Two Readings on
Working Capital Management
Keys To Successful Working Capital
From the perspective of the Chief Financial Offic er (CFO), the concept of working capital
management is relatively straightforward: to ensure that the organization is able to fund the
differenc e bet ween short-term assets and short-term liabilities. In practice, though, working
capital management has become the Achilles' heel of scores of finance organizations, with many
CFOs struggling to identify core working capital drivers and the appropriate level of working
As a result, companies can be limited in their ability to weather unforeseen or adverse events and
ensure that cas h is readily available where it is needed, regardless of the circumstances. By
understanding the role and drivers of working capital management and taking steps to reach the
"right" levels of working capital, companies can minimize risk, effectively prepare for uncert ainty
and improve overall performance.
Factors Influencing Working Ca pital Performance
For most CFOs, the greatest challenge with respect to working capital management is the need
to understand and influence factors that are out of their direct cont rol, in order to obtain a
complete picture of the company's needs. The CFO's span of cont rol can be limited in terms of
functional silos, though corporate finance may well have s ome powers of influence over operating
While organizations generally concent rate on the right processes, such as cash, payables and
their supply chain, they are less likely to take into account various internal and external
constraints that can dictate how effectively those processes are executed. For example, the legal
and business environments can have a significant impact on performance. Simil arly, internal
considerations as such as organizational structure, shared systems, autonomous business units,
multinational operations and even information technology can impact working c apital, creating
barriers that can hinder a CFO's ability to truly understand, and therefore manage, the company 's
The human factor is another important consideration. If management is foc used purely on top -line
growth, insufficient attention may be applied to cash flow management and forecasting. A hard -
line focus on year-end or quarter-end res ults can produce a flattering, but inaccurat e, picture of
working capital performance and lead to counter-productive behaviour. Consider the impact on
working capital of a year-end sales push, where production has been building up inventory (which
may not be the appropriate inventory) to meet this artificial demand and the quality of receivables
deteriorates during the early part of the following year.
While there is no magical solution for effecting robust working capital m anagement, there are a
number of prerequisites for gaining control of the complex process.
Cash Flow Forecasting
Proper cash flow forecasting is essential to successful working capital management. To do this
effectively, organizations must take into account internal and external working capital drivers and
consider the sensitivity of those drivers to changes in the business or market.
Various questions need to be asked: How will unforeseen events impact working capital
requirements? What if a sudden market downturn or upturn occurs? What if the c ompany loses a
major customer? What happens if a major competitor takes a significant action to improve its
market position? Since each of these could have a sizable impact on the business, organizations
must assume that the only certainty will be uncertainty, and prepare accordingly.
in addition to assessing the cash flow impact of potential events, companies should consider the
possibility of having to make additional working capital investments. That's beca use events could
affect non-operational cash requirements such as investments, credit ratings and the ability to
service debt, as well as invent ory, payables and receivables.
Companies must implement contingency plans that take a holistic view of the org anization in the
context of a variety of different challenging situations. This will help minimize the advers e effects
of unfores een events and provide financial flexibility in uncert ain times by having working capital
as a ready source of cash.
How can you manage uncert ainty? The three fundament al approaches are: control it, predict it,
react to it. The most successful approac hes are based around one approach, but contain
elements of all three. Market-leading companies, perhaps not surprisingly, are in the best position
to manage uncertainty, often enjoying the ability to control supply, minimize invent ory and apply
payment pressure on customers. Companies with less influenc e, however, must rely more heavily
on a strategy of prediction. To properly prepare for events and improve or maint ain performance
during times of uncertainty, organizations must develop an objective, business -driven view of the
role of working capital. Without real insight into true working capital drivers, a company may be
able to produce a reasonably good consolidat ed forec ast, but find that accuracy drops
considerably when it comes to producing divisional, operating unit or even a product -line forecast.
Beyond Balance Sheets
The most effective programs for both improving working capital performance and forecasting are
those that look beyond the local organization and consider the broader corporate environment.
Corporate investment and financing arrangements, for example, may provide for cash to be
delivered by one location, but utilized at others. Restrictions on the repatriation of cash, internal
inefficiencies in moving cash, delays driven by banks and sometimes -inadequate access to
information can mak e the process problematic.
Cash generated in one count ry, for example, many not have the same value to the organization
as cash generated in another. As a result, companies must plan global working capital
improvement initiatives in the context of the ultimate us e for the cash, rather than simply
managing local balance sheets.
Improving Working Capital Management
Successfully improving working capit al management requires a multi -pronged approac h.
Companies must seek granular detail to identify the underlying drivers of working capital. This
requires separating perception from re ality and pinpointing impediments to efficient cash flow,
such as poor links bet ween production and billing or clumsy treasury operations.
Companies must also adopt an ent repreneurial mindset. They must act quickly to drive change by
combining operational and financial skills, and expand their thinking beyond the finance
organization to gain a more complete view of overall operations. Rather than wait for the perfect
solution, they must identify and implement strategies that result in quick wins, generati ng short-
term cash to fund longer-term projects.
Having the right people in place can also make or break the effort. Companies need to identify
individuals who can be res ponsible for setting targets and performance levels and be held
accountable for deli vering. These professionals should be encouraged to challenge the status
quo and drive change, using cross-functional teams.
Finally and this is where many projects fail, companies must remove emotion from the analysis
process. All initiatives must be business-case driven, and projects without measurable results or
those not contributing to overall goals should be abandoned. Companies must agree on success
criteria, prioritize based on contributions to these criteria and continuously measure performance.
