TheTreasurer

Definitive guide to working capital management

A strong WCM strategy depends on promoting a cash culture that is fully understood by all parties, including suppliers, writes Brian Shanahan

It is very likely that a company that is good at working capital management (WCM) will have effective internal processes. This is usually the case because to be good at WCM requires effective processes.

For example, in order to collect cash from a customer, we need a clear customer order, a clean invoice, a good collections process, an efficient dispute process for when things go wrong and a good cash-allocations process for when the cash is collected.

Fail on one of these points and it is very likely that you will not be collecting invoices on time and the cost of process will escalate substantially.

It may seem obvious that the faster we can turn our initial cash investment into a product, sell it to a customer and collect the cash from that customer, that we will make more profit simply by churning the same cash investment faster and faster. But many companies do not see the strategic significance of this cycle and find they have high levels of working capital and falling levels of profitability.

 Being effective at WCM is a much better way of helping your supply base for a number of very good reasons 

Managing this cash cycle well opens up all sorts of strategic opportunities and gives your company a competitive edge on a number of fronts. There is an old saying that the man with cash always has options. In business, this might be the opportunity to fund capital investment and research.

It may be the opportunity to acquire new businesses in new markets. It may be that by being more effective in WCM, you are better able to serve your customer base and can take advantage of organic sales growth. And most of all, you can take advantage of funding these growth opportunities without any of the funding costs that come with borrowings, or share or bond placements.

Done badly, your company is unlikely to be operating at optimum performance and will miss out on the kinds of opportunities described above. In a worst-case scenario you may run out of cash and, as Professor Roland Smith used to say, “You only run out of cash once”.

We have many modern examples of this, such as Woolworths and BHS, so this is not just a theoretical statement.

Putting suppliers first

There are those who would suggest that there may be a need to sacrifice good WCM in order to protect your supply chain. Going down this route can be dangerous, since it will involve your company behaving like an informal bank with suppliers who may not be stable themselves.

On top of that, you will be limiting your own opportunities to invest, since working capital will be soaking up valuable cash that is protecting suppliers.

Being effective at WCM is a much better way of helping your supply base for a number of very good reasons. Firstly, if you are the lead in the chain and you are financially secure and efficient in WCM, it makes the entire supply chain more robust, since its lead player has more liquidity.

This will probably mean that you will pay your suppliers on time, given that you have no reason to artificially or systematically delay payment. It makes it more likely that suppliers might even be paid more quickly, since you will probably have some kind of supply chain finance facility that suppliers can take advantage of in order to minimise their own working capital exposure.

 Managing this cash cycle well opens up all sorts of strategic opportunities 

And if all of this is true, then your suppliers will feel more secure to invest in the future, meaning that your company should be able to reap the benefits of your suppliers’ efficiencies in the future through better-quality supplies at more competitive prices.

One common sign that there might be a problem is if your suppliers continually complain about late payment. For your company, this could be caused by poor invoice-capture processes, slow sign-off procedures for invoices, agreeing short payment terms with suppliers than cannot be fulfilled or slow dispute-management processes.

In these cases, the answer is to automate processing as much as possible and to ensure there is proper and timely compliance with authorisation workflows.

But these solutions will only work if it was your company and not the supplier that was at fault. In many cases, late payment is caused by the supplier. Examples would be sending invoices in weekly or monthly batches, issuing inaccurate invoices or sending invoices to the wrong location.

The supplier will still complain about late payment, but assume that it is your company that was the cause. This is an even greater reason that you need to have efficient and transparent processes, so that supplier process errors can be highlighted and communicated.

Continuous improvement

One of the biggest issues in recent years is companies that have completed successful working capital programmes that did not sustain themselves.

The first thing that should be acknowledged is that fewer than 10 of the world’s largest 3,000 companies have improved working capital every year since 1998. There are many reasons behind that.

Over time, there will be changes in personnel. This can mean that the experience of the working capital programme is lost. The best companies, in working capital management terms, all have either a working capital director or champion, and possibly a team that is dedicated to sustaining and improving working capital performance.

Another big issue is measurement. You cannot manage those things that you do not measure – and working capital is no exception. Most companies are able to measure working capital at a high level with day sales outstanding, overdues, days payable outstanding and days inventory outstanding, but very few have a drill-down capability to understand what is really driving the numbers every month.

The last big thing that can throw the ship off course is events. These could be mergers, acquisitions, changes of senior management or bad publicity for the company. These are all things that can push a company into emergency mode.

Maximising opportunities

In emergency mode it is common that all the good things about WCM are forgotten about until the emergency is over and then it might be too difficult to return to the pre-emergency norm. This is why people will sometimes talk about a cash culture where senior leaders need to practice what they preach.

Working capital performance must be properly incentivised and everyone in the company must understand how their actions impact working capital.

All this is important for suppliers, too. If they have agreed to longer payment terms with the promise of on-time payment or have entered into a supply chain finance arrangement, the continuity of those agreements and your company’s capability of fulfilling them is vital.

All treasurers must understand that the continuity of stable liquidity is vital to the effective WCM of a business. If suppliers are relying on that liquidity from their customer relationships, it is vital that your company lives up to its promises. If not, suppliers will seek deeper relationships elsewhere.

That will mean that future price decreases will go to competitors; when a product is in short supply it will go to the opposition and there is very little likelihood of suppliers engaging with R&D activity.

Good WCM is not just about dressing up your balance sheet and sticking it to the supply base. Good WCM is about maximising the opportunities for investment and cooperation across the supply chain, not for just one company in the chain.

There have been many studies over the years showing that supply chains that work together are far more profitable than those that behave in adversarial mode. In a well-oiled working capital machine, everyone gets a share.

About the author

Brian Shanahan is founder of working capital and procurement consultancy Informita and was a speaker at the ACT’s Smart Cash Conference

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