Working capital reduction is something which companies often overlook until tough financial times threaten solvency. When those times arrive, working capital reduction efforts are often frantic and centred on formal or informal extension of payment terms, squeezing customers to pay early and cutting back on inbound inventory orders.
None of those actions are sustainable over the long term though, and the companies that employ them often revert to the status quo if they manage to weather the economic storm.
Economic Growth Induces Amnesia
As our 2015 Supply Chain Report highlights, the last few years have seen the Australian economy in a period of modest but steady growth. This will mean that for many supply organisations, the hard times fade into distant memory, leaving them unprepared for any future plunge in the global economy.
That’s a great shame, because with some smart planning and a bit of determination (and perhaps the willingness to make some operational investments), sustained working capital reductions are possible, helping organisations to keep paying the bills in hard times, and to take advantage of capital investment opportunities when all is well.
Take a Principled Approach to Working Capital Reduction
Companies which excel in achieving sustained working capital reduction use a set of common guiding principles. These three principles—an overview of which you’ll find in this post—guide their working capital management methodologies and allow them not only to survive, but to thrive regardless of peaks and troughs in the economic cycle.
If yours is an organisation that sits among the leaders in working capital management, you can probably disregard the rest of this article. If not, you might just find some takeaways that can be used to make a sustainable improvement in your working capital utilisation.
1. The Governance Principle and Cash Culture
The first principle applied by leaders in working capital management is the need for strong top-down governance, along with a culture where everyone, including the janitor understands working capital and its importance.
Let’s face it; most people of employable age can grasp the need to have cash on hand to pay the bills. Indeed a high proportion of them are used to running family budgets, which is little different to managing commercial accounts payable and receivable. When an organization’s leadership and management speaks openly with the workforce about finance, employees can begin to relate to it and think more about the impact they have on working capital.
Governance includes pro-working capital policies which apply to all business functions. So for example, the sales department is discouraged from holding a view that every sale is good, instead being guided towards the pursuit of profitable sales to high-quality customers.
2. The Incremental Principle
Leaders in working capital reduction and management know how to focus their efforts. Companies often make the mistake of pursuing broad reduction programs with numerous targets. All too often these programs run out of steam and generate few results.
The firms that succeed are those that spend sufficient time and energy identifying which targets have the largest financial impact and are most feasible to resolve. They do this by seeking hard evidence through analysis and performance benchmarking. Once one or two key targets are identified, work commences on root cause evaluation and eventually, the development of solutions for working capital reduction.
With a laser focus on the most lucrative and practical opportunities, early wins inspire continued efforts to make incremental progress and roll out successful solutions into new areas.
3. The Segmentation Principle
A third key principle of working capital reduction is segmentation or, the recognition that one size does not fit all. Leaders in working capital management take steps to differentiate between strategic and non-strategic suppliers, partners, customers, and SKUs. Once categorised, the segments are targeted for working capital reduction in ways which best suit their importance and value to the organisation.
Companies that win with working capital know that segmentation presents challenges which can only be met when all functions align and collaborate on working with identified solutions.
They ensure that measures are taken to reduce resistance within certain functional groups which may not always recognise the need for change. It’s not necessarily easy for example, to convince sales professionals of the need to enforce more rigorous collections policies for non-strategic customers.
What Goes Up…
Must come down, and that includes global and national economies. That’s something which should never be forgotten in any line of business, as many companies found out in the first decade of this century.
If your company can take a few leaves now, from the books of those who lead in working capital management, the next recession may present opportunities as well as challenges. With more free cash to play with, you can be poised to take advantage of competitors’ tardiness.
The alternative is to let amnesia lull your organisation into a false sense of security and wake up on some future morning wondering where all the cash is when you need it. I know which option I prefer — do you?