May 15 2020

Working capital Management

Uncertainties in the global economy and financial markets are exerting severe pressures on companies and their supply chains.  The adage “cash is king” remains as relevant as ever, and the importance of positive cash flow in sustaining a business and reducing financial risk remains a top priority for all businesses.

As organisations embark on a Working Capital rationalisation exercise, they would serve well to take a very structured approach to solving the challenge. The success of this exercise depends on the effective operationalisation of 4 Key Levers

  1. Optimisation of Working Capital requirement
  2. Liquidity management
  3. Visibility and control over cash flows
  4. Organisational culture
  1. Optimisation of Working Capital requirement
  2. Driving sustainable improvements requires a maniacal focus on the cash drivers. Operational drivers behind cash flow outcomes broadly center around Accounts receivable, Inventory & Accounts Payable.

    • Accts receivable
      • Speed up Invoice to Cash cycle:
      • Heightened focus aged oustandings: Organisations should rapidly resolve collection issues, that can further reduce the total value of past due invoices.
      • Customer segmentation to drive collection strategies ie by segregating based on common characteristics eg, disputed with respect to pricing, discounts, quality issues etc, needing credit extension due to cash flow issues etc, account reconciliation issues
      • Dispute resolution: Cross functional dispute resolution teams, speeding up the invoice dispute resolution process itself
      • Invoicing:
      • The faster the billing function generates invoices and sends them to the customer after a product or service is delivered the sooner payment will be received. Electronic invoicing and payment tools can further speed up the payment process.
      • Invoicing errors are a frequent contributor to long payment cycles.
      • Quoted prices might not match up with master data, which leads to an incorrect invoice that is disputed by the customer. Root cause analysis of such errors can uncover the process failures that are driving such errors.
      • Payment terms:
      • Organisations often negotiate price discounts in exchange for faster payment terms. While there is a trade off with profit, for the short term this could serve as a liquidity booster.
      • Simplifying payment terms will help in limiting errors and enable faster collections turnaround.
      • Credit Policy:
      • Credit standards are the criteria that determine which customers will be granted credit and how much, and well structured credit policies that center around character, capacity, capital & conditions, enable collections to be predictable.
    • Inventory
      • Ageing review:
      • Review inventory ageing and develop strategies for liquidation of ageing and obsolete inventory that will free up cash
      • Supply chain management:
      • Centralizing inventory management through regional or national hubs to reduce warehousing costs and optimize shipment to end customers across channels.
      • Inventory reordering and stocking strategies:
      • Often production planning and inventory management applies rule-of-thumb stock levels across every segment / product. From a resource optimization standpoint, a differentiated reorder / stocking level for each demand segment or product may be more effective.
      • By analyzing order volume and frequency for each SKU the working capital team can categorise products into a) those that could be made using a "pull" system of automatic reordering b) those that should only be produced on a made-to-order basis 3) those that should not be produced at all.
      • Simplification & Standardisation of SKUs
      • by reducing the offerings and limiting SKU variants to those having high market demand.
      • Standardised contracts
      • will reduce complexity and make inventory managements more predictable and accurate
      • Accurate demand forecasting:
      • This is one of the most critical drivers of inventory. The ability to align production, inventory levels and delivery frequencies with actual customer demand will define the ultimate success in managing inventory at optimum levels. Organisations need to reduce volatility by understanding and fine tuning forecasts based on the different demand segments and the level of variability within those segments and then institute process changes that are more responsive to demand fluctuations. Demand fluctuations can be regulated to some extent by reducing quarter-end price discounts that cause customers to delay purchases.
    • Accts Payable
      • Terms of payment:
      • This typically entails extending payment terms if possible standardising terms wherever possible offering early payment terms by financing suppliers debt through a credit institution. These initiatives can accelerate the flow of cash
      • Optimising discounts: Organisations should draw a careful balance between early pay discount vs pricing for extended payment terms to optimise cash flow
      • Payment processes
      • Procurement policies: Consolidating vendors, to win price concessions, extend payment and delivery terms, and derive other value and benefits from suppliers.
  3. Liquidity management
    • Review trapped and illiquid cash, to make more effective use of available cash that may be lying idle.
    • Review the capex strategy and consider leasehold / rental as an alternative, deferring significant capex outlays or releasing cash through sale and leaseback.
  4. Visibility and control over cash flows
  5. Aligning overall operational processes with strategic intent is key to driving working capital improvement.Some key best practices would be:

    • A rolling quarterly cash flow forecast on an expected receipts and payments basis
    • Conduct weekly variance analysis of cash flows, understanding the reasons for variation and undertake corrective action
    • Monitor cash flow related metrics: Track KPIs in order to critically measure performance and improvement across the organization. Common metrics include average inventory levels, order fill rates, inventory turnover, CCC Days (AR, Inventory & AP), back orders and capacity utilization, Return on Capital, Working Capital as a % of sales. Marginal improvements in KPIs can lead to significant improvements in overall cash flow.n
    • CCC Days (Cash Conversion Cycle) is a key measure of the Efficiency of Working Capital Management) and is computed as CCC = DSO (Days of Sales outstanding ie AR) + DOI (Days of Inventory) – DPO (Days of Payments outstanding ie AP). The lower the number of days, higher the cash flow.