Managing liquidity before inflation heats up

Low levels of inflation are considered positive economic drivers when they help boost demand, lower unemployment, and drive economic growth. However, persistent long-term inflation or high rates of inflation can result in stagflation or deflation. Stagflation is when persistent high inflation, combined with high unemployment, lowers spending and results in lower overall economic growth. Deflation is much worse than inflation and stagflation since economic growth slows significantly while consumers wait for prices to drop. This further reduces spending, which leads to a deterioration in corporate revenue and profitability and drives unemployment significantly higher.

There’s a fine line between low levels of inflation, short-term transitory inflation, and persistent inflation. Even what starts off as low or transitory inflation can become persistent inflation if consumers and businesses keep expecting prices to increase in the future and change their behavior to account for those expectations. That is why a company should be prepared to respond to these changes by having a strong cash management foundation. While the strategies in any of these scenarios may be similar, the extent of the actions will change as inflation increases in magnitude and duration.

Withstanding disruptions with working capital improvement

A company can create strategic advantages by actively managing its working capital and being prepared for disruptions or challenges like inflation in the economic environment. By having a constant focus on cash, executives can leverage the current inflation cycle and related uncertainty to make their enterprise more competitive and not fall victim to market dynamics. By focusing on each working capital sub-cycle’s ability to meet inflation-driven changes, events, and challenges, enterprises can release cash and maximize purchasing power as inflation unfolds.

Agility within the order-to-cash, forecast-to-fulfill, and procure-to-pay subcycles is simply how quickly a company’s people, process, and technology can react and be responsive to market changes, events, and challenges to stabilize its cash conversion cycle. Rising inflation affects the various functions of a company and each of its working capital sub-cycles very differently.

Executives should seek to understand how both moderate and persistent inflation affects their business and prepare for increasing levels of inflation to remain competitive. As geopolitical events unfold and supply chains respond post-pandemic, the global economy will continue seeking a new normal. A company’s focus on its working capital process to minimize its cash conversion cycle can serve as a competitive advantage against peers and reduce the impact of outside factors such as inflation.

Maximizing the purchasing power of cash flows through agility

As inflation persists, less agile companies may appear profitable, while simultaneously experiencing losses in purchasing power and credit worthiness. This occurs when collections are not timely, when bad debt increases due to rapid deterioration of creditworthiness, and material and wage costs are not passed along to customers timely. Being agile and reacting quickly to changes like these allows enterprises to maximize the purchasing power of their cash flows in inflationary times.

Executives seeking to increase agility and respond to future inflation and profitability concerns can begin to prioritize their enterprises’ responsiveness with a focused effort on improving across each of the key working capital processes, including a few of the following areas:

Preparing for increasing levels of inflation

A robust framework for understanding and managing liquidity should be a priority for companies in any economic environment. For companies that have not undertaken this task, the current macroeconomic environment led by potential high inflation is an impetus to take a deeper dive into their working capital cycles to mitigate near-term liquidity risk and position their balance sheets for long-term growth opportunities.

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