With the pervading uncertainty regarding the future market scenario, companies are concerned about their liquidity position, not only funds needed for planned capital expenditure and growth, but also those required to drive operational improvement programs. With external avenues of easy funds drying up, the companies have to reassess how they have currently deployed capital in their operations. By increasing the productivity of their working capital, companies can better manage the economic storms that blow their way.
The immediate reaction to this problem is by aggressively collecting receivables, ruthlessly suppressing payment to suppliers, and cutting inventory across the board. But, a more effective approach is to rethink the business model, and streamline key processes across the value chain. Receivables and payables are different ways of financing inventory. Companies need to manage all three simultaneously across the value chain to drive fundamental reductions in asset level. The key is to uncover the underlying causes of excess working capital across the value chain. Companies should concentrate on the most promising actions that won’t impair flexibility and performance. This can lead to a much greater reduction in working capital; as much as 30% to 40% and cost savings of 5% to 10%.
Excess inventories are one of the most overlooked sources of cash, typically accounting for almost half the savings from working capital management. High inventories in an organisation could be symptomatic of poor sales processes, poor logistics planning, poor production planning, weak procurement process or a supplier delivery problem.
A company had 78 stocking locations, because the sales team believed that they must have inventory next to their office for them to be able to sell. In reality, the customers could potentially be served from just three mother warehouses. This reduced inventories by over 50% while significantly improving customer service levels.
A company had over 60 days WIP and FG inventories in the plant. It turned out that workers on one group of machines did changeovers only at the start of the shift, as that maximised production, and their performance bonus was linked to production. This created significant inventories at the next stage of production, and led to FIFO practice at the next stage, resulting in high finished goods inventory.
In a company, all SAP orders with multiple line items from multiple sources were booked as due for delivery the very next day, to ensure that the order get ahead in the queue for bottleneck components. The unintended consequence was that all non-bottleneck components got immediately delivered, invoiced and paid, while critical components were invariably delivered late, leading to significant WIP inventories and high cash-to-cash cycles. At another company the procurement function’s eagerness to lock in commodity prices led to six months of raw materials inventory, as well as value write-offs due to a sharp drop in commodity prices.
Excess inventories typically arise due to inability of many companies to successfully streamline cross-enterprise processes, as well as processes across customers and suppliers. Information visibility across the supply chain can lead to significant inventory reduction. An automotive spare parts company’s inventory turns went up from 6 turns to 32, once the company could gain visibility of stock of its channel partners, and suppliers, and automated the aggregation and order placement on suppliers. A truck manufacturer’s steel inventories dropped by 30%, once they could provide requirement visibility and gain stock visibility with their steel mills, service centers and stampers.
Postponed differentiation can lead to significant inventory reduction. This requires shifting the fulcrum between the push part of the supply chain and the pull part of the supply chain. Customer forecasts are critical to achieve savings in raw material inventories by redefining optimal safety-stock levels and batch sizes. This requires understanding of demand patterns, forecast quality, production throughput, supplier lead time and variability. For example, suppliers to big box retailers have to rely on their understanding of likely end-customer demand, and their assessment of forecast quality of retailers to place raw material orders, to ensure that they are able to meet likely orders, while optimising working capital.
Many companies are early payers and late collectors, a recipe for squandering working capital. Other companies have problems of mismatch in timing between incurred costs and receipt of customer payments. Many companies in India struggle with reconciliation of customer accounts. Their inability to properly square off part-payments against specific invoice line items, or account for customer non-payments due to quality or other issues in their IT systems leads to permanently non reconciled accounts. This invariably leads to huge receivables problems, as companies tend to loose history when key people move due to transfers or attrition. Many customers and channel partners of such companies have perfected this strategy to ensure that they get much higher credit than they otherwise deserve. The other challenge is to ensure that the credit limit discipline sticks. Companies need to continuously benchmark their performance against the rest of the industry, and ensure that the process discipline in accounts, collections and credit control are adhered to.
If fast paying companies are at one end of the spectrum, then companies that “lean on the trade” and use unpaid payables as a source of financing are at the other end. In between these two extremes is a more effective, integrated approach to payment renegotiations. Companies should benchmark payment terms and conditions, against industry best practices, and eliminate early payments except when attractive discounts are offered.
A quick benchmarking of working capital needs can quickly illustrate the quantum of value that is locked with in. Here are five principles that are critical for success of any working capital reduction:
1: All hands on deck, everyone needs to row
2: There’s no silver bullet, it’s every little thing that counts
3: Go back to basics, understand both what and why of operations
4: Re-evaluate everything because assumptions may have long changed
5: Rigor in approach and ruthlessness in execution
Done right, working capital management generates more cash for growth along with streamlined processes and lower costs. But, getting to it requires a diligent, no nonsense approach to ensure quick results without compromising long term value.