While working capital forecasting is critical to a company's ability to make informed strategic
business decisions, many CFOs struggle with the process because of a lack of control and real
insight into the underlying drivers of their working capital needs. By empowering the entire
organization to understand the company's true working capital needs, companies can
successfully reduce their financial risk, prepare for uncertainty and create a ready cash reserve
that will provide flexibility and security during difficult times.
This article was written by Andrew Harri s, senior director, Alvarez & Marsal, and originally
appeared in Financial Executive Magazine.
11 Ways Companies May Improve Their
Working Capital Position
With interest rates continuing to rise, oil and commodity costs mounting and ever-increasing
pressures from Wall Street to increase shareholder value, it's surprising that some companies are
not taking more measured steps to drive effective cash management and increase free cash flow.
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 cost and customer service improvement.
According to an analysis of financial results from the 2, 000 largest companies in the U.S. and
Europe performed in 2005 by Hackett-REL, U.S. and European companies have reduced working
capital by 12 perc ent and 17 percent, respectively, over the past three years. This strongly
indicates that awareness of the benefits of working capital and cash management improvement
has been elevat ed beyond the treasury to the office of the CEO.
Exce ss Ca sh
But while corporate profits may be soaring, corporations are still overlooking billions in cash a
staggering $460 billion in the U.S. and some $570 million (â‚¬469 million) in Europe. Thi s
enormous sum is literally stuck in transit, a result of inefficient receivables, pay ables and
inventory practices that could be reclaimed with relatively little investment.
Hackett-RE L, which is part of The Hackett Group, a strategic advisory firm, calculates that in the
U.S. alone, getting this excess under control would reduce total net debt by 29 percent, increase
net profit up to 11 percent and improve return on capital employed (ROCE) from 13.9 perc ent to
Liberating the billions in cash trapped on the balance sheet is easier than one may think. Dell Inc.,
for instance a lauded for overall strong corporat e management and working capital performance
builds a computer only when it has received payment for an order, and doesn't pay its o wn
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 ca pital position by at
least 20 percent over time if they pay attention to the following list of cash management do's and
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
lean as possible. A properly conceived and execut ed 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 protocol s. 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 on average of 30 days
to resolve and consuming significant amounts of sales, order -ent ry and cash collectors ' time.
By tackling the root cause of the disputes in this case, poor adherence to pricing policies the
company can eliminate the disputes, thereby improving customer service. E stablished dispute-
management protocols free up time for sales, order-entry and c ash collections ' personnel to be
more effective at their designated roles, and they also will inc reas e productivity, reduce operating
costs and potentially boost sales. And fi nally, days pay able outstanding (DP O) and working
capital will improve, as customers won't have reason to hold payment.
This example illustrates how working capital is one of the best indicators of underlying inefficiency
within an organization and why it is critical that senior executives remain focused on addressing
the primary caus es of working capital excesses to control operating costs and remain competitive.
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 wit h 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 cons umption,
efficiently and cost-effectively, and replicate this collaboration with your suppliers.
The resulting implications for inventory levels can be massive. By aligning ordering, production
and distribution processes, companies can increase inherent efficiency and achieve direct cost
savings almost instantly. At this point, payment terms can be most effectively negotiat ed.
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 a 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.
The same can hold true for customers. Would vendor-managed inventory at a customer site
provide you the insight int o true usage t o better plan your own production? It is important to
remember, however, that this is not the solution for all products, and it should be evaluated on a
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-t o-cash and purchase-
to-pay processes; this includes your sales organization.
A void prolific new product introductions without first establishing a clear product -range
management strategy. Whether in the consumer products or aluminium extrusions business,
many companies rely heavily on new products to maintain and grow market share. However, poor
product-range management creates inefficiency in the supply chain, as companies must support
old products with inventory and manufacturing capability. This increases operating cos ts and
exposes the company to obsolete inventory.
6) Don't forget to collect your ca sh. 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. Custom ers 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. Too 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 behaviours. Many companies will incentivise
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. A fter 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
9) Do not a ssume 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 perc ent 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 t he case of emergency if you have treated them fairly,
and, likewise, a customer will be willing to forgive a mistake if you have a strong working
That said, also realize t hat eac h customer is unique. Utilize segmentation tactics to split your
customers and suppliers into similar groups. For customers, segment ation may be bas ed on
criteria including, profitability, sales, A/R size, past -due debt, average order size and frequency.
Once segmentation is complete, it is important to define strategies for each segment based
around the segmentation criteria and your strategic goals.
For example, you should minimize the management cost for low-margin customers by changing
service levels, automating interaction, etc. Finally, allocate your resources according to the
segment ation, with the aim of maximizing value.
11) Celebrate succe ss in hitting targets. Emphasize the actions that helped you get there. Ask
your people to remember what it felt like when they hit the target so they can motivate thems elves
to hit it again.
Following these do's and don'ts will allow companies to optimize cash and highlight internal
inefficiencies that must be remedied to better serve customers. Moreover, these cash
management best practices will enable companies to build stronger partners hips with suppliers
across the total working capital value chain ultimately, translating into improved bottom -line
Source: W.B. Girmes & Company: M&A Resource Library. Thi s article originally appeared
in gtnews and was written by Andrew Ashby, Pre sident, Europe for The Hackett Group and