Working capital optimization is increasingly becoming a key value creation item on a company board agenda – large and small businesses alike. However, many companies still underestimate the importance of working capital management as a lever for freeing up the cash that can be used in other productive endeavors.
This is especially important for the capital-intensive industries. Such companies still see high levels of inventory and payables while very low turnover on receivables, conditions that point to the need for improving working capital situation.
So, why do companies struggle to effectively manage this part of the business? Typically, as a company grows and its operations become more complex, managing the cash conversion cycle across multiple stakeholders can become a daunting task. Companies are often held back by several internal challenges that prevent them from efficiently managing the working capital.
A recent case provides some insights into the typical challenges.This mid-sized manufacturing company had both the working capital and EBITDA been gradually deteriorating – inventory doubling over the period, struggle to collect receivables on time, while vendor payments not in line with the cash cycle. In addition, the data quality was a big bottleneck for any kind of analytics. There was no formal structure to manage working capital, nor could we see any robust collaboration among the stakeholders (procurement, finance, stores, production etc.) or an executive mandate.
In our experience, typical challenges can be categorized as –
- Governance/ Process Related Challenges
- Lack of real-time data and metrics needed to evaluate the effectiveness of working capital and improvements.
- Lack of a formal structure for working capital improvement efforts.
- Distributed stakeholders across inventory management, customer receivables and vendor payables, with different perspectives on how to enhance working capital.
- Time constraints that limit the focus on optimizing working capital because of other competing priorities.
- Account payables – High stock carrying cost, purchase quantities not geared to demand forecasts, proliferation in payment terms etc.
- Account Receivables – Inefficient billing processes leading to delayed or incorrect invoices, informal credit practices, undefined credit limits across customers etc.
- Inventory Management – Low inventory turns, poor scheduling & production processes, lack of visibility into inventory levels, obsolete inventory & write-offs etc.
- Inaccurate Sales, Inventory and Operations Planning (SIOP) – Increased demand volatility and shorter product lifecycles challenges manufacturers everywhere, yet the SIOP at many firms is not updated accordingly and is often out of date.
Core Operational Challenges
These challenges however can be tackled effectively by creating a focused Working Capital Optimization Plan. As a key stakeholder for working capital, the CFO is very often and primarily positioned to do the strategic visioning and lead a working capital optimization effort. Establishing the right infrastructure in support of working capital improvement is critical to the success of the program.
Here are some steps companies can take to implement and support a sustainable working capital optimization program –
STEP 1– Setup right processes and governance structure
- Mandate and communicate – an effective working capital optimization program should start with a mandate from the top – CEO and CFO.
- Collaborate and coordinate across the organization to set the goal of improving working capital into various systems, analytics, and performance metrics.
- Identify optimization levers and use them consistently, for example a more efficient inventory management etc.
- Measure effectiveness with metrics used as a constant feedback mechanism.
- Align incentives with improvement to sustain working capital improvements.
STEP 2– Fix core operational issues and monitor KPIs rigorously
- Take a holistic approach to enable better understanding of individual components of working capital.
- Establish a centralized and aggregated system in real time to enable effective cost optimization and risk management.
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