FX International Payments
By Karen Lynch
Even in an environment of stable interest rates, working capital management usually is more challenging for international business than domestic operations. "This is because of the multitude of factors that can restrict the receipt of funds or lessen the value of the funds received," according to the Forum for International Trade Training, which cited examples including exchange rate fluctuations, transmission delays, and slower collection of accounts receivable.1
Since the global financial crisis, interest rates have been at record lows. After an expected increase in December 2017, though, the U.S. Federal Reserve's main interest rate will have risen to 1.5 percent.2 That amounts to a full percentage point since the Fed ended seven years of near-zero policy rates in December 2015,3 and some observers expect the rate to reach 2 percent by the end of 2018.4 In November 2017, the Bank of England lifted its base lending rate for the first time in 10 years, from 0.25 percent to 0.5 percent, and projected two more increases over the next three years.5
Further, some economists are reportedly pressuring the Reserve Bank of Australia to increase its rate for the first time in seven years.6 The Bank of Korea lifted its rate in November 2017, amid growing expectations of rate hikes across the region.7
Central bank interest rates, which apply to short-term lending between banks, provide benchmarks for business loan rates. While there is no direct correlation, an example of their impact is the prime rate that U.S. banks charge their "best" customers. Historically, that prime rate has been three percentage points higher than the Fed's rate, and it has exactly matched Fed rate changes in recent history.8,9
A lack of focus on working capital and cash-flow optimization can result in higher debt expenses, decreased efficiency, missed growth opportunities and, ultimately, lower profitability, experts say. In the worst-case scenario, as the old saying goes, when you're out of cash, you're out of business.
Yet, despite its importance, "working capital management has been a back-burner issue for many companies in the recent past," according to the Treasury & Risk trade publication. "With interest rates at record lows for years, keeping DSO (days sales outstanding) low and DPO (days payments outstanding) high has not been a top priority. That's going to change as rates rise."10
Some of the biggest international businesses are already seen to be recasting their working capital management strategies, with a particular focus on extending DPO. The longer these companies take to pay their bills, however, the more pressure they apply to their suppliers' cash flow.
"Companies that maintain working capital performance at the expense of suppliers create risks across the value chain," according to global professional services firm PwC.11 "Additional focus on the asset side of the balance sheet (receivables and inventory) may be warranted as a means of releasing cash, and efforts to optimize payables should consider the impact on the supply chain."
Supply chain financing is one way to counterbalance the impact, experts say. Various techniques involve selling receivables to banks or other financial service providers (which are often called "factors"). In return, the suppliers get faster access to the money they are owed, enabling them to use it for working capital, while buyers generally get more time to pay.
During the financial crisis, companies had to become better at working capital management to survive, according to Veronica Wills, Associate Principal with the Hackett Group consultancy.12 With sudden drops in both revenue and access to low-cost financing, executives had to figure out how to balance their short-term assets and liabilities more efficiently to free up cash from operations.13
That acute focus relaxed in the three-to-five years following the crisis, according to Phil Beck, Senior Vice President of the SAP Ariba B2B e-commerce network.14 In a webcast, Wills and Beck described how, in many cases, low interest rates fostered complacency, while emphasis shifted to revenue enhancement and reductions in operating costs. Even as cash on hand increased, so did debt.
Now, however, with interest rates on an upward trajectory, companies are returning their attention to working capital management. Working capital management balances inventory, accounts receivable, and accounts payable, while also leveraging short-term financing. Examples of steps to improve cash levels include reducing DSO through customer incentives for faster payment16 and smoothing inconsistent cash flows with working capital loans.17 These days, though, "the lever that's easiest to pull in most cases is the DPO metric," Beck said.18
Recent Hackett Group research of the top 1,000 U.S. companies indicates that they are taking more control over the terms and conditions they're negotiating with suppliers, since DPO is also one of the largest dictators of cash flow from operations. The result has been a median DPO of 43.6 days, though the more aggressive companies have driven DPO up to 63.6 days. This is exerting a domino effect in the global supply chain, as suppliers come under pressure and, in turn, delay payments to their suppliers.19
Optimizing working capital management can take several months and even years, depending on a company's level of complexity and geographic range, Wills said – a call to action that should not be lost on import-export traders and global supply chain managers.
Wills and Beck cited best practices for working capital management in companies large and small. A first step is to analyze the rationale for an organization's current debt loads and, assuming changing interest rates, the burden related to future interest expenses.
