Creating value through working capital

13 Jan 20

Report: PwC’s Working Capital Report 2019/20: Creating value through working capital

Authors: Daniel Windaus, Stephen Tebbett, Henry Rosier, Joe Rafuse, Rob Vettoretti, Peter Greaves

Demica’s reflections on PwC’s Working Capital Report 2019/20

This commentary focuses on two of the five conclusions provided by PwC in their 2019/20 Working Capital Report: “Receivables and Inventory are major sources of opportunity” and “Working Capital is the next value driver”. Firstly, we consider whether the first-half of the new decade will focus on improved Receivables and Inventory performance due to Payables performance stagnating? Secondly, we examine whether “addressing excess working capital would lift overall ROIC (‘Return on Invested Capital’) by up to 30 bps (‘basis points’)”.

PwC’s data shows a 5.7% negative movement of DPO in 2018 from 2016, the apex of DPO within the five-year period of review commencing 2014. Net working capital days from 2016 to 2018, however, improved marginally by 0.6%; reinforcing PwC’s conjecture that the “asset side of the balance sheet is finally getting some much-needed attention”.

Demica has seen an increase of 60% in receivables assets on its platform from November 2018 to November 2019. Demica’s Head of Structuring, Francois Terrade, argues that “Receivables Finance will be the primary focus in the upcoming years whilst commodity financing will continue to dominate inventory financing. Greater traction for the market of Receivables Finance will come about due to capabilities in Unbilled Receivables Financing and Purchase Order Financing. Technology-providers, such as Demica, and traditional institutions are collaborating to enhance their offerings in this area”. Nevertheless, in order for the next decade to be defined as a true focus on the asset side, Inventory will also need to be addressed.

Inventory performance is the least serviced factor in the pursuit for optimising working capital but is required to realise the hypothesis stated at the beginning. Eight sectors out of the 18 analysed by PwC showed improvement in net working capital days. Examining the year-on-year trend of these eight sectors, utilising PwC’s 2018/19 report, “Navigating Uncertainty: PwC’s annual global Working Capital Study”, highlights the insignificant contribution of Inventory performance. The net median DIO change of the highlighted eight sectors, between the two reports, was a deterioration of two days. Therefore, the overall improvement was caused by changes in DPO and DSO leaving Inventory underserviced. Francois views that “financing of commodities will remain but disruption in the Inventory Financing market, by new players, is unlikely in 2020 due to the more difficult economic climate expected this year, the fragmented nature of the market and high-barriers to entry-requirement for sophisticated technological & structuring capacity necessary to assess and mitigate the many risks inherent to this asset class. ”.

Demica views that the first-half of the new decade will focus on improved Receivables performance, due to heavy investment in flexible Receivable Financing structures, with inventory performance likely be a later emphasis as Receivables take centre-stage.

PwC “judge that companies that are able to release more cash from working capital, would likely improve their return on investment”. Demica research on the average margin price of a Trade Receivables Securitisation (‘TRS’) compared to a Revolving Credit Facility (‘RCF’) supports this potential value driver for companies. Utilising information of 41 transactions from publicly traded companies, the average basis point difference between RCF and TRS across the credit rating spectrum is 68 bps. The transactions used in the analysis had a term range from one to three years on average.

The potential nominal saving of financing expense, from companies actively engaging in Receivables Financing, can generate increased net profits thus increased ROIC. The challenge will be which companies will be able to access the Receivable Finance structures to enable better utilisation of excess working capital. Francois believes, “larger corporates will be financed by banks through STS (Simple, Transparent and Standardised) securitisation whilst banks in combination with a technology-provider will service the companies that require more than factoring but are not at the size of large corporations who can access the securitisation market.”

In conclusion, there is much opportunity with Receivables and Inventory Financing and the benefits of using excess working capital is starting to gain greater traction; the development and refinement of financial products will enable more companies to access these benefits. On a macroeconomic level, Francois concluded his interview with the following, “As the overall economic environment shifts, our technology will help both corporates and investors  monitor risks which should enable more accurate true risk pricing”.

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