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Get to work on capital

It’s remarkable that so many companies appear to be so bad at managing working capital. Earlier this year REL Consultancy calculated that European businesses were missing out on EUR65bn of profit purely because of excess working capital. UK companies were estimated to have 28% (EUR100bn) too much working capital.

If these numbers sound like the product of an over-hyped researcher, consider this: REL estimates that chemicals group ICI could have squeezed an extra EUR1bn of cash out of its business – which would have almost totally eliminated the need for the company’s recent EUR1.3bn rights issue. And, at a major US IT company, REL improved working capital by $2.8bn in an 18-month period. Within another two or three years, working capital had been reduced by a total of almost $6bn.

One FD told us at the recent CFO Summit at The Belfry that, when she explained to her sales director what the interest cost was on the accounts receivable, he realised he was looking at a number that was not unadjacent to the profit he thought he’d made for the company.

So working capital matters, it can make a huge difference to the balance sheet and the bottom line – and it’s the FD’s job to sort it out. The problem is that excess working capital arises because of inefficiencies throughout the company, not just in the credit control unit.

Peter Wolf, an account director with REL, says that part of the problem the FD faces in tackling working capital is organisational structure.

A business with a manufacturing arm in Thailand, a sales operation in Germany and a shared service centre in Ireland doing the invoicing, will be unlikely to have tight working capital, especially given that there will be a manufacturing director, a sales director and an administration director, none of whose employees will be talking to anyone outside of their own silos. “The business is attempting to be global but in fact is very functional. In that environment, working capital is going to squirt out the sides,” Wolf says.

Think of the process – what REL dubs (and trademarks) as the customer-to-cash process – that balloons the receivables days’ sales outstanding: booking the order, relaying it to manufacturing, delivering it (hopefully intact and in the right quantities), issuing the invoice, and so on. A lot of things can go wrong anywhere in that process, with the result that the client doesn’t pay on time because the paperwork isn’t matching up properly or there’s a dispute about the quality of the goods. Moreover, if the invoice isn’t even issued in a timely manner, then the client can hardly be blamed for not paying promptly and the DSO statistics won’t even hint at the problem.

“Quick wins” can generate perhaps half the savings, Wolf says. For example, collectors sometimes work through the debtors list in alphabetical order, rather than homing in on the big accounts that are most overdue. So if you owe £5 and your name is Aardvark, expect a credit-control call from such businesses. Worse still, credit control staff often have perfectly legitimate things to do that don’t actually involve making phone calls to customers. “The rest of the time they’re filling in forms, doing reports, doing analysis,” says Wolf. “So you get rid of that, build up their confidence, remind them why they’re there, and help them to make service calls ahead of the due date: ‘Is everything on this contract okay? Is the paperwork complete?’ Then it’s legitimate to say, ‘Payment is due in 10 days, is there any obstacle that’s going to stop that being paid?’ You get wonders very quickly.”

If you imagine your aged debtors as a bell curve, then such tactics help chop the long tail on the right of the graph. To shift the bell further to the left, more difficult cross-functional issues need to be addressed.

Remuneration may be a problem: salesmen are often rewarded for booking sales even if their paperwork is incorrect or even fabricated. Meanwhile, there’s a finance team being incentivised on the number of correct invoices sent out.

“When you talk to the sales guy, the customer service rep, the person inputting the order into the system, the person producing the bill, the people doing the collecting, the people trying to resolve any disputes, they say, ‘Gosh! This is the first time we’ve had a meeting like this,'” Wolf says.

On the flip side of the coin, it’s tempting to think that, the more shambolic the payables process, the better off the company: pay little, pay slowly.

But as Wolf makes clear, if you regularly disappoint your suppliers then you probably get worse payment terms, worse service – and a more expensive finance function.

Alexander Bielenberg, REL Consultancy’s operations director, adds that many companies have also got too many suppliers. “That prevents them from running efficient purchasing operations and getting better terms by concentrating their muscle,” he says. The same can be said for customers. (Dare you fire some customers?). By exiting a low-value part of the market and opting to service it via distributors, large efficiencies can be had in the billing process and conversion of receivables to cash.

Moreover, businesses that have installed expensive e-procurement systems may be horrified to discover that they are being under-utilised and that employees often by-pass them. For inventories, businesses can re-examine whether they can shift from a build-to-stock model towards a build-to-order model. Much will depend on the level of service that has to be guaranteed to the client: do they expect 97% of deliveries within three days or would 90% within a week be fine?

Manufacturers often also suffer from the fact that each part of the assembly chain keeps its own buffer stocks of spare parts so as not to get caught out by any supply failure further upstream. This results in wasteful, multiple buffer stores that simply gobble up cash.

The main trick, however, is to take a broader view of working capital – receivables, payables and inventory. “In the long run you can’t sustainably improve one aspect of working capital without looking at the others and making sure they are aligned,” says Bielenberg.

And, increasingly, there will be more work done on the “collaborative extended enterprise” model, such that improvements to suppliers’ receivables functions will go hand-in-hand with their customers’ payables process.

“Everybody in the extended supply chain benefits from the best practice process,” he says.

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