly in the challenging current conditions, managing working capital requires a strategic plan that can be improved with the assistance of banking partners.

Bollinger recommends the following best practices to manage working capital:

  • Review your working capital strategy to make sure it aligns with current economic trends.
  • Work with banks and consultants who have the expertise to recommend new processes and solutions that will enhance liquidity and augment sustainable financial performance.
  • Be strategic about borrowing, particularly when the cost of capital is high.
  • Monitor your access to liquidity.
  • Strategically implement automation.
  • Implement metrics and reviews across teams so that change occurs throughout the organization.
  • Strategically review all business relationships.
  • Actively manage risk and fraud prevention.

In all markets, but particularly in volatile markets like we are experiencing now, companies should take a more strategic approach to their cash flow management and continuously monitor it," Bollinger said.

“Taking a comprehensive look at how they can increase efficiency, manage their liquidity and keep control over diverse banking relationships can help businesses thrive in challenging times."

To learn more, get in touch with our treasury management team today and discover what options might be best for your company.

This article is for general information and education only. It is provided as a courtesy to the clients and friends of City National Bank (City National). City National does not warrant that it is accurate or complete. Opinions expressed and estimates or projections given are those of the authors or persons quoted as of the date of the article with no obligation to update or notify of inaccuracy or change. This article may not be reproduced, distributed or further published by any person without the written consent of City National. Please cite source when quoting.

City National, its managed affiliates and subsidiaries, as a matter of policy, do not give tax, accounting, regulatory, or legal advice, and any information provided should not be construed as such. Rules in the areas of law, tax, and accounting are subject to change and open to varying interpretations. Any strategies discussed in this document were not intended to be used, and cannot be used for the purpose of avoiding any tax penalties that may be imposed. You should consult with your other advisors on the tax, accounting and legal implications of actions you may take based on any strategies or information presented taking into account your own particular circumstances. Trust services are offered through City National Bank.

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