As experienced throughout the global COVID-19 pandemic, the resulting period of economic volatility, labour shortages, and supply chain disruptions impacted the Working Capital of many businesses by forcing them to retreat into survival mode and implement a moderately conservative strategy. Aside of fluctuating business recovery in the post COVID-19 era, there are now legitimate concerns with the forecast of difficult economic conditions in 2023, as highlighted by CreditorWatch in their recent snapshot Economic Update – October 2022.
The ability to effectively manage Working Capital is becoming even more difficult. As interest rates increase and the cost of credit rises, the pressure also increases on organisations to free up cash from their operations and even more urgency to better use Cash Management. Several other factors such as rising financing costs, persistent inflation, and high inventory levels are pushing organisations to improve how they manage and optimise their Working Capital.
However, with the Executive Team constant gaze and micro-management of the P&L Statement (Revenue and Expenses), there is another alternative to significantly impact your organisation’s ongoing profitability and financial sustainability. A part of a broader focus on improving asset efficiency and a cheaper alternative than relying on credit or external debt. This alternative is equally as important but perhaps less visible (think Balance Sheet!) and it simply revolves around Working Capital Management.
Current challenges to optimising Working Capital
Working Capital is a simple business concept. Many organisations face various internal challenges that prevents their ability to unlock access to more cash and the ‘free’ cash hidden within the Balance Sheet. Unfortunately, what is equally difficult to recognise is the conscious requirement for Working Capital improvement but also understand what steps are required to improve sustained cashflow.
Limited access to required information
- Many organisations do not possess the real-time data (and metrics) required to evaluate the effectiveness of their Working Capital strategy.
- Manual processes and the time / effort to consolidate data are cumbersome, inefficient, inaccurate, and imprecise efforts.
Lack of formal structure and stakeholders’ ownership
- Without a formal and concise structure, it will be extremely difficult to sustain any Working Capital improvement effort.
- Few organisations have a structured improvement program with clear stakeholders’ ownership across the organisation, or, worse still, they simply lack the key internal resources, capabilities, and tools to implement a Working Capital program.
Too many stakeholders and competing perspectives
- Functionally, Working Capital is widely distributed across many stakeholders (and layers) and therefore, can make it politically and emotionally difficult to implement a Working Capital improvement program.
- In an organisation, each stakeholder is likely to have a unique perspective on how to enhance Working Capital and the relevant priorities in their day-to-day activities.
Time constraints due to other business priorities
- Organisations struggle to focus on improving their Working Capital Management because of other conflicting priorities (and agendas).
- Working Capital optimisation is meaningless without initiatives to promote cross-functional collaboration, create greater awareness of Cash Management, and to change the mindsets of individuals who drive performance.
Best Practices for Working Capital Management
The optimisation of Working Capital Management represents a systematic challenge for many organisations, but it is a fundamental part of the overall corporate strategy. Working Capital Management requires ongoing stakeholder awareness, cross-functional collaboration, and consistent but standardised practices throughout the organisation – a holistic and comprehensive approach to determine where greater efficiencies and cost savings can be achieved.
Only a fraction of organisations applies ’best practices’ methodology in their pursuit of “cash-excellence”. Ideally, organisations that excel at Working Capital Management also excel in the continual search for improvement, with aspiring to the recognition of ‘best practices’ approach. Therefore, an effective Working Capital Management strategy is vital for an organisation’s survival.
Recognise Working Capital as a source of value
Working Capital is not a straightforward task, but many organisations have put into practice robust measures to improve Cash Management, Accounts Receivable, Accounts Payable, and Inventory Management. But expert guidance on what is ‘best practice’ is scarce, industry specific, and hard to visualise what is a common approach.
Despite these challenges, the financial benefits alone are worth the extra effort involved. With better management of Working Capital, this preserves cash and can provide a critical lifeline when the business faces significant trading and / or liquidity constraints. CFOs and Executive Teams must embed a “cash excellence” mindset throughout the whole organisation and build upon their Cash Management capabilities.
Internal research to build actionable planning
An effective Working Capital Management strategy is researching the current stability of an organisation, understanding who their customers are, identifying the target market for new customers, and planning for growth opportunities. Unless the Executive Team have a deep understanding of the organisation’s Key Performance Metrics (KPI’s and KRA’s) and alignment to their long-term strategic goals, they will not be able to prepare actionable planning (and strategy) to effectively manage Working Capital in the future.
