Working capital is a highly effective barometer of a company’s operational and financial efficiency and effectiveness. The better its condition, the better positioned a company is to focus on developing its core business. By addressing the drivers of working capital, in fact, a company is sure to reap significant operating costs and customer service improvement.
Liberating the billions in cash trapped on the balance sheet is easier than one may think. Dell Inc., for instance, lauded for overall strong corporate management and working capital performance builds a computer only when it has received payment for an order, and doesn’t pay its own suppliers for an agreed-upon period of time thereafter. As a result, Dell enjoys negative working capital and, the more it grows, the more its suppliers finance its growth.
Not all companies can operate like Dell, but most can improve their working capital position by at least 20 percent over time if they pay attention to the following list of cash management do’s and don’ts:
(1) Get educated. There is more to working capital management than simply forcing debtors to pay as quickly as possible, delay paying suppliers as long as possible, and keep stock levels as low as possible. A properly conceived and executed improvement program will certainly focus on optimizing each of these components, but also, it will deliver additional benefits that extend far beyond operational rewards. All this underscores the need for ambitious executives to integrate working capital management into their strategic and tactical thinking, rather than view it as an extraneous added bonus.
(2) Institute dispute management protocols. Consider a case where a company’s working capital is deteriorating due to an increase in past-due accounts receivable (A/R). A review of the past-due A/R illustrates a high level of customer disputes, which are taking an average of 30 days to resolve and consuming significant amounts of sales, order-entry, and cash collectors’ time.
(3) Facilitate collaborative customer management. One of the most important cash management and working capital strategies that executives CFOs and treasurers, as well as CEOs can employ is to avoid thinking linearly and concerning themselves solely with their own company’s needs. If it is feasible to collaborate with customers to help them plan their inventory requirements more efficiently, it may be possible to match your production to their consumption, efficiently and cost-effectively, and replicate this collaboration with your suppliers.
(4) Educate personnel, customers, and suppliers. A business imperative should be to educate staff to consider the trade-offs between various working capital assets when negotiating with customers and suppliers. Depending on the usage pattern of raw material, there may be more to gain from negotiating consignment stock with a supplier instead of pushing for extended terms – particularly in cases of long lead-time items or those that require high minimum order quantities.
(5) Agree to formal terms with suppliers and customers and document carefully. This step cannot be stressed enough. Terms must be kept up to date and communicated to employees throughout the organization, especially to those involved in the customer-to-cash and purchase-to-pay processes; this includes your sales organization.
(6) Don’t forget to collect your cash. This may sound obvious, but many businesses fail to implement effective ongoing collection procedures to prevent excess overdue funds or build-up of old debts. Customers should be asked if invoices have been received and are clear to pay and, if not, to identify the problems preventing timely payment. Confirm and reconfirm the credit terms. Often, credit terms get lost in the translation of general payment terms and what’s on the payables ledger in front of the payables clerk.
(7) Steer clear of arbitrary top-down targets. Many companies, for example, impose a 10 percent reduction in working capital for each division that fails to take into account the realistic reduction opportunities within each division. This can result in goals that de-motivate employees by establishing impossible targets, creating severe unintended consequences. Instead, try to balance top-down with bottom-up intelligence when setting objectives.
(8) Establish targets that foster desired behaviors. Many companies will incentivize collections staff to minimize A/R over 60 days outstanding when, in fact, they should reward those who collect A/R within the agreed-upon time period. After all, what would stop someone from delaying collections activities until after 60 days when they can expect to be rewarded? Likewise, a purchasing manager may be driven by the purchase price and rewarded for buying when prices are low, but this provides no incentive to manage lot sizes and order frequency to minimize inventory.
(9) Do not assume all answers can be found externally. Before approaching existing customers and suppliers to discuss cash management goals, fully understand your own process gaps so you can credibly discuss poor payment processes. Approximately 75 percent of the issues that impact cash flow are internally generated.
(10) Treat suppliers as you would like customers to treat you. Far greater cash flow benefits can be realized by strategically leveraging your relationship with suppliers and customers. A supplier is more likely to support you in the case of an emergency if you have treated them fairly, and, likewise, a customer will be willing to forgive a mistake if you have a strong working relationship.