Align finances and operations to improve working capital


If you survey CFOs from different industry sectors, you will find that they are constantly striving to improve working capital efficiency and cash conversion cycle metrics.

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Often, however, there are conflicting goals that diminish improving a company’s working capital and cash conversion cycle. These conflicts arise from the lack of alignment between the operational departments of a company. By taking a few additional steps, a business can better align working capital goals across silos and improve business results.

The three essential components of the working capital equation are well known to finance and treasury staff:

  • Days Payable Overdue (DPO);
  • Overdue Inventory Days (DIO); and
  • Exceptional Sales Days (DSO).

The goals are simple: increase the DPO, and shorten the DIO and DSO

DIO reduction, typically managed by the COO, is considered the most difficult area to improve. But over time, companies have devoted substantial resources to improving the physical supply chain and reducing inventory to safe levels. The need to effectively manage inventory levels is also generally well understood by operations.

The CFO has more control over changes in DPO and DSO metrics. Faster debt collection is easy, but the sales team can try to boost business by providing longer payment terms to customers and thereby increasing the DSO.

In terms of DPO, the purchasing and sourcing teams can negotiate payment terms of 30 days with suppliers because this is how “it has always been done”. Certainly, a balance is necessary to maintain a good performance of the company. But a better understanding of the need to improve working capital and how the improvement benefits the business will help align goals between finance and operations to meet business goals.

The three T’s

To remember the three actions you need to take to improve working capital performance, think of them as the three T’s: train, target, and provide transactional support.

1. Practice. One of the most important tasks is to train and educate non-financial groups on what the value of the target improvement means for the business in terms of investment costs, improvement of the balance sheet and ratios. . It’s quite common for a finance manager to sit down with the purchasing manager to review each vendor’s payment terms, in which finance asks questions like “Why are we paying so many vendors in 15-20 days?” “

Sourcing typically responds, “Because it was negotiated that way years ago. It makes sense in the supply silo if you can write checks on the company’s capital account and never take an overdraft. No one questions purchasing managers if this is the case.

The CFO should explain, however, that there is a cost to paying too quickly or collecting too slowly on receivables, and often standardized terms can help set the baseline. Balance sheet costs or improvements are less tangible at the operational level. Training and understanding how operational activities translate into the company’s reported financial results will help align finance and operations goals.

2. Target. Establishing and assigning working capital objectives and exploring to operational levels is essential. Successful companies will assign working capital goals as key performance indicators in personal performance plans.

Many cases are similar. Finance wants to improve the efficiency of the working capital of the company and asks the operating groups of the company to improve the working capital. In turn, they expect results. But one detail can be overlooked: setting specific goals at the granular level. Once goals are set, monthly or quarterly reviews to track results against goals and active feedback from finance is needed on progress to bolster the effort. It also helps underline management’s commitment to the continued importance of meeting the company’s working capital goals.

3. Provide transactional support. Appointing resource people as liaison between finance and other groups can help bridge the gaps between the goals of different silos and provide transactional support to allow changes to move forward. A point of contact between finance and sales can help customers request longer payment terms or supplier financing and help find solutions that don’t increase DSO. Someone intermediate between finance and purchasing can help negotiate longer payment terms because even after training a specialist can provide advice and negotiate assistance. Having a resource person also helps change legacy attitudes towards operational performance, ensures transparency in operational groups, and maintains an ongoing focus on improvement.

Here’s an example of how it all comes together. A finance manager at a large retailer looks at the average inventory turns for a specific vendor and finds that inventory averaged 60 days, but the vendor payment terms were 30 days.

Through financial collaboration with purchasing, officials were able to explain to the supplier that retailers need to get 60-day payment terms to pay for goods at the mid-point of sale to reduce transportation costs.

Here is another example, but from a different industry. Large auto parts retailers have one-year inventory cycles. They could never grow if they had to pay suppliers 30 days and fund 335 days of inventory. Working extensively on aligning purchasing to implement business goals, they can lengthen vendor payment terms to better match the inventory period with the cash cycle.

The point is, businesses, industries, and circumstances can change. Historically, there may have been a lot of liquidity and fewer competitors, and financial metrics were not a major concern for companies or investors.

Fast forward to 2015. Increased competition, headwinds in the market or a change in a company’s circumstances can create an imperative to improve bottom lines with a more efficient use of capital. Successful improvement in the achievement of working capital goals will result in less cash deployed in operations, more capital available for business acquisitions, investment in new products or manufacturing and / or return of capital to shareholders. It all starts with aligning and tracking working capital goals across the organization.

Erik Wanberg is Managing Director of Wells Fargo Capital Finance.

days of pending inventory, days of unpaid debts, days of pending sales, working capital

About Donnie R. Losey

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