Commercial Bankers Can Help Borrowers Take a Closer Look at Liquidity
April 10, 2016
Years of historically low interest rates have led many companies to stockpile cash and otherwise become lax in their working capital management. But excess cash in the bank and money that’s tied up in bloated inventory and receivables might be better spent investing in new business opportunities or repaying debt.
As interest rates slowly start to rise, it’s important for your borrowers to renew their interest in running a tight ship to avoid being sunk by rising interest costs on their adjustable-rate credit lines.
A new twist on liquidity
As a banker, you likely have adopted a risk-averse approach to working capital management, generally equating higher liquidity with lower credit risk. A healthy dose of liquidity provides legitimate peace of mind, especially in times of economic uncertainty. But it’s possible to have too much of a good thing.
Each dollar tied up in working capital represents a dollar of forgone opportunities. Instead of carrying cash, receivables or inventory, a business could pay down debt, research product innovations, hire a salesperson, purchase new equipment or pay out dividends. Working capital alternatives potentially could increase profits, enhance investor returns and decrease leverage.
A focused approach
There is no universal balance between working capital safety nets and cash flow efficiency that works for all companies. But top performers in any industry closely manage cash flow and seek ways to free cash from working capital. In doing so, they usually target these three balance sheet accounts:
The ultimate goal when targeting these accounts is to reduce the cash conversion cycle. This essentially is the time it takes a company to convert inventory into cash. Efficient companies have shorter cycles than others in their industry.
Help from the sidelines
Bankers routinely monitor their borrowers’ working capital trends and understand the pros and cons of liquidity. By sharing the results of your due diligence efforts, you can help borrowers strike a balance between having too much and too little working capital on their balance sheets.
You might also recommend a financial professional to help an inefficient borrower benchmark its liquidity against competitors. He or she can advise management on ways to free up cash from receivables and inventory, as well as brainstorm alternative ways to spend their extra cash to add value.
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