Changes to be executed may include cultural shifts, such as a recognition of the importance of working capital management within all business units; incentive structures that link ongoing targets with compensation; and digital systems to execute, monitor, and analyze working capital management.
In considering DPO term changes, some leading companies are segmenting their suppliers by size, according to Wills, and doing cost/benefit analyses of how to proceed. This means, for example, that careful negotiations could be taking place with strategic suppliers. At the same time, midsized suppliers might simply be notified by mail that their terms of payment have changed. (In some cases, they may only have 30 days to adjust.) The smallest companies, on the other hand, may not see any change, because they account for so little of a big customer's spending that they would have a negligible impact on its cash flow.
As interest rates rise, working capital management is getting renewed attention in many international businesses since changes in the cost of money add to the challenges of managing cash flow across borders. Large, midsized, and small businesses may all wish to take stock of current practice and future requirements, as different impacts are expected throughout the world of import-export trade and global supply chain management.
Karen Lynch is a journalist who has covered global business, technology and policy in New York, Paris and Washington, DC, for more than 30 years. Karen also is a principal at Content Marketing Partners.
1. “These 5 Factors Will Change the Way You Manage Your Cash Flow,” Forum for International Trade Training; http://www.tradeready.ca/2016/topics/international-trade-finance/5-factors-will-change-way-manage-your-cash-flow/
2. “What the Latest Fed Rate Hike Means for Mortgage Rates,” USA Today;https://www.usatoday.com/story/money/personalfinance/2017/06/14/nerdwallet-mortgage-rates-fed-rate-hike-home-buyers-sellers/397475001/
3. “How Might Increases in the Fed Funds Rate Impact Other Interest Rates?” Federal Reserve Bank of St. Louis; https://www.stlouisfed.org/on-the-economy/2017/october/increases-fed-funds-rate-impact-other-interest-rates
4. “Rates Due for Moderate Increase,” Kiplinger; https://www.kiplinger.com/article/business/T019-C000-S010-interest-rate-forecast.html#rhkDyDvpxbcm46Vl.99
5. “UK interest rates rise for first time in 10 years,” BBC; http://www.bbc.com/news/business-41846330
6. “The Seven-year Interest Rate Itch,” The Guardian;https://www.theguardian.com/business/grogonomics/2017/nov/14/the-seven-year-interest-rate-itch-no-the-rba-shouldnt-scratch
7. “Bank of Korea Leads the Way in Asia with Interest-Rate Hike,” Bloomberg; https://www.bloomberg.com/news/articles/2017-11-30/bank-of-korea-raises-interest-rates-for-first-time-since-2011
8. “Q&A: How a Key Fed Interest Rate Affects the Economy,” Los Angeles Times;http://www.latimes.com/business/la-fi-fed-interest-rate-qa-20150615-story.html
9. “Here’s How the Fed’s Decision to Raise Interest Rates Could Impact Your Life,” Business Insider;http://www.businessinsider.com/federal-reserve-interest-rate-impact-consumers-businesses-2016-12/#the-feds-main-monetary-policy-tool-is-the-federal-funds-rate-1
10. “Rethinking Working Capital Management as Interest Rates Rise,” Treasury & Risk;http://www.treasuryandrisk.com/webseminars/rethinking-working-capital-management-as-interest?ref=sidebar-webseminars&slreturn=1511702171
11. “Pressure in the System: Working Capital Study,” PwC; https://www.pwc.com/gx/en/working-capital-management-services/assets/working-capital-opportunity-2017-2018.pdf
12. “Rethinking Working Capital Management as Interest Rates Rise,” Treasury & Risk;http://www.treasuryandrisk.com/webseminars/rethinking-working-capital-management-as-interest?ref=sidebar-webseminars&slreturn=1511702171
16. “Six Ways to Reduce Days Sales Outstanding,” CFO Magazine;http://ww2.cfo.com/cash-flow/2017/10/six-ways-reduce-days-sales-outstanding/
17. “Everything You Need to Know about Working Capital Loans,” Merchant Maverick; https://www.merchantmaverick.com/working-capital-loan/
18. “Rethinking Working Capital Management as Interest Rates Rise,” Treasury & Risk;http://www.treasuryandrisk.com/webseminars/rethinking-working-capital-management-as-interest?ref=sidebar-webseminars&slreturn=1511702171