Martin Flint, Director of Working Capital at Lloyds Banking Group, looks at practical ways companies could make a difference to the way they manage working capital.
With UK businesses facing increasing uncertainty, the efficient management of working capital can be a real source of competitive advantage. By generating cash more efficiently companies will be able to accelerate their growth ambitions so they can trade in new markets, expand their product range or employ new colleagues, without the need to obtain external funding.
Sustainable improvements in working capital
Businesses often look at short-term actions to improve working capital, including delaying payments or reducing inventory around financial period ends. But, these actions can be difficult to replicate regularly without impacting wider commercial relationships or without some form of reciprocation. So how can businesses deliver sustainable change?
- Senior management focus is critical. Working capital should be a permanent agenda item and a priority across the whole organisation.
- Enhanced management information and regular performance reviews will help to drive focus and behaviour.
- Training commercial and procurement teams to understand the impact of potential changes in working capital in negotiations with suppliers and customers.
How to improve your cash conversion cycle (CCC)
A key part of evaluating working capital performance is to understand how long it takes cash to move through your business. The CCC measures the number of days between the purchase of raw materials and inventory through to the collection of cash from your eventual product sales. But how can your CCC be more efficient?
- Improving receipts from customers
A simple way of looking for improvements is to understand the reasons why customer invoices are overdue and develop an improvement plan to look at the underlying invoicing, collection and dispute management processes. Tightening up invoicing procedures by improving the timeliness and increasing the frequency of invoice preparation is an easy first step.
Segmenting and prioritising customers by size, importance or risk profile and implementing proactive collection activities should help to reduce overdue invoices. Defining roles and responsibilities across sales, customer service and credit control will also help to accelerate the resolution of any disputes.
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- Managing supplier payments
The management of payables, including supplier payment terms can be key to managing working capital. Companies can see benefits from leveraging and consolidating spend, extending payment terms and increasing supplier collaboration.
There are other activities that could increase the time taken to pay suppliers, but it is important that this is managed in a way that doesn’t increase risk within the supply chain through impacting a supplier’s cash flow. Just delaying payments can be counterproductive to developing supplier relationships and pricing negotiations.
A review of contract compliance would ensure that payment terms detailed in the latest contracts are accurately captured so payments are not made earlier than agreed terms. Reviewing the frequency of supplier payments may also improve cash flow and process efficiency. Over recent years payment processes have been changed to range from bi-weekly, weekly or monthly payment runs.
Although attempting to implement payment term and payment process changes together could lead to suppliers experiencing cash flow difficulties and disrupt the supply chain. This is where supplier finance can help by increasing payment days.
- Inventory management
One of the concerns about reducing inventory is the potential impact on customers and the ability to service their orders which could ultimately lead to lower sales. Therefore, inventory optimisation needs to be considered carefully and alongside analysis of customers’ and products’ contribution to sales, profit and payment performance, enabling different service levels (e.g. targets) to be set. Operating uniform service levels for all customers can lead to high inventory levels and the potential for obsolete stock. Why offer the same level of service for a customer that continually pays you late?
Developing relationships and working closely with clients to understand their likely demand can also lead to better inventory management. It is important that any sales forecast is at the right product level otherwise it cannot be used for determining material requirements and will lead to difficulties in purchasing and manufacturing scheduling.
Updating supplier lead times will ensure stock is received on time and minimise last minute requests for raw materials. Managing supplier performance will help to reduce any safety stock that is held due to historical concerns about a supplier’s ability to make orders on time and in full. Negotiating shorter lead times with suppliers and reducing any minimum order quantities could also reduce inventory. Smaller, more frequent deliveries can lead to lower inventory balances.
Finally, selling to new markets and customers can lead to a rapid growth in product range. A cross-functional approach to the introduction of new products can help to minimise inventory levels where the quantum and phasing of customer demand is uncertain and harder to forecast. At the same time, monitoring the volume of sales identifies when an item is becoming slow moving and could be discontinued.
At a time when focusing on working capital is becoming more important it is highly likely that your competitors, customers and suppliers are looking at ways to become more efficient. Given this, can you afford not to look at all your options?
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