5 Ways to Free Up Working Capital Amid High Interest Rates

Interest rates in most economies continue to be high, impacting borrowing and working capital for businesses.

From keeping rates near-zero for years, central banks have been steadily raising borrowing costs because of runaway inflation – a direct result of high demand for products and services and an easy access to capital from the various COVID-19 financial stimulus packages.

Interest rates in the Euro Area since January 2022 have increased from -0.5% to 4.25% as of September 2023 while in the U.S., the rates are up to 5.5% from 0.08% in the same period.

You can add to this the pressure from the Russia-Ukraine war that has not only introduced supply chain vulnerabilities since February 2022 but also increased prices of essential commodities and services.

The Imperative of Working Capital Optimization

In this backdrop, the question arises: how should businesses respond to this difficult situation?

The answer: by prioritizing working capital optimization.

In times of rising interest rates, proactive management of receivables, payables, and inventory becomes critical.

To understand the ground reality more closely, GEP surveyed companies operating in the U.S. and the U.K. The goal was to to gain insights into the benefits of working capital optimization, specifically account payables and payment terms, given the pressure of high interest rates.

Take the case of a median Fortune 500 company with around $2.4 billion in third-party annual spend. The company could improve its financial returns by leveraging the rising interest rates. The improvement multiples are based on the company's ability to increase its average days payable outstanding (DPO) -- a measure of how long a company takes to pay its suppliers. A higher DPO means the company is holding onto cash for longer.

In this case, a company that was able to go from 30 to 60 days average DPO (2022 to 2023) realized a minimum of five times improvement on held funds (assuming an effective rate of 1% in 2022 and 3% in 2023).

The U.S. Vs. E.U

While U.S. enterprises have some leeway in working capital management strategies, they must tread carefully, considering the potential ethical implications. Stretching payment cycles might strain smaller businesses, and thus, a balanced approach is advocated.

In the EU, tighter regulations are in place to protect small and medium size enterprises. There, the room for extending payment terms is limited, necessitating more scrutiny.

5 Guiding Principles for Procurement

The current financial landscape has presented an opportunity for procurement functions to evolve into strategic entities. Central to this evolution is mastering working capital management, which integrates aspects of payables, receivables, and inventory. Considering procurement’s proximity to third-party spending, the function is poised to lead this working capital optimization.

Here's a five-way roadmap to consider:

1. Refine Supplier Payment Terms

Strike a balance between extended payment terms and incentives for early payments.

2. Regulate Expenses

Periodically reassess costs, ensuring quality isn’t compromised.

3. Inventory Management

By identifying redundant or slow-moving items and maintaining optimal stock levels, cash can be freed.

4. Strengthen Customer Credit Policies

Instituting credit checks and caps can offset the risk of delayed payments.

5. Expand Financing Avenues

During cash flow hitches, ponder over short-term financial aids like invoice factoring.

Conclusion

In the current macroeconomic environment, the emphasis on working capital management has never been more pronounced. As interest rates fluctuate, companies that can judiciously manage their working capital stand to gain.

Download our bulletin to get the full roadmap on working capital optimization.