Managing working capital of a business is very important. Regardless of what amount is invested in the fixed assets or infrastructure, how the liquid funds and working capital is managed will spell success or failure of the business. Many a businesses have lost because of wrong policies/inadequate policies in working capital management. The profitability of any business is directly proportionate to the better/effective usage of the working capital. Those who know this secret and who continuously mind this aspect in business are more successful. In this paper, I have adopted certain concepts and terminologies which are commonly in the western countries for the sake of easy understanding.
Working capital performance is comprised of a complicated set of interactions within the corporate framework that can be viewed through the lenses of Accounts Receivable, Accounts Payable and Inventory. Understanding these interactions, their performance drivers, and the affect on Working Capital requires accurate and timely information. With current performance data in hand, we may see that there is still room for improvement.
But how is this best achieved? Should we focus more on cash flow? Perhaps our inventory processes can be further optimized. Often the accuracy, depth, and timeliness of the information the organization can access could be improved.
Before starting, one key point needs to be made. This has to be driven from the top. The cross functional nature of a Working Capital improvement initiative is going to require a team effort. The following plan includes tips on who should be involved in the initiative.
Step 1: Define the initiative
It is important to view Working Capital performance improvement as strategic within the organization and understand that it is going to take a team effort involving members from several different areas and management levels within your organization. Starting with a plan to clearly define goals and the scope, will give you a greater chance of success for your initiative. In the plan, identify the teams and team players, steering committee members, objective of the initiative, scope of the initiative, and high level milestones. Also define any risks in the project along with the steps that will mitigate the risks. Return on investment should be fully quantified as well as the metrics that are going to be used to quantify the return.
It is important to have an executive in charge for a project such as this, as well as a steering committee. The steering committee should be comprised of high level managers from operations and finance. Areas that should be represented are Inventory, Purchasing, Manufacturing, Accounts Receivable, Sales, Accounts Payable, Information Technology and Finance/Treasury. The steering committee is invaluable in helping to implement process changes that otherwise might meet with resistance within the organization. The executive-in-charge should have enough authority to remove roadblocks anywhere in the affected areas of the business.
Make sure to define realistic objectives and scope so that you can achieve a significant impact within a few months. The team needs to stay energized by realizing results that are within reach in a fairly short period of time.
Step 2: Collect the required information
Understanding Working Capital performance starts with data. Information that is accurate and easy to use for analysis is critical in the assessment phase. Information feedback which provides a common view of targets and achievements across the enterprise is imperative in measurement and plays a key role in making sure process improvements stick. Information needs to serve all of the direct and indirect members of the team. The steering committee may want a collection of dashboards (giving out the performance measurements constantly) during the initiative to measure the effect on the business and verify that progress is being made. Departmental managers require informational dashboards and reports in order to track progress in areas of their responsibility. Business analysts will require analytic information to identify bottlenecks in the business and track business improvement initiatives. Sharing information increases the awareness of Working Capital performance and the impact each division and department has on performance. Empowering managers with information enables them to take an active role in the corporate improvement initiative.
Many of the key metrics commonly used in Working Capital management are provided at the end of this paper. These are just a starting point, to have a greater impact, create custom metrics to measure progress.
Make the information visible on a daily basis. Working Capital performance management is not a quarter-end activity, current performance information should be monitored regularly and the data should support real time decisions and corrective actions.
Step 3: Form a cross-functional team to identify strategies for improvement.
At first glance, effectively managing Working Capital seems simple:
Extend supply payments, Shorten the customer payment timeframes, Minimize inventory and Maximize inventory turns.
Unfortunately, things are not that simple - every action has a reaction. Extending payment terms to vendors without an overall strategy will probably result in higher prices for products they supply. How do you shorten customer payment timeframes without risking good relations; you may not be able to. Forcing inventory on your suppliers may result in higher prices as well. Innovation will involve people and processes throughout your organization, so you will need cross functional teams to work together to accomplish your goals.
Separate teams might be created to target specific areas for potential improvement. For example, a Credit and Collections team might target customer payments and credit processes. An Inventory team might be created to focus on improvement around inventory and sourcing. For improvements around Accounts Payable, a team might be put together involving Accounts Payable and sourcing. Define these teams in the project charter. Each team should have a clear set of directives and should understand what they are trying to achieve. These teams should be directed by the steering committee.
Put your teams to work to develop the right strategy. Following are some suggestions.
