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Faculty of Economics and Business
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Making work from working capital, even with plenty of work

Date:26 February 2020

By Wim Westerman

“Yes, always work!” That was my answer for many years to the question of whether I was still working on corporate projects at the University of Groningen, The Netherlands. With a specialization in both mergers & acquisitions and cash & working capital, I was always in a good position. In good times with plenty of work, big acquisitions are simply the strategy route to be considered and, in bad times with little work, a search for more liquidity rather comes to the fore. Or in my words of the time: "mergers & acquisitions low, cash & working capital high and vice versa". With the Dutch and other economies running like a madman at times, it is after the global financial crisis quite “vice versa”. And if attention is paid to cash & working capital, it often goes more to cash (balance and liquidity management) than to working capital (in a narrow sense, without cash). That is actually a shame.

Let us briefly review a few, well-known, reasons why working capital management (including debtor management, inventory management and creditor management) should be an important topic. Firstly, working capital captures in general more than 20% of a company's investment amount and with a little attention one can easily save some money, with "a penny saved" being "a penny earned". Secondly, there is a strong link with financing: investing in working capital pretty soon ends up in reducing cash and borrowing money from suppliers, banks and the like in the short term. Thirdly, working capital management is closely related to the business activities, or to put it into a (too) blunt equation: handling working capital properly = doing the daily job well.

However, not everyone holds that working capital management is important. Why, for example, try to save 2% of the interest paid on a just little amount of money by working stubbornly on working capital efficiency, if a fat takeover can earn 20% on a lot more? Also, let's face it: it is more fun to trumpet around that you are involved in a billion dollar deal than to convey that you saved 60,000 euros with one phone call. Moreover, you can’t usually call out the latter too loudly because someone else may have lost 60,000 euros as a result. And then it is also true that pressing one button may cause several bells to ring aloud. For example, lowering stock levels seems great, but may also provoke bottlenecks in the production, hassle with the suppliers and more need for flexibility at the bank.

How do we view working capital management from the ivory tower of science? To be honest, we follow practice, but we come up with nice thoughts. For example, we have in the meantime “invented” that there is not a general optimum level of working capital, but that a company can indeed have too much or too little working capital. This is reflected in scope for investments, business performance and therefore also in enterprise value. It is weird to witness though, that cash acquisitions do continue all the time anyway. Furthermore, the usual “suspects” are relevant too. If a company carries relatively more working capital, it is often larger, older, more profitable and it has more debt. It can then take a heavier load. Corporate internationalisation and interest levels are factors that are more ambiguous.

In addition to the above, rather general factors do also matter. Culture and customs is one of them. Paying on time is an old-fashioned practice that can even lead to mistrust here and there, to give just one example. Also, laws and regulations are ubiquitous, with regard to payment periods, interest rates, import restrictions and (re) insurance. Economic conditions, such as economic development, price stability and economic growth, play a role as well. Today's extremely low interest rates no longer seem to be so important in Europe, but the risk stored in working capital remains of course present. Finally, the banks, markets and (business) activities determine the leeway that a company itself has.

What does a financial manager do with this? General factors such as culture and customs, laws and regulations, information systems, economic conditions, as well as banks, markets and activities, are external to the working capital function. The motto here is simply "keep up". Yet, a financial manager can partially control internal factors, such as the size and age of the company, growth and profitability, as well as solvency. Finally, internal organization and strategic direction (call it the corporate philosophy) also matter and are co-shaped by the finance function. Some financial managers want or need to be independent of "the bank" and thus create their own frameworks more than others. Either way, "working on working capital" matters in economically exuberant (acquisition) times.

See for a Dutch version: CM Web, “Werk maken van werkkapitaal, ook bij volop werk”, 08/27, 2019