A period of sustained growth and favourable conditions created by a fall in the value of Sterling have contributed to record pressure on manufacturers to increase their working capital.
Working capital is the amount of money that a company dedicates to the day-to-day cash being used within its business. Firms that are growing naturally dedicate more cash to working capital, so to a certain degree this pressure is to be expected and can be viewed as a positive indicator of the UK manufacturing community’s health.
But in reality, if a company has too much money tied up in working capital, it means investing in more productive areas of their business - whether that’s in new people, new products or new markets - can’t happen at short notice.
Equally, by locking up cash in this way, manufacturers increase the risk of being financially unprepared for a drop in business activity if economic conditions deteriorate quickly.
The results come from the second Lloyds Bank Working Capital Index - a measure we’ve developed that uses Lloyds Bank Regional Purchasing Managers’ Index (PMI) data to calculate the pressure British businesses are under to either increase or decrease working capital.
A reading of more than 100 indicates pressure to devote more cash to working capital, while a reading of less than 100 indicates pressure to prioritise liquidity. It hit 126.1 in June 2017, a record high for the manufacturing sector. This is compared with a reading of 105 in the services sector, and 104.8 for the construction industry.
The findings suggest that the fall in the Sterling exchange rate and resulting rise in input costs has prompted manufacturers to buy more materials in expectation of further inflation, causing the fastest build-up of inventory in the sector for more than 17 years.
But previous highs in this Index have coincided with improving financial conditions. The fact that pressure to increase working capital has increased, while financial conditions remain relatively low, means manufacturers are taking on more and more risk.
With the UK’s economic and political landscape still gripped in a period of uncertainty, firms in the sector now need to balance devoting more working capital to boosting exports, for example, while freeing up cash that could be used to fund further growth, improve productivity through investing in new technology or weather turbulent financial conditions.
Our experience shows that by undertaking a programme of working capital improvements businesses can typically release around three to five per cent of turnover in additional cash, allowing them much more freedom to invest in growth, productivity improvements or to give themselves a buffer to see them through more troubling times.
Working capital focuses on the short-term funds required by a company, so its management must prioritise keeping this money as accessible as possible. Operationally, it’s vital that correct and timely information and reporting processes are put in place to analyse payables, debtors and collection processes. Inventory management information should also be at the right level of detail to focus attention on areas of possible improvement.
To simplify this, Lloyds Bank has created a working capital management tool that allows our relationship managers to analyse the cycles of manufacturers, benchmark them against their peers and identify financial opportunities and challenges.
While this holistic view is invaluable, at a more fundamental level, working capital improvements require a change of thinking.
Firms need an action plan, so that improvements can be adopted across every department of a business. If the whole organisation is not committed to improving working capital, businesses run the risk of missing an important and lucrative opportunity.