- Know your customers, how they pay and why
- Improve cash flow visibility by customer
- Analyze true (net) customer profitability
- Know your vendors
- Constantly evaluate vendor performance
- Associate costs with vendor performance
- Arm buyers with vendor performance data
- Communicate more with Customers and Suppliers
- Collaborate and share more information
- Publish vendor performance scorecards
- More communication decreases variability
- Evaluate Inventory Efficiency
- Understand inventory-turns down to the item level
- Understand relationships between inventory-turns, demand, and customer service requirements
- Implement lean processes and techniques
Step 4: Put your Initiative to work
Being able to put an initiative into motion and realize its benefits is a discipline and takes resources - people, processes, and information. Detailed project plans should be used to make sure that the project stays on track. An experienced project leader is also critical to the success of the initiative.
Step 5: Measure and Validate the Improvements against Standards set
As the initiative unfolds, it is important that you be able to measure success and validate that improvements are being made. To do this, you must have historical standard information so that you can measure impact of the initiative. Having a timeline of informational metrics is imperative. This information should be made available to all members of all teams so that they can see progress and feel good that their efforts are paying off. Share your success with the customers and vendors. This will encourage them to work more closely with you to improve their businesses as well. Dashboards are a great way to show progress and make them accessible to all members of the team. Additional motivation is inspired by progress and being part of a team that has made a difference.
Step 6: Adjust Project plan and Re-work
Every initiative will have room for improvement. Assume that this will be the case and use this step to analyze the issues to determine how it could be made better. Reflect this in the project charter and re-iterate steps 1-5. Commitment means doing this. For example, during the initiative, you may find out that not having a single version of a customer is hampering progress. Use this step to adjust the strategy and address the issue. Leverage your early success to justify the investment in the follow-on iterations of the project. View this as a performance improvement discipline which never ends. Continue to monitor and make adjustments to the process where necessary. In order to make sure your process improvements stick, continue to monitor and analyze the suggested metrics. Keep the improvement initiatives in the forefront of your managers' minds by distributing performance reports and dashboards. Tie compensation to continuous improvement of the key measurements. This will ensure that managers and employees stay motivated and contribute to the continued success of the initiative.
Metrics to be measured and watched:
Working capital performance metrics are powerful indicators on how well a company is managing Working Capital and managing the company overall. These metrics not only highlight the drivers of Working Capital, but also shed light on the dynamics of a supply chain. It shows how well a company manages their inventory, receivables and payables. There are many metrics that can shed light on how well a company is managing these three areas. In addition to custom metrics developed as part of your initiative, below are some of the metrics that a company might want to see in order to measure their success.
Cash Conversion Cycle (CCC) - DSO + DIO - DPO. A negative cash conversion cycle makes Working Capital a source of cash and highlights how well a company is being managed.
Days Sales Outstanding (DSO) - measures the time between the close of a sale and the collection of payment.
Days Inventory Outstanding (DIO) - measures the amount of time items stay in inventory.
Days Purchasing Outstanding (DPO) - measures the amount of time a company takes to pay their vendors.
Inventory Turns - measures how well inventory is managed and how the rate at which inventory turns over.
Open AP - amount of accounts payable that needs to be paid.
Open AR - amount of accounts receivable in which the cash has not yet been received from your customers.
Purchase lead-time - This is defined as the time period from placing the order to time by which the raw materials arrive at the store. This lead-time is use full in deciding upon the level for the reorder point.
Manufacturing lead-time - This is defined as the time taken by the manufacturing systems to finish the product. This time includes the process time taken at each workstation, and travel time between the workstation.
Delivery lead time / response time - This is the time period from receiving the order to dispatching the finished goods.
On-Time Customer Performance - the measure of how well you meet customer expectation of shipments from orders received by customers.
On-Time Vendor Performance - the measure of how well your vendors meet your expectations regarding delivery of raw materials and components.
Revenue - recognized sales.
Cost of Goods Sold - direct costs such as material costs, material overhead costs, outside processing costs, overhead costs and resource costs.
Gross Margins - (Revenue - COGS).
Net Margin - takes into account selling price minus cost of goods sold, freight, commissions, royalties, returns, rebates and other costs. Net Margin gives a clearer picture of profitability as compared to gross margins.
Cash Flow Projections - is often a rolling number of weeks (e.g. Rolling 13 weeks) that projects inflows and outflows of cash.
Spend - amount that a company purchases raw materials and components from a vendor.
Vendor Quality - defines the quality of raw materials and components that is delivered to a customer, sometimes measured in rejects as compared to accepted raw materials and components. |
