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Scotland has £35.6bn in hidden cash that could be used to fund growth

Posted: 26th September 2017

• Businesses in Scotland now have £35.6bn tied up in excess working capital
• Sustained growth has driven the pressure on firms in Scotland to increase working capital
• This could leave businesses exposed to greater risks if financial conditions deteriorated

Sustained economic growth and the fall in the Sterling exchange rate have put record pressure on businesses in Scotland 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 a new report from Bank of Scotland.

Firms across Scotland now have around £35.6bn tied up in excess working capital – up 13 per cent from £31.5bn 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 nationally 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.

Simon Quin, of Bank of Scotland Global Transaction Banking, said: “The increase in the working capital index in Scotland over the past six months is the highest of anywhere in the UK. Significantly, at 105.2, it now suggests Scottish businesses are now under pressure to increase working capital, whereas in April, the pressure was to decrease it.

“This is probably a result of the fact that GDP in Scotland has seen a bit of a resurgence during that time, outstripping the rest of Britain earlier this year, and aided by the small recovery in the price of Brent Crude.

“But 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 nationwide 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.

“Ultimately, every pound tied up in working capital is a pound that could be invested in other, more productive areas of a business and this is something that businesses in Scotland should be managing closely.”

The findings come from Bank of Scotland’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 companies focus on releasing cash from working capital when they are facing challenges.

An Index 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.

The current reading for Scotland of 105.2 is an increase of more than five points from 99.5 in April of this year.

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.

UK wide, one in four businesses said their customers had taken longer to pay during the past 12 months, increasing the value of firms’ outstanding invoices. At the same time, businesses are continuing to rapidly build up inventory, leading to more cash being locked up in stock.

With as many as one in three firms in the UK saying they are concerned by economic uncertainty or a fall in sales during the next 12 months, these factors could spell trouble for businesses in Scotland if economic conditions declined.

Simon Quin added: “Whether businesses expect to grow through exporting, or they anticipate challenges due to weakening domestic demand, firms in Scotland 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 ahead of embarking on further growth, a new exports programme, or before any possible future storm hits.”

UK variations

Although Scotland saw the biggest increase in its Index score, the pressure to increase working capital grew in every other part of the UK apart from the East of England, where the Index fell from 112.0 to 107.8.

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.

For more information about the Bank of Scotland Working Capital Index visit http://business.bankofscotland.co.uk/business-resource-centre/insights-and-ideas/working-capital-management/

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