Sustained economic growth and the fall in the Sterling exchange rate have put record pressure on British businesses to increase the amount of money tied up in working capital, leaving them at risk if growth were to weaken in the months ahead, according to the latest report from Lloyds Bank Commercial Banking.
Firms across Britain now have around £535bn tied up in excess working capital – up seven per cent from £498bn since the last report was released in May – meaning that firms could struggle to free up cash either to grow or to weather turbulent financial conditions.
The sustained growth seen in the past 12 months – particularly in manufacturing and in the services sector – has increased the amount of cash tied up in the day-to-day running of businesses, with the impacts from the fall in Sterling, forward purchasing of inventory and a rise in input costs, being fully realised.
At the same time, one in four businesses said their customers had taken longer to pay during the past 12 months, increasing the value of firms’ outstanding invoices. This comes as businesses are continuing to rapidly build up inventory, leading to more cash being locked up in stock, which is then unable to be used for growth.
With as many as one in three firms saying they are concerned by economic uncertainty or a fall in sales during the next 12 months, these factors could spell trouble for British businesses if economic conditions declined.
Adrian Walker, managing director, head of Global Transaction Banking at Lloyds Bank, said: “Increasing pressure for British businesses to hold more working capital has to date largely been driven by economic growth fuelled by the fall in Sterling. But, if there were any economic obstacles on the horizon this could be a double-edged sword.
“By locking up cash in this way, it stops investment in other more productive areas of the business, whether that be investing in new people, creating new products or targeting new markets.
“With as many as one in three businesses telling us that their greatest concerns for the next 12 months are economic uncertainty or a fall in sales, this reliance on future growth prospects is concerning.”
The findings come from Lloyds Bank’s second Working Capital Index, a six-monthly report 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.
Working capital is the amount of money that a company ties up in the day-to-day costs of doing business. Growing businesses tend to use more working capital, while pressure falls when firms realise they are facing challenges.
The current Index reading of 108.0 is an increase of almost four points, from 104.1 at the end of 2016, and is just below the highest point seen since the research started in 2000.
The Index highlights that with the UK’s domestic outlook looking weaker, businesses are increasingly going to need to rely on exports for future growth.
While the current relative weakness of Sterling makes conditions for international trade benign, the practicalities of exporting mean that it often places even greater stress on working capital through shipping times and slower payments.
Mr Walker added: “Whether businesses expect to grow through exporting, or they anticipate challenges due to weakening domestic demand, UK firms could benefit from the operational efficiency and cash flow boost that comes from working capital improvements.
“In the past, previous highs in this Index have coincided with improving financial conditions. The fact that the Index is currently climbing while financial conditions remain relatively low means businesses are taking on more and more risk.
“Our experience is that businesses that undertake a programme of working capital improvements can typically release around three to five per cent of turnover in additional cash, allowing them much more freedom to invest in growth, trade internationally, expand their product set or to give themselves a buffer to see them through more troubling times.
“But doing so successfully isn’t easy. It requires change across a number of business functions, and so the time to undertake that work should be done ahead of embarking on further growth, a new exports programme, or before any possible future storm hits.”
Manufacturing under pressure
The manufacturing sector has been a source of hope and opportunity for the British economy in recent months as the fall in Sterling made British manufactured goods more competitive overseas.
But the sector’s growth, together with rising import costs and pre-purchasing of materials in expectation of inflation, has pushed the sector’s working capital index to 126.1, which could be hampering growth amongst manufacturing businesses.
This compares with readings of just 105.0 and 104.8 in the services and construction sectors respectively.
The pressure to increase working capital grew in every region apart from the East of England, where the Index fell from 112.0 to 107.8. Although, the East of England still saw high pressure on businesses to hold more working capital.
Scotland, where a reading of 99.5 indicated pressure to reduce working capital six months ago, saw the biggest increase, with the Index reading rising more than five points to 105.2.
Wales remained the region with the highest pressure to increase working capital with the Index climbing from 113.7 in April to 114.3 now.
(Source: Working Capital)