It’s clear why every company should optimise their working capital strategy. The question is how. The three essentials, says Ian Fleming, MD of HSBC Working Capital Advisory, are benchmarking, the smart use of data and the right finance tools.
The most effective businesses tend to excel in managing their working capital and perform better in their sector. We’re now seeing more companies combining a working capital initiative with a profit improvement agenda. Why? Because it’s not just about driving profit and loss, but is actually about delivering cash profit; about making sure the balance sheet improves as well. And, when a company needs to be fleet of foot for a tactical acquisition, for example, who wants to have to tell the board that the flexibility just isn’t there?
Optimising working capital is critical as a component of the overall return on invested capital, but it involves balancing trade-offs. It's the complexity; the fact that it touches so many parts of the business, which gives you the opportunity for significant improvement but also for internal inefficiency and conflict.
Look at the sales function, for example. It wants to make sure there are no stock-outs or service issues, that it achieves or even exceeds its sales targets. So, it may want to hold a higher inventory than is necessary and underplay potential credit issues. The treasury, on the other hand, is focused on liquidity management, cash flow forecast accuracy and facility constraints or covenants. They can contradict. To get these functions in line, you need to make sure your KPIs take working capital into account – from return on capital employed through to something as simple as networking capital as a proportion of sales. And those KPIs need to accommodate these functional trade-offs and percolate throughout the business.
There are actions that can be taken within the treasury or the finance function alone but we’re seeing a renewed focus and involvement in working capital management initiatives. Increasingly, the treasury doesn’t just aggregate information, but challenges it, and goes more deeply into business systems and processes.
So how do successful companies manage their working capital? Firstly they benchmark their performance against their sector and peer group; secondly, they get the right information and they’re then smart at using that data, and thirdly, they choose the best financial tools and use them wisely. Time and time again, the adage is proved true – what gets measured gets done.
Benchmarking – comparing your business with your peers, and your regions or divisions with each other – is an important starting point and not least because it very often takes the management of working capital from a tactical discussion to a strategic discussion, and that tends to get boardrooms interested.
There’s no secret to benchmarking – for publicly listed companies the information is already available to their various stakeholders. Companies can be ranked by their outstanding days payable, inventory and sales (DPO, DIO and DSO), together with their cash conversion days (CDD). At the time of writing, Kimberly-Clarke, for example, was ranked fourth in a sample of FMCG companies and Unilever were first. Between the two, there was a 19-day difference for DSO. What it tells us is that, if Kimberly-Clarke could improve their DSO to the level of Unilever's DSO – by multiplying their daily sales of £54m – they could generate additional free cashflow of over one billion dollars.
Gauging relative working capital efficiency says to the company Board that, by managing your working capital as effectively as the number one company, you can create free cashflow.
Of course, a benchmark only tells you what’s possible, not how to make it happen. Its value is in bringing up all those questions you need to answer – why is the business model different and how can we do things differently in our own organisation?
When you know how you compare and can set objectives for improving your working capital, the key is then knowledge. The right data, effectively collected, analysed and interpreted, is what underpins your forecasting, target-tracking, KPI evaluation and more. Without it, you can’t identify areas for improvement or do more of the things that work.
Data comes from many sources – customer relationship management, inventory and logistics systems, sales and operation planning, bank systems, credit and collections, ERP and the treasury management system. From my experience as a treasurer over the years and actually and supporting the implementation of shared service functions, I know that a lot of this data is available within shared service functions that are well served with people who understand how you process data quickly and well. They tend not to be so blessed with high quality analytics skills – the people who are bright at extracting and challenging the data, asking the right questions of the data and applying it to solving business issues beyond process efficiency.
So understanding where this data is within your business is one thing, but actually making sure that you've got the analytics to use it in the most effective way is very important.
At its simplest, improving working capital is nothing more than making sure that cash going out gets paid later and cash coming in arrives as soon as possible. That’s a scenario, however, that almost inevitably creates tension between buyers and suppliers. Choosing the right tools – both organisational and financial – can help you manage this in a way that maximises your cash efficiency and minimises conflict.
Organisationally, for managing payables, you might be considering harmonising payment terms, implementing improved purchase order control, settlement discounts or the timing of payment runs. Typical financial tools available include supply chain finance, purchasing cards or dynamic discounting. For managing receivables, opportunities for improvement might include more sophisticated credit risk management, order processing efficiencies, the introduction of eBilling or the offer of settlement discount, and the related tools might include receivables finance, securitisation, credit protection and documentary credits to improve risk management.
What’s clear, though, is that optimising working capital takes a blend of operational efficiencies and financial tools. And the payback can be substantial, with accelerated cashflow, reduced costs and the flexibility to grow.
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