Two Readings on Working Capital Management Keys To Successful Working Capital ManagementFrom the perspective of the Chief Financial Officer (CFO), the concept of working capital management is relativelystraightforward: to ensure that the organization is able to fund the difference between short-term assets and short-term liabilities. In practice, though, working capital management has become the Achilles heel of scores of financeorganizations, with many CFOs struggling to identify core working capital drivers and the appropriate level ofworking capital.As a result, companies can be limited in their ability to weather unforeseen or adverse events and ensure that cashis readily available where it is needed, regardless of the circumstances. By understanding the role and drivers ofworking capital management and taking steps to reach the "right" levels of working capital, companies can minimizerisk, effectively prepare for uncertainty and improve overall performance.Factors Influencing Working Capital PerformanceFor most CFOs, the greatest challenge with respect to working capital management is the need to understand andinfluence factors that are out of their direct control, in order to obtain a complete picture of the companys needs.The CFOs span of control can be limited in terms of functional silos, though corporate finance may well have somepowers of influence over operating units.While organizations generally concentrate on the right processes, such as cash, payables and their supply chain,they are less likely to take into account various internal and external constraints that can dictate how effectivelythose processes are executed. For example, the legal and business environments can have a significant impact onperformance. Similarly, internal considerations as such as organizational structure, shared systems, autonomousbusiness units, multinational operations and even information technology can impact working capital, creatingbarriers that can hinder a CFOs ability to truly understand, and therefore manage, the companys needs.The human factor is another important consideration. If management is focused purely on top-line growth,insufficient attention may be applied to cash flow management and forecasting. A hard-line focus on year-end orquarter-end results can produce a flattering, but inaccurate, picture of working capital performance and lead tocounter-productive behaviour. Consider the impact on working capital of a year-end sales push, where productionhas been building up inventory (which may not be the appropriate inventory) to meet this artificial demand and thequality of receivables deteriorates during the early part of the following year.While there is no magical solution for effecting robust working capital management, there are a number ofprerequisites for gaining control of the complex process.Cash Flow ForecastingProper cash flow forecasting is essential to successful working capital management. To do this effectively,organizations must take into account internal and external working capital drivers and consider the sensitivity ofthose drivers to changes in the business or market.Various questions need to be asked: How will unforeseen events impact working capital requirements? What if asudden market downturn or upturn occurs? What if the company loses a major customer? What happens if a majorcompetitor takes a significant action to improve its market position? Since each of these could have a sizable impacton the business, organizations must assume that the only certainty will be uncertainty, and prepare accordingly.in addition to assessing the cash flow impact of potential events, companies should consider the possibility ofhaving to make additional working capital investments. Thats because events could affect non-operational cashrequirements such as investments, credit ratings and the ability to service debt, as well as inventory, payables andreceivables.Companies must implement contingency plans that take a holistic view of the organization in the context of a varietyof different challenging situations. This will help minimize the adverse effects of unforeseen events and providefinancial flexibility in uncertain times by having working capital as a ready source of cash.How can you manage uncertainty? The three fundamental approaches are: control it, predict it, react to it. The mostsuccessful approaches are based around one approach, but contain elements of all three. Market-leadingcompanies, perhaps not surprisingly, are in the best position to manage uncertainty, often enjoying the ability tocontrol supply, minimize inventory and apply payment pressure on customers. Companies with less influence,however, must rely more heavily on a strategy of prediction. To properly prepare for events and improve or maintainperformance during times of uncertainty, organizations must develop an objective, business-driven view of the roleof working capital. Without real insight into true working capital drivers, a company may be able to produce areasonably good consolidated forecast, but find that accuracy drops considerably when it comes to producingdivisional, operating unit or even a product-line forecast.Beyond Balance Sheets