Reduce potential impact on Customers, Suppliers, and Partners
Improving Working Capital Management can affect customers, suppliers, vendors, and partners. Building strong, transparent, and supportive external relationships is the key to flexible Working Capital policies but these must be mutually beneficial and can be readily adapted to normal business cycles. Organisations must look for methods to simplify processes and eliminate costs but being mindful of how these change initiatives may affect other areas in the value chain.
Conduct more cashflow forecasting analysis
Ongoing economic uncertainty and the difficulty for organisations with satisfying customer demand because of labour shortages and supply chain disruptions can potentially impact cash flow and Working Capital Management (over an extended period). Consideration must be given to the short-term or long-term impact and how that determination will affect cashflow estimates – what is important to note is that historical patterns may not materialise within a one (1) year period.
This means that Treasurers are developing forecasts in unprecedented circumstances. Cashflow monitoring must be conducted more frequently than in the past, but information should also be shared across your organisational silos through more co-ordinated communication, education, and collaboration. Sharing such information insight is vital to cashflow forecasting accuracy and proactively planning for fluctuations in Working Capital.
Gain more insights into your organisation’s Cash Conversion Cycle (CCC)
The Cash Conversion Cycle (CCC) is a Working Capital metric which measures how many days it takes an organisation to convert cash into inventory, and then back into cash via the sales process.
- Benchmarking! Explore your organisation’s Cash Conversion Cycle (CCC) measurement to your competitor’s model, or similar industry, or similar revenue size, or target ‘best practice’ organisations, by evaluating the trends and results.
- Measure your current Cash Conversion Cycle (CCC) v. previous cycles (inc. EOFY periods) to evaluate whether Working Capital is deteriorating or improving and determine whether the results are considered ‘normal’ or ‘not normal’, but relative to industry sector (and standards).
- This provides an indication of ‘Baseline Results’ for your organisation’s Cash Conversion Cycle (CCC) but a further opportunity to review your processes, align your approach, and then undertake improvements.
NOTE: The preference for any business will be striving for a lower value of the Cash Conversion Cycle (CCC) since the result indicates healthy Working Capital levels, positive cash-flows, liquidity, and profitability.
Identify areas of opportunity
The potential Working Capital improvement will eventuate but only with a solid understanding of the existing cash situation. This step will always require cross-functional collaboration across the organisation and to identify all opportunities, by assembling individuals (or teams) who are enthusiastic about leading change and with a history in Working Capital deliverables.
Cash Management
- Deliver efficiencies by centrally managing cash, funding, and foreign exchange for the whole organisation by not only helping reduce overall cash needs but also drive business behaviour and actions.
- Promote and engage ‘best practice’ in cash forecasting across the organisation, with regular education, follow-ups with subsidiaries, and escalation of inaccurate cash forecasts to build awareness (within each business function) as to how their work activities affect Cash Management performance.
Accounts Receivable
- Install rigorous collections and risk management by improving the processes to monitor collections, disputes management, reminders, track slippage with predictive metrics, and identify emerging trends from results.
- Provide constant reporting analysis back to Sales and Operations to tailor customer engagements and remediation action.
Accounts Payable
- Improve payment discipline by overhauling internal supplier payment authorisations (refer Authorisation Matrix) and processes.
- Improve the timing of supplier payments, lengthen supplier terms to navigate short-term gaps in cash flow and manage rebates to drive customer support (and growth).
Inventory Management
- Identify inventory reduction opportunities but without compromising on customer service levels or risking stock outages.
- Identify and rationalise underperforming SKU’s, stock cycle counts, slow moving stock lines, with robust Action Plans to focus on core products and simplify operational efficiency (including procurement and leverage of supplier relationships).
Prioritise areas of opportunity
Working Capital opportunities are ranked (by priority) and then create a Working Capital Roadmap, with actionable planning. This roadmap must support the company’s strategy and business objectives – actions that can be implemented immediately to preserve liquidity, while designing more complex longer-term initiatives in parallel.
Rapid Actions
- Will free up Working Capital and can be executed immediately without justification.
Discrete Actions
- Actions accomplished with minimal system or process changes, by “value driven” and backed with high-level analysis, but not an in-depth appraisal.
Complex Actions (Initiatives)
- These are initiatives that will be dependent on executing IT systems (ERP, SaaS, BI) and/or process changes.
- A ‘high-level and detailed’ analysis is required to validate the opportunities and then, who leads this team engagement.
Improve processes first, then automate with SaaS technology
Before technology can even be discussed as an option for improving Working Capital, organisations must put the right Change Management processes in place and embed cultural change. By initiating change to break down departmental silos, this allows for cross-functional processes to be unified, employees begin to “work smarter” and belief (with commitment) intensifies across the organisation.
