Creating Value for Private Equity Through Working Capital

Chief financial officers (CFOs) and operating partners know the value of maximizing working capital. 

Most portfolio companies face an accounts receivable and an accounts payable timing mismatch: long payment terms on their receivables and much shorter terms on the payables side. Simply put, money has to go out the door before money is coming in the door.

This situation leads to a cash-flow crunch and a strong need to better manage working capital. This problem often shows up more for middle-market companies that are more constrained due to limited leverage to standardize terms with their suppliers or lengthen terms with their customers. So, to build shareholder value for the private equity sponsor and/or execute mergers and acquisitions, portfolio companies have to find ways to free up cash.

Easier said than done. As CFOs and operating partners well know, there are multiple challenges to optimizing working capital, including:

• Limited data analysis 
  • Many companies lack the real-time data and metrics needed to evaluate the effectiveness of working capital and improvements.
• Lack of a formal structure for working capital improvement efforts
  • Whether improving working capital is a cross-functional effort or driven by finance, it can be difficult to sustain the effort without a dedicated and focused leader. Without clear ownership and tools, companies find their working capital optimization efforts fall to the wayside.
• The number of working capital stakeholders and their differing perspectives
  • The distributed nature of working capital, in which one stakeholder within finance may own accounts payable and another accounts receivable, can make it difficult to implement a working capital improvement program. Also, most working capital projects require procurement to negotiate terms extensions, so natural tension may arise when implementing a strategy.
• Time constraints
  • Organizations often struggle to focus on optimizing working capital because of other priorities competing for attention, especially with human resource constraints within the organizations.

Finding New Solutions

Operating partners and CFOs of portfolio companies are finding value in utilizing third-party strategic solutions, like LSQ’s working capital platform, FastTrack. 

The reasons a trusted partner in this space helps speed up and maximize a company’s ROI include:

Mandate and Communicate

A CFO or operating partner can serve as the executive sponsor for a working capital initiative and support senior management by freeing up their team’s time in implementation by providing an expert to do the bulk of the work. While making it clear that improving working capital is an organization-wide priority, providing a solution can alleviate anxiety for those involved.

Collaborate and Coordinate Across the Organization. 

Because working capital touches so many different parts of an organization, CFOs should request the collaboration of their team for an initial rollout and ensure all team members know what resources (time, reports and personnel) are needed. An industry expert, like LSQ, can provide a list of what’s needed from each team and then transfer the workload to the LSQ team for implementation.

Identify Optimization Levers and Use Them Consistently 

Whether a company is looking to free up working capital through terms extensions on the accounts payables, reduce days sales outstanding on the accounts receivables, or leverage the value of inventory, a working capital platform can help manage all three levers consistently and effectively.

Measure Effectiveness with Data 

After initial analysis, a company receives a range of working capital through accounts payable, accounts receivable, and inventory. Working capital platforms that are skilled in data analysis can provide insight into the best path to get a working capital lift as quickly as possible. Feedback to the CFOs and operating partners in the way of metrics can monitor the program’s effectiveness and savings on the cost of capital. Having a plan based on analytics gives a CFO the highest chance of success when implementing a solution.

Align Incentives with Improvement 

Coupling data for where to get a working capital lift with providing incentives to suppliers to adopt terms extensions is key to success. By offering a supply chain finance program, suppliers are able to take early payment at a small discount and are more comfortable with accepting longer terms. Incentivizing suppliers is one portion, but also incentivizing the teams involved in a working capital optimization project should also be made available. LSQ offers rebates that can be used for additional working capital unlocked through a COGS reduction, which could be a tool to enhance a team’s compensation package. Incentives can help align procurement with the finance and treasury departments.

CFOs and operating partners are charged with steering companies toward growth. One of the best ways to do this is freeing up working capital so there’s more options available. Utilizing an industry expert and software designed to manage accounts receivable and accounts payable, such as LSQ, increase the chances of success.