Rigorous control over free cash flow gives treasury a seat at the strategy table.
By working to shorten the cash conversion cycle and making free cash flow a key metric of success, treasury at one NeuGroup member company gained credibility, responsibility and authority as a strategic partner within the enterprise. Its experience offers a road map for other corporates where treasury aims to augment its role in working capital management.
- Companies that succeed in this effort will better weather economic headwinds as the Fed fights inflation with higher interest rates, raising the specter of recession and presenting new challenges for finance executives.
- A recent survey from The Hackett Group titled “The Great Working Capital Reset” noted that “companies with robust working capital management skills will be best positioned to invest in new capabilities that can fuel recovery and growth.”
Shorten the cash conversion cycle. Several years ago, the NeuGroup member company had a low, non-investment-grade credit rating and faced extremely high funding rates. That prompted treasury to lobby to shorten the cash conversion cycle dramatically. At a recent meeting of NeuGroup for Large-Cap Assistant Treasurers, the head of global treasury explained how a reduction of about 50% was achieved:
- Consolidate all cash functions under treasury and give it oversight of and insight into regional teams in accounts payable and the credit and collections departments, even if they do not report directly to treasury. “We centralized cash to ensure we had the right level of understanding on what the ins and outs are,” the member said.
- Go after each and every link in the chain. The member recommends “chasing every single” element that affects cash flow—including accounts receivable, payables, inventory and credit terms.
- Engrain a cash mindset and a sense of urgency about it into the corporate culture. “Every company shows the Street how revenues grew year over year and quarter over quarter; so the whole philosophy was, why can’t free cash flow be managed like that as well, at the same level of detail and scrutiny,” the member said.
- “The process we follow is similar to the one companies follow for metrics such as revenue and gross margin.”
Obtain buy-in, enable action. The company’s past financial challenges gave treasury extra leverage to pursue the initiative, but an important early step was procuring support from top management, to gain cooperation from other departments. Also:
- Free cash flow can be a nebulous concept for corporate colleagues outside of finance, so defining specific actions and setting discrete targets that translate into terms relevant to different departments was critical.
- Using the textbook definition of free cash flow—cash flow from operations minus capital expenditures—the metric has been incorporated into employee incentives like other financial metrics such as P&L.
- Incentives were designed to coordinate sales and collections in the same quarter, and a matrix was created—now reviewed weekly by the CEO, CFO and COO—to modulate inventories and dampen their impact on cash.
Reap benefits. The member’s company now has a very strong investment-grade credit rating and generates robust free cash flow each quarter. The member said the cash flow rigor and discipline that treasury forged has been retained across the organization, up to the CEO.
- Perhaps the greatest benefit and one that should inspire any treasury team: The initiative increased treasury’s credibility within the company as a strategic partner. It now exerts influence across the enterprise, including procurement, operations and sales. “The leadership team realized that treasury has a vantage point to view things happening under the covers that can later affect P&L,” the member said.
- Besides elevating treasury to the position of strategic advisor to other parts of the company, having the free cash flow policies and procedures in place helped it quickly decide what to do when the pandemic hit, and business slowed. “We had done multiple tiers of downside scenarios over the years and how to navigate through them,” the member said. “So, for us it was easier to reuse them versus building something brand new.”
- Managing free cash flow enables the company to better understand the cash dynamics of each business as well as inventories and supply chains and the amount of cash available. That scrutiny enables it to fund its capital allocation priorities from its balance sheet, rather than approaching a currently volatile debt market.
