Unlocking Working Capital potential to fuel operational growth
Amidst the aftermath of the COVID-19 pandemic, geopolitical tensions, and persistent inflation, it is crucial for companies to prioritize efficient working capital management (WCM) in order to navigate near-term uncertainty and foster growth during the economic recovery. We identified four key reasons that make WCM crucial:
1. Economic headwinds are expected to be persistent: Despite the recovery of most advanced economies to pre-pandemic levels of output, growth in 2023 is projected to be sluggish. Recent downward revisions in growth forecasts highlight the challenges that lie ahead. For instance, the GDP growth forecast for the EU has been reduced to around 0.75%, a mere one-fifth of the previous year’s growth1. The IMF has also predicted that Germany will be the second weakest G7 economy next year, following the UK, with an anticipated GDP contraction of 0.11%1. Moreover, recent data reveals that the German economy contracted slightly for two consecutive quarters, by 0.5% in Q4 2022 and 0.3% in Q1 20232.
2. Inflationary pressure remains high until at least 2024: The Russian invasion of Ukraine has led to skyrocketing energy and food prices, resulting in persistent inflationary pressures. Additionally, rising material costs and supply chain challenges pose a threat to inventory levels, leaving businesses susceptible to supply shortages and price fluctuations. Although the IMF predicts a decline in inflation in Germany from 8.7% in 2022 to 6.1% in 2023, a return to the 2% target is not expected until at least 2025. Consequently, some companies have turned to forward buying and speculative upstocking. However, this strategy strains working capital and depletes cash reserves.
3. Interest rate peak has probably been reached: Central banks across the world have continued to tighten monetary policy and roll back quantitative easing to defeat red-hot inflation. In Europe, the ECB has raised its key interest rate by 0.25 percentage points to 3.5% in June, marking the eighth consecutive increase since July 2023. This rate-hiking cycle is the fastest in the ECB‘s history. ECB President Christine Lagarde announced further rate hikes in July, indicating an ongoing trend. According to a survey conducted by Bloomberg, it is projected that the peak will be reached at 4% in September 2023. Consequently, financing and working capital is becoming increasingly expensive.
4. Corporate cash flows are coming under increasing pressure: According to PwC, Days Cash on Hand of companies decreased by 10% in 20214. In 2022, the intensified efforts of central banks worldwide to combat inflation by raising interest rates have significantly impacted corporate cash flows. Mounting challenges stem from factors such as cost inflation, supply chain disruptions, and geopolitical events like the war in Ukraine, which have also influenced lender sentiment and global debt markets. In Europe, institutional loan issuance suffered a decline of 42% so far in 2023 compared to the previous year (as of July)5. As a result, the management of liquidity and working capital has become increasingly important.
Thorsten Gladiator, Managing Partner Capitalmind Investec: Supply chain issues and increasing (raw) material prices lead to higher funding requirements in working capital. A variety of working capital financing products allows for tailor-made solutions.
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