What’s the biggest issue when it comes to working capital? It’s consistency, according to Gavin Swindell, Managing Director at REL Consulting.
Working capital is a consequence of a series of processes relating to a company’s suppliers, customers and internal operational processes, and involves managing inventories, accounts receivable (AR) and payable (AP), and cash. These processes do not vary greatly from quarter-to-quarter or even year-to-year, ie the client and supplier base remain relatively constant. But if working capital results are inconsistent when the processes are fundamentally stable, then this indicates a lack of control or management.
Working capital inconsistency partly stems from the fact that companies’ attitude and approach towards working capital can swing wildly, says Swindell. “Most of the time, companies allow working capital to inflate while they focus on cost or service drivers. Then the pendulum swings back, driven by changes in the economy, 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 simultaneously inflating again,” he says.
During the financial crisis between 2008 and 2010, Swindell observed that many companies took working capital more seriously because bank lending was reduced, but optimising internal processes was not as easy as they anticipated. As a result, today CFOs and treasurers tend to address the symptoms rather than the cause. “They want better cash flow forecasting,” explains Swindell, “which is in vogue. They say that they can’t predict their short-term cash needs. Obviously the operational spend on working capital is a big factor in those day-to-day cash demands. The fact that they want better cash forecasting tools implies that their working capital processes aren’t under control.”
This lack of consistency would clearly be unacceptable for most companies when managing costs and service, yet often it’s the standard operating procedure for working capital. “If companies truly want to achieve optimised global performance of the supply chain/service delivery model and the associated cost/service/cash equation, then a sustained, consistent and structured effort needs to be implemented to ensure functional alignment around the working capital policies in place and proper measurement of the relevant trade-offs,” he says.
Swindell believes that it will take top-level sponsorship to improve working capital because the discipline relies on a number of different business units that, in many respects, are judged on competing metrics. “For example, a purchasing department may be excellent in achieving a low price, but is it concerned about the terms it gives away or the quantity it needs to buy in order to achieve that price?” he asks. These terms may not suit other areas of the business. “It is a well-worn cliché, but no individual board member has the power to make a substantial difference on working capital. The whole board and the CEO need to collectively get behind working capital and make it a company priority if they want to see an improvement.”
When trying to achieve better working capital, companies are hampered by the way they are organised in silos by function. “Working capital can’t be solved by taking a functional approach – you can’t just give a target to a manager of a certain department. It has to be a cross-functional project with a cross-functional working party or process redesign,” argues Swindell. “Working capital oils the wheels of the business: the better the wheels – which are the functions – work together the less oil, or working capital, you need. But businesses find it very difficult. In my view this is the ultimate test as to how well a business is actually running.” Unless a company can achieve cohesiveness and functional alignment, it will always struggle with what constitutes best practice.
Best practice tools and techniques must be employed to ensure a scientific approach drives these parameters. For large global companies, best practice can be gleaned from internal high performers. “Companies should do an internal benchmark, which looks at where they are performing best,” Swindell suggests. “If a business unit, which doesn’t believe it can improve, sees another unit achieving 10% - 30% better results, then it begins to ask the right questions.” Companies should also perform external benchmark studies by looking at sector peers. External benchmarks do not have to be limited in scope to an obvious competitor, but can be a known company which is held in high esteem.
First published on www.treasurytoday.com