How to make your working capital work harder

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Working capital is a calculation of current assets minus current liabilities less cash on hand. At its simplest, it represents the amount of day-by-day operating liquidity required by a business. A corporation may possess both assets and profitability, but it would be short of liquidity if those same assets could not be transferred into usable cash.

Lending will remain constricted
“If the recession has taught finance experts anything it is that available credit has been significantly curtailed but even when a recovery is in full swing, we should not expect lending to return to similar levels to those which fueled some very legitimate business successes,” warns Gavin Swindell, European managing director of consultants REL.

He says the term most experts use to characterise company liquidity is Days Working Capital (DWC), which measures the average number of days that sales are tied up in the operating cycle. DWC is affected by a number of factors including inventories, receivables and payables. It will be minimised by maximising credit facilities from suppliers, reducing the need for stock and maximising the cash conversion rate from issued invoices to cash. If over time DWC numbers move up then it will have a negative financial impact on a company’s bottom line and the firm’s ability to make strategic decisions.

Swindell says there exists a geographic divide on the performance of DWC. With the exception of a few business sectors, such as retail, Europe consistently performs 20% worse than north America. For those European companies this could equate to over €650 billion in cash that is essentially being left unused.

Changing behaviour is the challenge
Many cannot understand why such a simple issue can be overlooked; why inefficiencies within known areas like stocks, incomings and outgoings fester to contribute to poor working capital. Swindell says many companies do make efforts to improve the issue but often they lack the capabilities and experience to make any sustainable progress.

“This is mainly because it is not easy to change organisational behaviour at a process level that will translate into the company’s balance sheet.”

Surprising to some given the current recession and almost universal focus on cash, “there are companies who are simply unaware of the working capital issue. Often these are cash rich organisations or market leaders; despite this they have potential generate significant improvements to their liquidity,” says Swindell.

Playing smarter
He argues that although it is difficult to pinpoint the long-term recessionary impact on DWC, smart companies saw the writing on the wall and began taking steps early to prepare for the cycle to hit the bottom.

Swindell says the really smart ones created a cash culture that remains in place, whatever the weather.

“The companies that have made working capital part of their 2009 improvement plans, will not only deal with the recession better but have probably increased their chances of long term survival immeasurably. For those companies without a working capital procedure it’s never too late, but the longer the wait the more pressured the change may be.”

Companies interested in actively managing their liquidity need to measure effectively the performance of their receivables, payables and inventories.

Swindell’s advice is that a small number of simple measures will soon tell companies what’s going on with their working capital.

First understand the size of the opportunity and its location, be it within a specific company geography or element of working capital; company leaders must focus action on the areas that will yield the greatest benefit.
Ensure that any changes are sustainable by embedding process and disciplines at the front end. For example, within customer terms, customer service levels, supplier terms, demand signals and an optimised level and location of inventory.
Institutionalise these initiatives to ensure that the business does not take its eyes off the ball when the next initiative comes along.