Working capital is a highly effective barometer of a company’s
operational and financial efficiency and effectiveness. The
better its condition, the better placed the company is to focus
on developing its core business.
The early, primitive attempts at maximizing cash
management can be traced back to the late 1970s.
Unbelievably, there are still some companies who haven’t yet
understood that putting cash trapped in the balance sheet to
better use can give them a competitive edge over their rivals.
A most recent report shows a further reduction of working
capital in companies in the US and Europe compared with the
previous year, of between 3 per cent and 5 per cent. This
demonstrates the continuing increase in the importance of
working capital management to help companies achieve their
strategic objectives.
How to do It
There is more to working capital management than simply telling
a company to collect its debtors as quickly as possible, to
delay paying its suppliers as long as possible, and to keep
stock levels as low as possible. A properly conceived and
executed improvement program will certainly focus on optimizing
each of these components, but will deliver additional benefits
that extend far beyond the merely operational. It will
demonstrate the need for ambitious corporates to integrate
working capital management into their strategic and tactical
thinking, rather than view it as an optional bolt-on extra.
There are a number of dos and don’ts to help guide corporate
thinking. Firstly, do think of working capital management as
a strategic objective that can enable your corporation’s goals.
We cannot over-emphasize this opening point. The same factors
that drive a company’s working capital also drive its operating
costs and customer service performance. Therefore, by addressing
the drivers of working capital a company will also experience
significant improvement in operating costs and customer service.
For example, a company’s working capital is deteriorating due
to an increase in past due accounts receivable (AR). A review of
the overdue AR illustrates a high level of customer disputes.
The disputes are taking on average 30 days to resolve and
consuming significant amounts of sales, order entry, and cash
collectors’ time. By tackling the root cause of the disputes, in
this case poor adherence to pricing policies, the company can
eliminate the disputes, thereby improving customer service.
This will free up the time of staff in sales, order entry and
cash collections, enabling them to be more effective at their
designated roles. This in turn increases productivity, reduces
operating costs, and potentially increases sales. Working
capital will improve, as customers will have fewer reasons to
hold payment. This example illustrates how working capital is
one of the best indicators of underlying inefficiency within an
organization.
Consider Another Perspective
Don’t think of things only from your own company’s perspective.
If you can help your own customers plan their inventory
requirements more efficiently, for instance, you can match your
production to their consumption, efficiently and
cost-effectively, and do the same with your own suppliers. The
potential implications for inventory levels are huge. By
aligning ordering production and distribution processes, you
increase inherent efficiency and achieve direct cost
savings almost instantly, as a by-product. And then you discuss
the best way to bill or to pay.
Do educate your organization to consider the trade-offs between
different working capital assets when negotiating with customers
and suppliers. Depending on the usage pattern of a raw material,
there may be more to gain from negotiating consignment stock
with a supplier versus pushing for extended terms. This could
apply particularly in cases of long lead-time items, or those
that require high minimum order quantities.
Agree Formal Terms
Do agree formal terms with suppliers and customers and document
those terms carefully. Keep them up to date, and communicate
those payment terms to employees throughout your business,
particularly those involved in the customer to cash and purchase
to pay processes, including your sales organization.
Don’t allow prolific new product introduction without a clear
product range management strategy. Poor product range management
creates inefficiency in the supply chain, as companies are
required to support old products with inventory and
manufacturing capability. This increases operating costs and
exposes the company to an obsolete inventory that may have to be
disposed of.
Collect your Cash
Don’t forget to collect your cash. Many businesses fail to
implement effective ongoing collection procedures to
prevent excess overdue funds or build-up of old debtors. Ask
customers if invoices have been received and are clear to pay.
If not, identify the problems that are preventing timely payment.
Confirm and reconfirm the credit terms agreed upon with the
customer. Often, credit terms get lost in the translation of
general payment terms and what’s on the payables ledger in front
of the payables clerk. Do devote the requisite amount of time
and attention to the critical issue of dispute management.
Don’t set top-down targets uniformly across the business. For
instance, too many companies impose a 10 per cent reduction in
working capital for each division. This fails to take into
account the potential opportunity within a division and can
result in setting an impossible target that acts to de-motivate.
Instead, balance top-down with bottom-up intelligence when
setting targets.
Targets Drive Behaviour
Do set targets that drive the desired behaviour. Many companies
will incentivise collections staff to minimize the aged AR over
60 days. Does this mean that customers who pay one to 60 days
late are good payers? No, aged AR over 60 days will result in
increased costs and time it takes to collect the debt. By
incentivising staff to lower the amount over 60 days, you
keep your costs down. Do educate staff, customers and suppliers
that cash and cash management are important, and are an integral
part of a successful business relationship.
Look Within Yourself
Don’t assume that all the answers are to be found externally.
Before approaching existing customers and suppliers to discuss
cash management goals, fully understand your own process gaps so
you can credibly discuss poor payment processes.
Do treat suppliers as you would like your customers to treat
you. Far greater cash flow benefits can be realized by
strategically leveraging the relationship you have with
suppliers and customers. In addition, a supplier is more likely
to support you in an emergency if you have treated them fairly.
Don’t however, treat everyone the same. Use segmentation tactics
to split your customer supplier into similar groups. This may be
based on a basket of criteria including profitability, sales, AR
size, past due debt, average order size and frequency. Define
strategies for each segment based around the criteria and your
strategic goals.
Do celebrate success in hitting targets. Emphasise the
actions that helped you get there.
Conclusion
To summarise briefly, following the dos and don’ts will enable
you to optimize cash and to highlight inefficiencies in your
processes that must be remedied to better serve customers. It
will enable you to build stronger partnerships with your
suppliers across the total working capital value chain. This
translates ultimately into improvement in bottom-line results,
often a good deal quicker than you might expect, and helps
clarify the senior management focus on strategic imperatives.