What’s the biggest issue when it comes to working capital? Despite the fact that companies typically take too long to collect payment from customers; pay suppliers more quickly than they should; and hold far too much inventory, the underlying problem is much simpler – consistency.
Most business leaders understand that the key to working capital management is optimisation, not simply reduction. The right level of working capital should be defined by the business’s service delivery model. Customers must be satisfied, suppliers must stay in business and inventory must be available to meet orders and forecasts.
But at many companies, the attitude and approach towards working capital can swing wildly from year to year, or even from quarter to quarter. Companies often allow working capital to inflate while they focus on cost or service drivers. Then the pendulum swings back; driven by changes in the economy, the prevailing business environment or the end of the fiscal year. Suddenly cash becomes the priority, and companies begin to squeeze working capital for all it’s worth, usually focusing on quick fixes rather than making changes that will result in sustained improvements. Eventually, the status quo returns and working capital retreats into the background while simultaneously inflating again.
While this lack of consistency would clearly be unacceptable for most companies when managing costs and service, too often it’s the standard operating procedure for working capital. Few companies are able to optimise the cash variable or adjust their cost, service or cash balance easily without a major company initiative or project. The normal day-to-day functions are not usually able to self-adjust without some strong external force.
This is the narrative that supply chain management (SCM) firms often hear from numerous clients, and one that is confirmed by ‘The REL 1,000’, REL’s annual working capital survey of Europe’s 1,000 largest listed groups by sales. This survey continues to highlight, year after year, the inconsistent working capital performance by many companies across multiple industries. A separate survey of the 1,000 largest public companies in the US tells a similar story.
The recession was a driver for improvements, with the survey finding that since 2005 the constituent companies have improved their efficiency in converting working capital into revenue. However, most recently there are clear signs that their ability to maintain this improvement is faltering as companies revert back to normal habits.
In Europe, the REL 1000’s analysis of performance in key areas, including receivables, payables, inventory, debt, and cash on hand, shows that while these companies improved performance marginally in 2011, they still have about €886bn in excess working capital. This equates to about 9.4% per cent of EU gross domestic product (GDP).
REL’s research also reveals that companies are turning away from the strategy of hoarding cash – a practice that emerged at the start of the 2008-09 recession, and peaked in 2012 – and are increasing investment in anticipation of growth and reducing cash on hand. However, they are continuing to take advantage of low-cost loans, with the analysis highlighting an increase in debt levels.
Despite some minimal improvement in working capital performance, there hasn’t been any indication that companies can actually generate sustainable improvement in the key areas of receivables, payables, and inventory. Sixty-nine percent have not been able to maintain their working capital performance over a three-year period, without deteriorating by more than 5%.
With capital expenditure increasing, a real danger point is nearing. Due to low interest rates companies are going back to financing working capital, which means taking on more debt, more leverage and the whole cycle repeating itself. Clearly striking and maintaining the correct mathematical balance between cost/service and cash is easier said than done.
The Globalisation Challenge
The global nature of business only accentuates the problem. It’s hard enough for a national business or division to manage working capital with people centred in one place and operating in one language, with a single cultural background. But when you add in the dimension of globalisation, with shared services, centralised manufacturing plants, corporate purchasing objectives, local customer priorities and managers based in an array of countries – each with its own distinctive language, background and business norms – the challenge is simply too much to be effectively dealt with on a project or tactical basis.
If companies truly want to achieve optimised global performance of the supply chain/service delivery model and the associated cost, service and cash equation, then a sustained, consistent and structured effort needs to be implemented. This ensure that functional alignment around the working capital policies is in place and there is proper measurement of the relevant trade-offs.
Best practice tools and techniques must be employed to ensure that science, rather than experience, drives these parameters and the resulting performance levels. Plans need to be made and followed. Procedures need to be changed and then enforced. Cultural language obstacles need to be treated empathetically. Incentives should reflect business priorities only. Senior management must step up to the plate and let their staff know that working capital is a priority. All staff, including those at middle and more junior levels, should understand their roles and responsibilities in supporting working capital optimisation goals.
When it comes to optimising global business performance the devil is in the detail as it relates to thousands of customer orders, stock-keeping units (SKUs) and suppliers. But it’s still consistency that counts, and only a concerted effort by all staff throughout the organisation can make it happen.
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