Working Capital Management is a strategic process that addresses efficiency from multiple angles and key business segments. But unlocking Working Capital requires visibility and control from across the entire enterprise, which is gained from collaboration across teams and then implementing the right technologies (e.g. ERP, SaaS, BI) to enhance productivity. The undisputable fact is that advanced technology is essential to optimising Working Capital Management.
The option to implementing critical technology improvements should always be a viable alternative to doing nothing!
Undertake a Working Capital project
The Working Capital Roadmap is your guide to assign clear direction and ownership of your initiatives. Set up a compliance governance structure (track and monitor progress) as your success will be measured by the following four (4) items:
Engagement from Executive Team
- Ensure the Working Capital program is sponsored by the CFO and Executive Team, who function as ‘cash-excellence’ role models for your organisation.
Clear Tracking
- Use a Dashboard with simple but robust Key Performance Indicators (KPI’s) to make progress visible, keep your Executive Team and the whole organisation informed of progress.
- Ensure Key Performance Indicators (KPI’s) and other metrics are aligned with overall strategy, goals, and communicated across the organisation.
- Metrics may change year-to-year (?) as your strategy changes, but make sure your Key Performance Indicators (KPI’s) are specific to your industry and organisation.
AGILE Principles
- Embed AGILE principles across your key stakeholders, teams, and individuals to drive accountability with quick feedback to facilitate remediation action (if required) but to fast-track progress and alignment.
Realign Incentives Plan
- Align your Incentives Plan to include new Working Capital metrics to Managers, key stakeholders, and individual teams.
- This indicative focus beyond just the P&L Statement (Revenue, Expenses) and to provide transparency of the importance of Working Capital.
Alternative financing: Is it a viable option (or not)?
Supply chain financing can benefit customers and suppliers but if used in a responsible way. Facilities can be extremely attractive and have limits that change with the level of trading activity and of course with seasonal funding requirements. When used well, facilities help bridge the “funding gaps” that businesses must manage (where suppliers are paid in advance of sales being converted into customer collections or cash).
The same for invoice financing (debtor finance, cashflow finance, Accounts Receivable finance), which is another way businesses can improve their cash flow. While more businesses are using invoice financing to ’unlock cash’ from the value of their unpaid invoices to improve working capital, there is still a cost to be factored into the decision-making process.
This is about balancing “Risk” v. “Benefit” and because each organisation, industry sector, markets, and customer segments are vastly different – think ‘fit for purpose’ facility and therefore, not a one (1) size fit-all mentality.
Reduce cash leakage by challenging internal processes
Any financing may also be a risk. A facility should only be considered, BUT once a business has managed (and optimised) the efficiency of its Working Capital cycle, so that the requirement for the facility is clear, sizing justified, and ROI benefits are appropriate.
Supply chain finance or invoice finance will not solve issues associated with historically poor Working Capital Management! In fact, it can often exacerbate these issues and access to financing may typically decrease due to poor internal processes, results, and risk frameworks.
Executives and their Management Teams should challenge their own organisation (including key stakeholders, teams, individuals) and do their homework – firstly, to optimise the Working Capital cycles of their business, and secondly, implementing robust processes to drive not only responsibility but also accountability for delivering (v. target) Working Capital metrics. This helps to provide a clear understanding of the underlying gaps in Working Capital Management and clarity in terms of any residual “funding gaps” that may need financing.
Summary
Working Capital drives cashflow, and more cash means more flexibility for organisations with making smart business decisions to reduce capital needs and fund business growth regardless of their size, structure, and industry sector. Businesses that continually make decisions within their functional silos and not holistically across the entire organisation will frequently fail to optimise any Working Capital improvements.
The importance of ‘best practice’ in Working Capital Management is building a “cash-excellence” culture across the organisation. A strong disciplinary Working Capital initiative leads to instilling committed disciplines in operations and drives significant gains in resource productivity and profitable growth. This redirection by your Executive Team places a commitment on long-term business decisions and strengthening the awareness of a ‘cash culture’ across the organisation. Your Process Champions (and change agents) are selected to help build cross-functional collaboration and stakeholder management, but with a sustained focus on Change Management.
Are you ready to implement “best practice” in optimising Working Capital? Then, simply accept the Change challenge and commit to a unique rebuild of your Working Capital.
This article was a Guest Author contribution and collaboration with CreditorWatch.
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