Working capital as a barometer of efficiency

Properly implemented, working capital management is far more than just tuning receivables terms - it is THE efficiency meter in the company!

Working capital is a highly efficient barometer of a company's operational effectiveness and efficiency. The better the conditions, the better the company is able to concentrate on its core competencies.

The first simple attempts to maximize cash management date back to the early 1970s. But even today, 55 years later, there are still companies that are not able to recognize that "trapped" capital in the current assets of the balance sheet could be used more optimally to better stand up to competitors in daily competition. There are clear signs that awareness of optimization in this area has moved beyond the finance department and into the CEO's office. At least that's according to numerous studies by global management consultancies specializing in this area.

Approach

Working capital management consulting is not simply telling a company to get its debtors to pay as quickly as possible, to withhold money from suppliers for as long as possible and, last but not least, to minimize inventory turnover (measured in days). A properly understood and executed improvement program undoubtedly focuses on optimizing each of these components, but delivers additional benefits that go far beyond "mere" operational activities. It demonstrates the need for ambitious companies to integrate working capital management into their strategic and tactical thinking.

There are a number of important "dos" and "don'ts" to help guide business thinking. First, think of working capital management as a strategic objective that can enable your company's goals. This is an important step to consider. The same factors that influence a company's working capital also influence their operating costs and customer service performance. As a result, by incorporating the control components of working capital, it also experiences a significant improvement in operating costs and customer service.

This example illustrates how working capital is one of the best indicators of underlying inefficiencies within an organization. For this reason, it is extremely important that the management in charge focus on analyzing the original working capital issues in order to better manage their operating costs and remain competitive in the market. Some other ideas mentioned below can be more comprehensive to support success.

Working capital processes encompass the entire performance spectrum of a company, which can be imagined as a gearbox with three cogwheels, which in turn have numerous teeth and mesh with each other:

For example, a company's working capital deteriorates due to the increase in overdue receivables from its customers. If customers do not pay on time, there is usually a specific reason for this, which can often be interpreted as dissatisfaction. This raises the question of why customers are dissatisfied. An individual solution to the many individual open and silent customer complaints takes an average of 30 days. By questioning the cause of the dissatisfaction, it is possible to find out whether it is the pricing policy, the quality of the product or the customer service that leads the customer to take such action. This leads to less time being tied up by sales staff in order entry and accounts receivable and allows the people involved to focus more on their actual task - selling, processing orders and booking incoming payments. As a result, productivity increases, operating costs are reduced and sales are maximized. As a result, working capital is improved as customers have fewer reasons to withhold payment.

Look at things from a different perspective

Don't think about things only from the perspective of your own company. If you can help your own customers to plan their warehouses more efficiently, you can, for example, match your production with your customers' consumption extremely efficiently. Do this just as efficiently and cost-effectively with your own suppliers. The potential for optimizing warehouse stocks is huge. By adjusting the set-up, production and distribution processes, you increase the associated efficiency and achieve direct cost savings almost immediately as a side effect. Only then do you discuss the best way to achieve delivery conditions with your suppliers and customers. Teach your organization to take a holistic view of the trade-offs between the various wishes of your customers and suppliers. For example, depending on the consumption pattern of a commodity, it may be extremely attractive for both parties (you and the supplier) to set up a consignment stock on a brokerage basis in exchange for better payment terms. This could apply in particular to goods that take a long time to produce or require high minimum order quantities. The same criteria may apply to a customer. Would a supplier-controlled inventory for the customer side help you to match purchasing exactly to consumption and thus enable a better plan for production? It should be noted that this is not the solution for all products and should be evaluated on a case by case basis.

Agree formal delivery terms

Agree formal delivery conditions with suppliers and customers and document these very carefully. Always keep them up to date and ensure that all employees concerned are informed of these conditions without exception. Especially those who are responsible for purchasing, sales and administrative background work (e.g. accounts receivable/accounts payable). Do not allow a large-scale launch of a new product without a clear product supply management strategy. Whether you're in the consumer packaged goods industry or in the manufacturing of steel beams, in today's market, many companies are relying on new products to maintain market share and grow. However, poor supply management causes inefficiencies in the supply chain. It is also still very common to support old products with high inventories that can no longer be used for new products. This significantly increases operating costs and exposes the company to obsolete stock that needs to be disposed of. Have you ever calculated which is more expensive for you: losing a sale or holding a certain quantity of goods? (See also the tip: read our article "Supplier management".

Collect your money

Don't forget to collect your cash. Many companies implement effective and ongoing accounts receivable management systems to prevent excess and overdue capital or accumulation of old debtors. Ask customers if their invoices have been received and are free to pay. If not, flag the issues that are preventing timely payment. Confirm and reconfirm the credit terms agreed with the customer. Often credit terms get lost in translation of the general payment terms and what is in the master data of the accounts receivable general ledger. Dedicate the necessary time and attention to critically address customer complaints (silent and open). Record customer and supplier complaints in a formal manner. Debates with customers hold cash, reduce productivity and have a negative impact on service levels.

Do not set top-down targets equally for all business processes. For example, too many companies set a 10 percent reduction in working capital for each department. This can cripple potential optimization opportunities within a department and result in the setting of an impossible target. Last but not least, a blanket order can also be very demotivating for individual employees, as they see it as unfair because they themselves have always exceeded the targets. It is better to align a top-down strategy with an individual bottom-up strategy if goals are to be achieved.

Target drive behavior

Specify goals that guide the desired behavior. Many companies want to introduce incentive models to improve their customers' poor payment behavior of, for example, 60 days. Does this mean that customers who pay between 1 and 60 days late are good customers? No, outstanding debts of 60 days result in increased costs and time to collect the debt. By encouraging staff to reduce the number of 60-day days, your costs will be reduced. For example, a buyer may be rewarded based on the purchase price, but he has no interest in increasing inventory turnover by consciously including purchase quantities and frequency in his decision as a co-entrepreneur. Educate your staff, customers and suppliers who are relevantly responsible for the input and output of liquid funds and be an integral part of a successful business relationship.

Look inside yourself

Don't assume that all the answers can be found externally. Before involving existing customers and suppliers in negotiations to arrange payment terms, first fully understand your own payment processes. This will enable you to discuss poor payment processes credibly. Negotiate with suppliers the way you want your customers to negotiate with you. Far greater benefits from cash in circulation can be strategically realized through the leverage of your relationship with customers and suppliers than through an uncompromising stance. In addition, a supplier is more likely to support you in an emergency if you have treated them fairly (which does not mean softly). Likewise, a customer is more willing to forgive a mistake if you have formed a strong business relationship together. However, don't treat everyone the same. Use segmentation tactics to split your customers and suppliers into similar groups. This can be based on a basket of criteria including profitability, sales, outstanding size, overdue debt, average order size and frequency. Define strategies for each segment that is enhanced by the criteria and your strategic objectives. For example, you should minimize the management costs caused by customers with a small margin. You could achieve this by changing service levels and automating dependencies. Finally, allocate your resources according to the segment. The goal is to maximize value. Celebrate success when you achieve goals. Highlight the activities that helped you get there. Ask your people to remember how you achieved the goals while they are already in the following month or quarter. In short: be able to motivate yourself to surpass the achieved goal.

Summary

To summarize: the "dos" and "don'ts" allow you to optimize cash and highlight inefficiencies in your processes that need to be addressed to better serve customers. They allow you to build stronger partnerships with your suppliers across the entire working capital value chain. This ultimately results in improved bottom line results. Often much faster than you might expect and helps explain the focus of senior management on strategic directions.