Improving working capital management - a $1.1 trillion opportunity
21 November 2016
Evolving global business trends, such as rapid technological advances and shifts in economic power from developed to emerging markets continue to present both risk and opportunities. In this environment, I believe companies must be nimble to take advantage while also responding to risk. Effective working capital management is an important lever in achieving a strong balance sheet, efficiently managing cash and capital, and enabling growth and resilience.
According to PwC’s 2015 Working Capital Survey, globally companies have the opportunity to free up as much as US$1.1 trillion from their balance sheets through improved working capital management. Such a change not only enables increases in cash flow, in my view it also helps pay down debt, reduces the cost of capital and unlocks cash which can be used to invest in growth.
Spotlight on Industrial Products
In my experience, working capital management is particularly important for Industrial Products (IP) firms, which typically incur substantial upfront costs for materials and labor and have longer production cycles than those in other sectors.
Although PwC’s research shows that working capital management is improving across most industries, Industrial Products companies have generally fallen behind other industries when it comes to making improvements. IP firms have been challenged by high capital consumption requirements to fund growth, extended global supply chains that increase inventories and complex organisational structures, which make it more difficult to influence working capital from a corporate level.
However, PwC’s research shows that there is a significant gap between top and bottom performers across IP sectors, suggesting that IP firms do have opportunities to improve performance.
The charts below illustrate average days inventory outstanding (DIO), days payable outstanding (DPO), and days sales outstanding (DSO) for global companies across four IP sectors. They show that from 2012 to 2015, the various sectors saw improvements in DPO of 7 days on average, but generally deteriorated in DIO and DSO, highlighting the opportunity to focus in these areas.
Typical barriers to working capital excellence
If change were easy to do many businesses would have done it already. There are many barriers which make it difficult for IP firms to achieve and maintain strong working capital performance. For instance there are natural tensions between many of the internal players i.e. Sales, Procurement, Finance and Manufacturing. These tensions could also be heightened by the requirements of external parties i.e. banks, rating agencies, customers and suppliers. The chart below highlights key concerns.
Potential steps to improve working capital performance
Before suggesting solutions, it’s important to remember that higher working capital is often a knock-on effect of other issues. For example, an upstream structural, policy, or process issue, can cause problems down the end to end process chain, leading to businesses carrying more working capital than necessary. Many aspects may be interconnected to cause this.
That said, top-tier performance requires thoughtful fixes, but also the right organisational structure and infrastructure to align and support the core processes. Pursuing a comprehensive, well-balanced approach can help drive success in this area.
So what steps, depending upon your circumstances, might you consider to achieve success?
- Align the organisation culture: incorporate financing alternatives to optimise the improvement effort, develop a ‘cash’ culture, clearly define policies, centralise policy setting and processes, and embed performance goals within incentive plans.
- Improve the supporting infrastructure: implement enabling technology, streamline the number of banking partners and accounts, develop and monitor KPIs, and consider financial market solutions such as trade finance and supply chain finance.
- Decrease receivables: redefine customer relationships, improve billing accuracy and process, proactively manage key receivables, and consider factoring and invoice discounting.
- Optimise payables: rationalise the number of and/or extend payment terms for different supplier tiers, improve vendor and contract management, adopt the right payment techniques and consider the trade-off of early payment discounts.
- Reduce inventory levels: improve manufacturing and inventory planning, rationalise products and SKUs.
In my experience, as well as the objectives and actions noted above there are a number of key success factors that should be followed by any change project in this area. These factors, although hard to execute, make achieving your destination more likely. They include:
- securing executive sponsorship for change
- thinking big, starting small and scaling fast (80/20)
- navigating the “many owners, yet no one accountable” dynamics
- recognising it’s not just a “finance” issue
- properly incentivising teams
- balancing benefits with costs
So there you have it – a comprehensive coordinated approach is best but even small improvements can add significant value. For example, for a company with US$10 billion in revenue and 15% gross margins, just a one day improvement could yield over US$50 million of incremental cash. A prize worth going for indeed!