Unlocking Working Capital Can Be Key To Improved Financial Performance: Strategies To Consider

As companies vie for position and competitive advantages in an increasingly complex global financial environment, how efficiently working capital is managed takes on even greater significance.

Every dollar locked up in working capital bogs down a corporation’s financial performance. If capital is locked in the supply chain, or receivables/payables are not being managed effectively, a company is unable to use its cash flows to its best advantage. This could result in higher capital expenditures or the need to turn to the equity or debt markets to supplement cash flow.

However, once working capital is unlocked, every dollar can support investment and value creation for the present and future.

Adding Value to the Treasurer’s Role

In the past, corporate treasury served as a support center for a company’s business units. The treasurer’s responsibilities usually included overseeing payments and collections, making cash flow decisions to ensure daily liquidity, and gathering and analyzing financial information to support these efforts through activities like cash forecasting. But in recent years, treasurers have begun to play a more strategic role.

“One of the toughest challenges facing treasurers today is getting control of global cash,” notes Michael Golden, Senior Vice President of Global Liquidity Management at Bank of America. “However, the ability to control cash and maximize its use will enable the treasurer to assume a more value-added role within the corporation.”

Current Business Climate Raises Stakes

Numerous factors are forcing corporate treasurers to optimize their working capital and cost-effectively fund vital business requirements. One of the leading impetuses for corporate treasury to work at its highest possible level is an economy that has eroded revenue and put a greater focus on improving efficiency to maintain profitability. Global competition, global market volatilities and the demand for increased shareholder value also are dictating optimal working capital processes.

What’s more, as traditional external funding sources become less available and more expensive, organizations are being forced to find alternatives to debt, which include mobilizing internal liquidity to maximize yields and lower funding costs. Finally, high-profile corporate governance mandates are driving treasurers to get a clear picture of enterprise-wide cash positions, both to mitigate risk and ensure that they have the ability to meet current obligations.

As some treasurers already have discovered, maximizing the use of capital resources has allowed them to recapture significant amounts of money that can now go toward research and development, acquisitions, share buybacks, paying down debt and even dividend raising. Working capital management is an untapped treasure-trove for increasing shareholder value and improving the bottom line. Here are some suggestions how to achieve these goals.

Obtain and Manage Information More Effectively

“Getting accurate, real-time information and finding out where liquidity is are vital to the treasurer’s ability to maximize working capital,” states Golden. This is why treasury workstations interfaced with Enterprise Resource Planning (ERP) systems and their bank provider systems are some of the most powerful tools available to treasurers. ERP provides real-time financial information from every functional department within a corporation. Market subscriptions and websites also give treasury personnel access to almost any data that affect their company’s operations. Other treasury technology helps to gather, consolidate and report some of this critical information.

The real key, however, is to garner financial value from this influx of information, and use it to measure the cost of each financial decision. Treasurers need to have analytical tools to automatically sift through all this data and provide them with precise strategic information and costs. Without these tools, expenditures on information and data systems are worthless.

Many treasurers also are integrating their ERP systems with internal systems, such as treasury workstations, as well as with their banks and other key external partners to develop straight-through processes. By doing so, they enjoy the added benefit of improved cash-flow forecasting, both a key driver to achieving precise working capital management and reaching treasury objectives.

Improve Working Capital Processes Before a Crisis Arises

For many corporations and treasurers, working capital management has been viewed as a strategic priority. It is sometimes ignored in favor of other seemingly more urgent or high-profile tasks, such as mergers, acquisitions, divestitures or new product launches. Yet, by waiting for a crisis to occur before concentrating on working capital or scrambling to raise cash, treasurers can jeopardize their corporation’s financial stability. In fact, treasurers should consider which everyday tasks can be outsourced, so they can concentrate on freeing up cash.

Make Working Capital a Company-Wide Priority

Managing working capital can be a daunting task for treasurers to handle alone. “There has to be senior leadership buy-in, as well as agreement throughout the whole organization that (controlling cash) will be a priority,” says Golden. In fact, the quality of a company’s products or services, how quickly they’re delivered and the level of customer service all impact working capital. For working capital management initiatives to be successful, they must extend to the sales force, the purchasing department, production facilities, and even accounts payable and receivable.

Contact Customers Before Payments Become Overdue

One way to improve receivables payments and customer service levels is to categorize customers according to the value of their business and focus collections on those who owe the most. By contacting those customers who generate the majority of receivables before, and not after their payment due dates, companies can immediately address any problems that could delay payment.

Have a System in Place for Handling Disputes

Companies with strong working capital performance have a dispute management process in place that assigns resolution responsibilities to specific individuals. When disputes remain unresolved beyond a pre-determined time limit, they usually become the responsibility of senior staff. It’s a proactive way of doing business, and it’s a proven method for improving receivables.

Consider Obtaining Supplier Discounts for Early Payment

Although many companies negotiate extended payment terms from their suppliers when cash flows are tight, it could be just as valuable and profitable over the long run to negotiate discounts for making early payments. In fact, companies that rely on payment term extensions time and time again may find that the costs of their goods and services eventually increase to cover the expense of those extensions. What’s more, competitors who pay promptly may be enjoying discounts and other cost concessions that could be difficult to undercut.

Try To Balance Inventory with Customer Needs

While some customers may need goods for next-day or same-day delivery, others are willing to wait a week or more to receive shipment. Still others may be satisfied to receive a portion of their order the next day and the rest in a week or two. It pays to talk to customers to determine their specific needs. Rather than trying to have all orders delivered in full from inventory in one shipment, companies can stagger shipments to free up cash, floor space and operating expenses that result from excessive inventory. Many of the companies successful at managing working capital are the best at predicting demands on inventory.

Get an Accurate Measure of Days Sales Outstanding (DSO)

The best way to gauge how much cash is flowing into a corporation is to measure the DSO, which is total receivables divided by total credit sales for the period, multiplied by the days in that period. Presumably, the lower the DSO, the faster a company is converting receivables into cash. However, that isn’t necessarily the case. A DSO can be low because a company is issuing credit notes to clear disputed items — a practice that doesn’t generate additional cash.

To get a more accurate measure, compare the actual DSO, as described above, with the best possible DSO (the DSO that could be achieved if all customers paid at their exact payment terms). For example, if all sales were made at 30-day terms, the best possible DSO would be 30. The true performance measure is the difference between best possible DSO and actual DSO. Measure it and break it down into three components: disputed debt, bad debt and delinquent debt — and then address the problems that have created those debts.

Fine Tune Receivables, Payables and Inventory

Any working capital management initiative should include immediate action to improve all three areas in an organization: revenue management (receivables), supply chain management (inventory), and expenditure management (payables). A strategy that encompasses all three will prove to be the most rewarding. For example, recent studies show that large multinationals have improvement potentials in the range of several hundred million dollars. At the P&L level, returns on investment can be as high as 10 times.

Choose the Right Financial Partner

Golden feels that “liquidity management is a key component of working capital management.” What’s more, he firmly believes that “liquidity management structure and solutions need to be tailored for every business.” When choosing a bank provider, make sure they have the tools, techniques, capabilities and consultative approach to devise the appropriate solution for you.

This article appeared in September 2003. (BA)

About The Author John Manzella [Full Bio]

John Manzella, founder of the Manzella Report, is a world-recognized speaker, author of several books, and an international columnist on global business, trade policy, labor, and the latest economic trends. His valuable insight, analysis and strategic direction have been vital to many of the world's largest corporations, associations and universities preparing for the business, economic and political challenges ahead.




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