In today’s era, managing cash and liquidity effectively has become paramount considering the increase in non-performing assets and ballooning corporate balance sheets. The implementation of GST, technological advancements and alternative sources of debt funding are providing corporations an opportunity to rethink their approach towards effectively managing working capital (WC).

Our recent research on working capital at Indian companies ( Annual Working Capital Report) indicates a growing need for the companies to focus on improving working capital performance. While the overall cash-conversion cycle has broadly remained stable, the receivable days have increased.

While there appears to be an increase in short-term debt funding, often, Indian businesses stretch payables to fund their WC needs, which affects supplier relationships. This, in turn, impacts the EBITDA margin in the long run. Companies with efficient WC management tend to have better EBITDA margins and return on capital employed. While leaders often worry that bulging account receivables stem from an increasing unwillingness of customers to pay their invoices on time, our experience suggests otherwise.

A WC optimisation drive requires strategic and disciplined efforts from a company’s leadership and can yield substantial results.

A large BSE 10 company which has successfully managed to optimise its WC with strategic interventions is a case in point. The firm had significant levels of accounts receivable, had not billed their clients for services rendered, and was stretching accounts payable to fund this requirement.

While stretching payables reduced the overall net WC, it limited the firm’s ability to negotiate material costs and pricing with suppliers, reducing EBITDA margins.

So, the big question here is: What contributed to the increased billing and collection lead-times? A diagnostic was undertaken and the key insights included lack of documentation control and accuracy, redundant steps for invoice approvals, ambiguous contractual credit terms, lack of understanding of customer payment process, absence of standardised systems, limited system-based progress reporting, and unclear roles and responsibilities.

These were discussed with the management, and they decided to implement certain initiatives to reduce operational lead time through internal process improvements, system changes, and defining organisational roles and responsibilities.

Consequently, over an 18-month period, there was a sustained 35 per cent reduction in operational lead times, which reduced days of sales outstanding by over 50 per cent.

Further, this reduced the need for short-terms borrowings by over 90 per cent, reducing financing costs by 60 per cent, increasing the company’s cash flow, and generating substantial value for the shareholders.

Our research and discussions with several leading companies suggest that this company is not alone.

Process improvements directly affect WC management, when aimed at lead time reduction, better customer engagement and improved vendor relations.

Let’s take the example of the telecom sector, where uncertainty and consolidation have resulted in cash flow becoming a critical factor.

Debtors and inventory of fixed assets are critical components in the telecom sector that impact WC of the organisation. That is where process improvements can play a key role to optimise WC, which are mainly levered around engaging with customers to ensure prompt payments, inventory norms and ageing of inventory.

Now with the advent of disruptive technologies, WC requirements will play an even bigger role in influencing major decisions like starting new projects in the telecom sector.

Private equity firms

For private equity firms, WC and cash management are key drivers for value creation. PEs have a better appreciation for cash flows, especially in high-growth economies like India where manipulating WC is an easy way to repay debt or finance growth. This de-leveraging of the balance sheet increases the company’s equity value.

Operational improvements are a key lever for private equity to generate above-average market returns. The very act of getting a PE investor on-board primes a company for change, a mindset for creating sustainable change in an organisation.

For PEs, a deep focus on working capital management across the transaction life-cycle — from due diligence to exit — and adopting a mindset to implement initiatives and improve cash flow are the most important levers for generating value and returns.

Naveen Tiwari is Partner and Leader, Working Capital Advisory Services, EY India, and Paresh Vaish is Partner and Leader, Performance Improvement, EY India, The views are personal

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