Drive incremental value through working capital optimization
As interest rates were near zero in the past years, PE funds were especially focused on EBITDA maximization rather than cash management and working capital optimization. However, with the recent rise in interest rates, working capital and cash performance have become critical levers for value creation and building resilience, especially in the following scenarios:
- Decline in revenue and raised interest rates having impacted liquidity: Working capital improvements can help release locked liquidity to prevent supply chain disruptions and lost revenues, offset margin/ cost erosion, improve service, and reduce net debt.
- Underperformance in working capital compared to peers: Bringing working capital to industry standards can improve exit valuation.
- Lack of funding for value creation initiatives: Liquidity released through working capital improvements can support funding.
- Distressed situations: In times of distress, working capital management becomes a matter of survival.
To manage working capital more effectively, many PE-owned businesses have followed typical cash improvement methods, such as extending supplier terms, running down old stock or factoring some of the debtor book. While these tactics can help to some extent, PEs should also consider adopting holistic tools that enable firms to optimize working capital management.
A possible initiative would be to employ tools and processes to sharpen cash forecasting. Increased accuracy in predicting what is needed where and when and the inclusion of cash pooling and repatriation measures, will help optimize the use of existing cash. While cash flow forecasts are a requirement for most businesses, they are not always deployed effectively. A short-term (bottom-up) direct cash flow forecast for at least 13-weeks, with a weekly cadence of variance analysis, re-forecasting and mitigation actions typically proves most effective.
Another potential opportunity to improve working capital could be the use of advanced data analytics for managing receivables, payables, and inventory. Leveraging advanced technology can improve trend tracking and digital processes. Moreover, transactional data analytics increases transparency and provide the business with actionable insights enabling improved cash performance .
Furthermore, the treasury management discipline is critical for supporting the cash forecasting and process improvements, as well as optimizing the liquidity of a portco’s cash position through cash pooling, releasing trapped cash and flexible financing structures.