Injecting Liquidity into your Balance Sheet: Ways to help Enhance Working Capital, Reduce Risk and Improve Key Metrics
The three words spoken most often by company management during the COVID-19 pandemic are ... liquidity … liquidity … liquidity. In fact, Google Trends¹ saw a sharp increase in searches for the word from January to March of 2020, as the sudden onset of COVID-19 disruptions prompted immediate viability concerns across companies around the world.
In uncertain times, companies rethink product offerings, realign supply chains, revisit sales strategies, reassess work environments, and ensure that sufficient cash flow is available to meet their short and medium-term needs. While the past year has been an extreme example, we encourage this level of assessment on an ongoing basis.
When it comes to liquidity, status quo is stagnation. Finding creative and cost-effective solutions to enhance working capital, reduce risk, and improve metrics should be top-of-mind all the time. Company management focused on the key components of working capital on their balance sheets, namely Cash, Account Receivables, Inventory and Accounts Payable, are most successful in adapting to unprecedented times.
As the saying goes, “cash is king.” As such, monitoring cash positions is critical to ensure sufficient liquidity is generated from operations in order to meet expenses, grow the business, anticipate unexpected cash demands, be strategically positioned to take advantage of favorable market conditions, and repay investors. When cash is tight, a thorough analysis should be undertaken around other balance sheet components to determine if cash flow can be maximized and risk to the company minimized.
The primary benefit of all working capital solutions offered by banks and technology providers (“Providers”) is that they allow companies to optimize cash flows and match them with their operating and investment goals. The below sections describe critical balance sheet metrics and how specific working capital solutions can be deployed to enhance them.
Account receivables (Receivables) are a significant component of working capital alongside cash and inventory. The amount of Receivables on a balance sheet at any given time depends, in part, on sales cycles, the terms of sales offered, and credit and debt collection policies. For example, a liberal credit policy increases sales volume and therefore increases Receivables on the balance sheet. However, such a policy may also increase the cost of carry for the Receivables (i.e. capital cost), and collection costs if Receivables become delinquent. From a risk perspective, a company may assume greater credit and cross border risks the higher the value of Receivables on the balance sheet, so it is prudent to find ways to convert Receivables to cash and also mitigate unacceptable levels of customer credit risk.
A Receivables Finance solution allows corporates to shorten their Days Sales Outstanding (DSO) by selling receivables earlier in the collection process to Providers and quickly converting these receivables to cash. This solution also allows companies to mitigate buyer credit risks while potentially increasing sales volumes.
For many companies, inventory constitutes a significant part of total working capital. Therefore, efficient inventory management drives enhanced liquidity to maximize shareholder earnings. For inventory management to be effective, two conflicting objectives – minimizing inventory on hand while maintaining a consistent flow of raw material, parts and/or components needed in the production cycle – need to be managed.
Like cash, a company holds inventory for transactional, precautionary, and speculative reasons. The costs associated with each are purchase costs (i.e. product, transportation, inspection costs) and carrying costs (i.e. storage, insurance, and cost of carry). Company management use several methods to efficiently manage inventory positions. When cash is scarce however, it is important for a company to explore ways of improving Days Inventory Outstanding (DIO) and thereby enhance its Cash Conversion Cycle (CCC).
An Inventory Finance solution allows corporates to optimize their DIOs by working with Providers to manage their inventory levels through various structures including:
a) Flash Title, where the Provider purchases inventory from a nominated supplier and instantaneously sells it to the company on extended payment terms;
b) Sale on Delivery where the Provider purchases inventory from a nominated supplier and holds title while in transit, then sells it the company either at the inventory’s destination or port on extended payment terms;
c) Just-in-Time where the Provider purchases, owns and maintains inventory from a nominated supplier, then sells it to the company on a pre-determined basis.
Accounts Payable (Payables) are an effective way for a company to obtain financing to support working capital needs. The longer the payment terms, the more advantageous it is for the company’s liquidity position. Payables can be a relatively inexpensive way to obtain financing. However, during uncertain economic times, or when there is a deterioration in a company’s credit profile, suppliers may shorten payment terms thereby causing the company to have to revisit its working capital needs.
A Supply Chain Finance solution allows companies to enhance Days Payables Outstanding (DPOs) by seeking extended payment terms from their suppliers while at the same time, offering discounting facilities via Providers through which suppliers can opt to discount receivables earlier in the collection process and at competitive rates.
Enhancing Working Capital and Reducing Risk on the Balance Sheet
In order to support a company’s working capital objectives, Providers offer thought leadership by providing guidance and insights around ways to maximize a company’s working capital position. In addition, Providers offer an array of sophisticated, automated and digitized working capital products designed to assist in shortening Days Sales Outstanding and reducing credit risk around Receivables, enhancing Days Inventory Outstanding and extending Days Payables Outstanding to achieve the optimal Cash Conversion Cycle.
Providers will analyze the impact of injecting liquidity into the supply chain and extending payment terms to customers in order to facilitate sales in an efficient and effective manner. Finally, Providers will address the operational and IT infrastructure of the company in order to propose efficient and seamless integration of working capital solutions to their existing business processes.
The working capital solutions available, either individually or collectively, can significantly enhance working capital and reduce credit risk while offering greater efficiency, transparency and security.
Faced with numerous challenges around optimizing working capital, companies today are increasingly turning their attention to these working capital solutions in order to enhance liquidity, reduce risk and enhance working capital.
Partners make the difference: Mizuho can help!
Identifying a client’s optimal working capital solution is a hallmark of Mizuho. We begin by taking a consultative approach in order to understand their business model, the sector in which they operate, the regional economic forces at work and global socio-economic and political factors that may affect inventory purchases or sales. Mizuho has significant access to robust data and utilizes state of the art analytics tools.
To meet growing market demand for working capital products, Mizuho’s product offering includes pre-shipment/purchase order finance, account receivable finance, supply chain finance and the a soon to be rolled out inventory finance product, all of which can significantly enhance working capital. Whether offering cloud based technology or Application Programming Interface (API) interfaces, Mizuho’s working capital solutions offer greater efficiency, transparency and security.
1. Source: https://trends.google.com/trends/explore?date=2020-01-01%202020-03-31&q=Liquidity
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