How chemical firms can tap into their working capital in the new economy

The first quarter of 2020 presented setbacks in the form of falling oil prices and simmering global trade tensions, putting liquidity to the test. And then came the biggest shock of them all — COVID-19. Like every other industry, the chemicals sector was also impacted by pandemic-related crises. Depressed manufacturing, whether from quarantine-related shutdowns or reduced short-term prospects in oil and gas, pressured revenue. Significant uncertainty around the timing of COVID-19 subsiding has also increased the difficulty of accessing capital markets.

However, history has shown us that chemical companies can take several steps to increase liquidity in the crisis, setting themselves up to take advantage of emerging opportunities.

A sector already under liquidity pressure

Liquidity was already under pressure in the chemicals sector. Revenue, which saw strong growth from 2016 to 2018, slowed in 2019. Gross margins started to erode across the sector in 2019, after seeing only modest growth in 2017 and 2018. These headwinds occurred simultaneously with a 13.2% compound annual growth rate in capital expenditures from 2016 to 2019.

All of these factors, both pandemic-related and those occurring over the last several years, point to a significant need for greater liquidity. Having a strong buffer of cash, combined with high cash conversion efficiency, will help companies survive the crisis, manage the next 6-18 months, and come out in a stronger position.

Learning from history to shape the now, next and beyond

Uncertain economic times can bring enormous opportunities as tectonic changes recreate market landscapes. EY research, based on experience from the 2008 financial crisis, found that agility and foresight are essential for chemical companies to evolve as winners. Decisive leadership, data-based responsiveness and the ability to reshape quickly are the key characteristics a company needs in this environment.

When a crisis unfolds, companies should center measures around immediate liquidity, selective restructuring and re-evaluation of investments. EY research found that those companies that increased capital and decreased cost of goods sold (COGS), while keeping tight controls on working capital during the last crisis, were more likely to be positioned to succeed in the long term. This is how companies can deal with crisis-related troubles in the “now.”

In the “next” stage, the focus should be on the ability to reboot and react. It will become necessary to free up working capital to realize incremental financing for an agile restart. Companies should reconsider their market strategy and how to partner with their customers and suppliers through the crisis to increase agility.

Post the pandemic crisis, when chemical companies are in the “beyond” phase, they should focus on cash conversion efficiency by putting structural improvements in place. This will enable companies to navigate through times of uncertainty and support aggressive growth strategies.

EY methodology for “succeeding” in a recession

Ways to improve cash flow for both short- and long-term needs

In this environment, managing working capital is becoming even more important. Customers will hold payments and suppliers will request payment terms adjustments. Production plants have been shut down and operations interrupted, leaving some chemical companies with excess inventory. According to economists,¹ the impacts from COVID-19 peaked in the second quarter of 2020, but structural impacts combined with oil price wars are projected to impact the chemicals industry through the end of 2021. As of Q2 2020, chemicals companies on average have 1.3 months of run-rate in cash, which will only carry them so far without structural changes in managing working capital. Structural improvements in working capital can increase this cushion by 15-35 days in preparation for another economic downturn.

Successful chemicals companies are now looking beyond the top and bottom line to include a focus on the balance sheet and cash conversion efficiency. Driving a cash culture and operating discipline will be critical to delivering future value. Establishing a centralized cash leadership office (CLO) to improve working capital will not only drive cash culture but also enable sustainable and measurable improvements. This will enable companies to do what they do best: invest in production and process efficiencies that will help not only deliver greater value to their shareholders, but also be a critical pillar in the road to economic recovery.

Areas where a cash management office can improve working capital include the following:

1. Accounts receivables, including optimizing collections and dispute processes, aligning customer payment terms, and accelerating billing — helping to enable chemicals companies to thrive in the coming quarters
2. Accounts payable, such as identification of critical categories and aligning payment terms to industry benchmarks — which can enable chemicals companies to manage suppliers based on their business risk
3. Managing end-to-end inventory, including MRO (maintenance, repair, and operating supply) — which is critical to helping a chemical company not only meet the customer demand, but also helping to prevent the supply chain from being disrupted.