The most effective programs for both improving working capital performance and forecasting are those that lookbeyond the local organization and consider the broader corporate environment. Corporate investment and financingarrangements, for example, may provide for cash to be delivered by one location, but utilized at others. Restrictionson the repatriation of cash, internal inefficiencies in moving cash, delays driven by banks and sometimes-inadequate access to information can make the process problematic.Cash generated in one country, for example, many not have the same value to the organization as cash generatedin another. As a result, companies must plan global working capital improvement initiatives in the context of theultimate use for the cash, rather than simply managing local balance sheets.Improving Working Capital ManagementSuccessfully improving working capital management requires a multi-pronged approach. Companies must seekgranular detail to identify the underlying drivers of working capital. This requires separating perception from realityand pinpointing impediments to efficient cash flow, such as poor links between production and billing or clumsytreasury operations.Companies must also adopt an entrepreneurial mindset. They must act quickly to drive change by combiningoperational and financial skills, and expand their thinking beyond the finance organization to gain a more completeview of overall operations. Rather than wait for the perfect solution, they must identify and implement strategies thatresult in quick wins, generating short-term cash to fund longer-term projects.Having the right people in place can also make or break the effort. Companies need to identify individuals who canbe responsible for setting targets and performance levels and be held accountable for delivering. Theseprofessionals should be encouraged to challenge the status quo and drive change, using cross-functional teams.Measured ApproachFinally and this is where many projects fail, companies must remove emotion from the analysis process. Allinitiatives must be business-case driven, and projects without measurable results or those not contributing to overallgoals should be abandoned. Companies must agree on success criteria, prioritize based on contributions to thesecriteria and continuously measure performance.While working capital forecasting is critical to a companys ability to make informed strategic business decisions,many CFOs struggle with the process because of a lack of control and real insight into the underlying drivers of theirworking capital needs. By empowering the entire organization to understand the companys true working capitalneeds, companies can successfully reduce their financial risk, prepare for uncertainty and create a ready cashreserve that will provide flexibility and security during difficult times.This article was written by Andrew Harris, senior director, Alvarez & Marsal, and originallyappeared in Financial Executive Magazine. 11 Ways Companies May Improve Their Working Capital PositionWith interest rates continuing to rise, oil and commodity costs mounting and ever-increasing pressures from WallStreet to increase shareholder value, its surprising that some companies are not taking more measured steps todrive effective cash management and increase free cash flow.Working capital is a highly effective barometer of a companys operational and financial efficiency and effectiveness.The better its condition, the better positioned a company is to focus on developing its core business. By addressingthe drivers of working capital, in fact, a company is sure to reap significant operating cost and customer serviceimprovement.According to an analysis of financial results from the 2,000 largest companies in the U.S. and Europe performed in2005 by Hackett-REL, U.S. and European companies have reduced working capital by 12 percent and 17 percent,respectively, over the past three years. This strongly indicates that awareness of the benefits of working capital andcash management improvement has been elevated beyond the treasury to the office of the CEO.Excess CashBut while corporate profits may be soaring, corporations are still overlooking billions in cash a staggering $460billion in the U.S. and some $570 million (â‚¬469 million) in Europe. This enormous sum is literally stuck in transit, aresult of inefficient receivables, payables and inventory practices that could be reclaimed with relatively littleinvestment.Hackett-REL, which is part of The Hackett Group, a strategic advisory firm, calculates that in the U.S. alone, gettingthis excess under control would reduce total net debt by 29 percent, increase net profit up to 11 percent andimprove return on capital employed (ROCE) from 13.9 percent to 15.1 percent.Liberating the billions in cash trapped on the balance sheet is easier than one may think. Dell Inc., for instance alauded for overall strong corporate management and working capital performance builds a computer only when it
has received payment for an order, and doesnt pay its own suppliers for an agreed-upon period of time thereafter.As a result, Dell enjoys negative working capital and, the more it grows, the more its suppliers finance its growth.Not all companies can operate like Dell, but most can improve their working capital position by at least 20 percentover time if they pay attention to the following list of cash management dos and donts:1) Get educated. There is more to working capital management than simply forcing debtors to pay as quickly aspossible, delay paying suppliers as long as possible and keep stock levels as lean as possible. A properlyconceived and executed improvement program will certainly focus on optimizing each of these components, butalso, it will deliver additional benefits that extend far beyond operational rewards. All this underscores the need forambitious executives to integrate working capital management into their strategic and tactical thinking, rather thanview it as an extraneous added bonus.2) Institute dispute management protocols. Consider a case where a companys working capital isdeteriorating due to an increase in past-due accounts receivable (A/R). A review of the past-due A/R illustrates ahigh level of customer disputes, which are taking on average of 30 days to resolve and consuming significantamounts 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 eliminatethe disputes, thereby improving customer service. Established dispute-management protocols free up time forsales, order-entry and cash collections personnel to be more effective at their designated roles, and they also willincrease productivity, reduce operating costs and potentially boost sales. And finally, days payable outstanding(DPO) and working capital will improve, as customers wont have reason to hold payment.This example illustrates how working capital is one of the best indicators of underlying inefficiency within anorganization and why it