Working Capital Still King When Funding Business Needs

Working capital, at a high level, represents a firm’s ability to meet short-term obligations — the bills to be paid, the money on hand that’s needed to keep operations humming.

From an accounting standpoint, the main drivers of working capital are receivables, inventory and payables, which translates to current assets less current liabilities. The spread? Well, that’s the funding on hand that gives a company the liquidity necessary to pay employees and suppliers, meet tax obligations and even pivot to meet unanticipated expenses.

Gourang Shah, head of advisory at JPMorgan Chase, told PYMNTS’ Karen Webster that efficient working capital demands that treasurers and financial professionals pull the levers of inventory, receivables and payables adroitly to match supply and demand — no easy task given inflation and supply chain snarls.

But the impetus is there, he said, given the current macro uncertainty.

The challenges right now are formidable. Shah noted his own previous tenure in automotive design, where shock absorbers (in the form of working capital) help auto sustain rough terrain, but there’s some bouncing around.

And for companies that had been previously used to cheap financing, that shock absorption has been worn away a bit. Ditto for the consumer demand that’d built up as a result of stimulus programs — that spending firepower has waned a bit, so forecasting has become very difficult for larger companies.

“You may have inventory which is sitting unsold,” he said, “which can affect working capital significantly.”

Related: Lost Art of Demand Forecasting Makes a Comeback

The conversation came against the backdrop where a report from the bank found that last year, the working capital of S&P 1500 companies returned to pre-pandemic levels. During that year, several industries also showed positive working capital impacts into the pandemic and beyond.

In the pharma industry, for example, there was what he termed “amazing demand” during the pandemic, and where multi-week decreases in inventory were the norm. During the pandemic, too, tech firms such as Apple saw notable declines in inventory, spurred by significant consumer demand. Auto firms saw supply constraints due to semiconductor shortages, and what inventory there was on hand was rapidly depleted.

But with the uncertain macro environment, he said, working capital has become a project. In the bid to improve that working capital management, there are two sides to examine: the process, tied to the procurement to payment, or order to cash processes.

There are a number of inefficiencies that exist here, he said, such as with tackling payment runs, whether they are daily, weekly or monthly. On the other side lies financing, which can help address supply chain pressures and can help increase the DPO. The net impact here is that companies hang on to cash longer.

As a result, he said, “The companies that tend to do well are the ones that have strong balance sheets that allow you to go after growth when they see the right opportunity.” Those firms are the ones with the cash on hand to increase R&D spending, fueling future growth.

There are also companies that do not have the luxury of investing in growth because their balance sheets are not that strong. Part of the solution in making supply chains more efficient is to embed more payments in the process, in the interactions between buyers and suppliers.

See also: Carriers and Shippers Ready for a Payments ‘Overhaul’

The urgency is there, said Shah, because last year when working capital levels were good, financial executives tended to devote less time to improving those processes. The focus is now coming “back” on working capital management, given the challenges of inflation and how onerous the cost of tapping into other funding sources (i.e., bank loans) is becoming.

He noted, too, that many companies are looking at environmental, social and governance (ESG)-friendly forms of financing, such as green bonds, and earned-wage access is gaining ground, too — a boon for those of us living in the paycheck-to-paycheck economy. But such initiatives will take time.

“When you think about ‘laddering up’ to ESG goals, it’s a vision, but in terms of execution and moving the needle, it becomes a lot more complicated,” said Shah.

Looking ahead, he said, companies are stretching out their scenario analyzes to three years rather than the customary two years, in order to make sure their working capital processes and buffers are adequate.

As he told Webster: “Right now, working capital is your cheapest source of funding.”