Managing the increased challenge of competing priorities
The new economic reality for companies is one of high inflation, increased interest rates and rising cost of capital – all of which are causing a range of impact across companies within a sector. This is due to multiple factors, including the amount of leverage and size of company.
Companies that find themselves with higher leverage may look to obtain more favorable payment terms or lower minimum order quantities to reduce cash tied up in working capital. In contrast, companies that have lower debt leverage may decide to deploy more capital towards trading partners who need it to generate further incremental returns in margin.
The difference in cash conversion cycle between large (>$10b annual revenue) and small companies (<$1b annual revenue) has continued to grow. At Q4 2022, small companies had an average 33 days’ higher cash conversion cycle (+82%).1 Smaller companies typically have less and more expensive financing options. Therefore, for many of these smaller companies, faster payment may become an increasingly valued negotiation lever, which larger companies can offer for a relatively lower cost and in return for other favorable terms.
For many companies, there remains an opportunity to reduce overall working capital, balanced against other priorities. According to our analysis, there remains a wide range in performance between the best and lowest performers; in terms of sector days payable outstanding (DPOs), there is a range of between 20 to 60 days difference in each sector between lower-quartile and upper-quartile performers. 1 Most likely, as stressors continue, one of the first actions companies will take will be to delay payments or push terms.
What does this mean?
One of the areas that is typically the first lever for action when trying to improve financial performance is procurement. Procurement will typically evaluate price, working capital, as well as other factors, such as total landed cost and lead-times, into a negotiation strategy. The current economic environment is creating opportunity for procurement to reduce cost, including negotiating cost reductions from lower commodity prices (from peak prices) and reducing working capital costs with appropriate trade-offs. For example, historically, leading organizations were able to generate significant working capital benefits through extending payment terms or improve profit margin by offering early payment discounts. However, given the wide range of impacts on companies in the current economic environment, binary negotiation strategies are no longer optimal. Organizations need to gear-up to approach procurement negotiations in a more deliberate way and at greater scale.