is critical that senior executives remain focused on addressing the primary causes ofworking capital excesses to control operating costs and remain competitive.3) Facilitate collaborative customer management. One of the most important cash management andworking capital strategies that executives CFOs and treasurers, as well as CEOs can employ is to avoid thinkinglinearly and concerning themselves solely with their own companys needs. If it is feasible to collaborate withcustomers to help them plan their inventory requirements more efficiently, it may be possible to match yourproduction to their consumption, efficiently and cost-effectively, and replicate this collaboration with your suppliers.The resulting implications for inventory levels can be massive. By aligning ordering, production and distributionprocesses, companies can increase inherent efficiency and achieve direct cost savings almost instantly. At thispoint, payment terms can be most effectively negotiated.4) Educate personnel, customers and suppliers. A business imperative should be to educate staff toconsider the trade-offs between various 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 stockwith a supplier instead of pushing for extended terms - particularly in cases of long lead-time items or those thatrequire high minimum-order quantities.The same can hold true for customers. Would vendor-managed inventory at a customer site provide you the insightinto true usage to better plan your own production? It is important to remember, however, that this is not the solutionfor all products, and it should be evaluated on a case-by-case basis.5) Agree to formal terms with suppliers and customers and document carefully. This step cannot bestressed enough. Terms must be kept up to date and communicated to employees throughout the organization,especially to those involved in the customer-to-cash and purchase-to-pay processes; this includes your salesorganization.Avoid prolific new product introductions without first establishing a clear product-range management strategy.Whether in the consumer products or aluminium extrusions business, many companies rely heavily on newproducts to maintain and grow market share. However, poor product-range management creates inefficiency in thesupply chain, as companies must support old products with inventory and manufacturing capability. This increasesoperating costs and exposes the company to obsolete inventory.6) Dont forget to collect your cash. This may sound obvious, but many businesses fail to implement effectiveongoing collection procedures to prevent excess overdue funds or build-up of old debts. Customers should beasked if invoices have been received and are clear to pay and, if not, to identify the problems preventing timelypayment. Confirm and reconfirm the credit terms. Often, credit terms get lost in the translation of general paymentterms and whats on the payables ledger in front of the payables clerk.7) Steer clear of arbitrary top- down targets. Too many companies, for example, impose a 10 percentreduction in working capital for each division that fails to take into account the realistic reduction opportunities withineach division. This can result in goals that de-motivate employees by establishing impossible targets, creatingsevere unintended consequences. Instead, try to balance top-down with bottom-up intelligence when settingobjectives.8) Establish targets that foster desired behaviours. Many companies will incentivise collections staff tominimize A/R over 60 days outstanding when, in fact, they should reward those who collect A/R within the agreed-upon time period. After all, what would stop someone from delaying collections activities until after 60 days whenthey can expect to be rewarded? Likewise, a purchasing manager may be driven by the purchase price andrewarded for buying when prices are low, but this provides no incentive to manage lot sizes and order frequency tominimize inventory.
9) Do not assume all answers can be found externally. Before approaching existing customers andsuppliers to discuss cash management goals, fully understand your own process gaps so you can credibly discusspoor payment processes. Approximately 75 percent of the issues that impact cash flow are internally generated.10) Treat suppliers as you would like customers to treat you. Far greater cash flow benefits can berealized by strategically leveraging your relationship with suppliers and customers. A supplier is more likely tosupport you in the case of emergency if you have treated them fairly, and, likewise, a customer will be willing toforgive a mistake if you have a strong working relationship.That said, also realize that each customer is unique. Utilize segmentation tactics to split your customers andsuppliers into similar groups. For customers, segmentation may be based on criteria including, profitability, sales, A/R size, past-due debt, average order size and frequency. Once segmentation is complete, it is important to definestrategies for each segment based around the segmentation criteria and your strategic goals.For example, you should minimize the management cost for low-margin customers by changing service levels,automating interaction, etc. Finally, allocate your resources according to the segmentation, with the aim ofmaximizing value.11) Celebrate success in hitting targets. Emphasize the actions that helped you get there. Ask your peopleto remember what it felt like when they hit the target so they can motivate themselves to hit it again.SummaryFollowing these dos and donts will allow companies to optimize cash and highlight internal inefficiencies that mustbe remedied to better serve customers. Moreover, these cash management best practices will enable companies tobuild stronger partnerships with suppliers across the total working capital value chain ultimately, translating intoimproved bottom-line results.Source: W.B. Girmes & Company: M&A Resource Library . This article originally appeared ingtnews and was written by Andrew Ashby, President, Europe for The Hackett Group and Hackett-REL .