How to optimize working capital: Strategies, examples, and expert advice

How to optimize working capital: Strategies, examples, and expert advice

Team Balance
Team Balance
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It takes almost 220 days for a company to convert money they paid a supplier into cash received from a sale. In this environment, B2B payments can either ease or worsen the balance sheet. Kevin Yang, our Head of Credit, who has worked in the payments space for over 10 years, sat down with us to discuss the complex considerations when it comes to conserving cash and what businesses can do to stay ahead.

The importance of working capital

According to a survey conducted recently by the CNBC CFO Council, 68% of CFOs expect a recession to occur in the first half of 2023. Within reason, CFOs are becoming more and more concerned about preserving cash to weather the upcoming storm. Enter working capital optimization—the process of aligning costs with cash collections from customers.

To maximize capital, businesses try to speed up collection of cash from sales and delay paying vendors as long as possible. The goal is to reduce the amount of cash required to conduct day-to-day business.

If businesses reduce the time it takes to collect outstanding payments, this is known as days sales outstanding (DSO) acceleration. If businesses extend the time it takes to pay vendors, this is known as days payables outstanding (DPO) extension. 

The long cash conversion cycle: Why optimizing working capital is a must

Both DSO and DPO are measured in number of days and represent the average days a business has to wait to collect on a sale (DSO) and the average days a business can put off paying a vendor after purchase (DPO). For a company generating $50M in revenue annually, a 30 day improvement across DSO and DPO can lead to more than $4M in cash being freed up from operations. 

Many treasurers and financial controllers are known to strategically delay vendor payments at the end of a financial reporting period to increase reported cash balances. However, this is only a temporary window dressing for the balance sheet, and does not yield long-term cash benefits.

On the flip side, squeezing customers and suppliers for collection can strain valuable business relationships.

With this in mind, businesses often turn to third party working capital solutions.

How does a company manage working capital?

The most traditional way to optimize the working capital gap is through a bank line of credit. This comes in many flavors, such as revolving vs. non-revolving, asset backed vs. fully secured, fixed rate vs. floating rating. The credit line size and pricing is determined based on the size and creditworthiness of the borrowing company.

Obtaining a bank line typically requires going through lengthy approval processes, and can often come with significant added costs for third-party financial and collateral audits. However, a line of credit tends to be the cheapest form of financing most companies can secure.

In recent years, a slew of fintech lenders have come to the scene to offer working capital financing. These tend to be direct lending programs, with varying withdrawal and repayment structures, and higher interest rates.

Typical program offers include lines of credit, merchant cash advance, and invoice-based financing. Loans offered by fintech lenders tend to be less competitive on interest rates. However, they do tend to have a higher risk tolerance when it comes to early stage and smaller businesses. There are also speciality financing solutions, which can include:

PO financing:

Purchase order financing is primarily for large standalone projects. The purchase order lender will pay the supplier to manufacture and deliver the goods to the customer. Once the customer accepts the goods, the lender is paid by the customer directly. If the customer is large and credit worthy, and the borrower has a successful track record of delivering, then the lender would supply the capital to help execute the project.

The lender may limit its obligations only to a percentage of the capital required, and expect the borrowing entity to put up some equity as incentive for the order to be fulfilled. PO financing typically comes at a higher fee compared to AR factoring because of the added risk associated with project execution.

AR factoring:

Accounts receivable factoring is primarily used to get cash advances against outstanding invoices. This is because large enterprises typically impose long payment terms on their suppliers. For instance, Walmart may only pay a supplier for goods purchased 60 days after invoicing.

The supplier can leverage a factoring solution to get paid immediately, with the factor expecting repayment from Walmart after 60 days. Fees are typically charged as a percentage of the invoice being factored, and the risk appetite is dependent on the credit worthiness of the customer being invoiced.

SCF (supply chain financing):

This method is primarily used by large enterprise buyers to improve their DPO. When a supplier invoices a buyer, the SCF company can act as an intermediary and offer the supplier an option to get paid immediately with a fee. The buyer will then repay the SCF company under the original net terms arrangement. The primary benefit is that suppliers get paid quickly, while buyers still benefit from the time they need to pay their invoices.

Embedded payment solutions

The lines between B2B and B2C are beginning to fade. Behind every enterprise buyer and supplier is a human that just wants an easy way to transact. But with most business payments being done offline, easy isn’t really an option.

Luckily, embedded payment solutions are becoming more mainstream and simplifying how businesses can boost their cash flow. 

Embedded payments allow businesses to integrate fintech products directly into their own systems. So rather than relying on third-party integrations, businesses can have full control over the payments process and provide a more branded experience for their customers. API-first platforms are enabling embedded payments to play a major role in moving B2B payments online. And digital can simply no longer be on the back burner. 

By 2025, Gartner expects 80% of B2B sales interactions between suppliers and buyers to occur in digital channels. According to McKinsey, 60% of B2B buyers indicate they are open to purchasing on digital marketplaces. Another 60% of B2B companies are building marketplaces. In this environment, embedded payments are key for transitioning to e-commerce while still proactively managing cash-flow. Why? Depending on various third-party providers creates disjointed experiences for customers.

Embedded payment platforms create a consolidated payments experience, while seamlessly connecting to a businesses internal tech stack. 

For example, by offering payment processing and instant in-cart financing, buyers get valuable DPO relief, with the convenience of online purchasing. On the merchant side, getting paid automatically and instantly once the buyer completes a purchase – minimizes DSO and receivables outstanding. 

Ready to get the best of both worlds?

For businesses looking to double down on how they boost working capital without sacrificing digitization, a modern tech stack is a necessary addition to your payments process—one that works to get you paid faster, while enabling buyers to delay payment. You'll gain the runway you need to be responsive to the needs of your business, and the scalability you need to thrive in the digital era. 

Reach out to our team to learn more about Balance.

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