Brian Shanahan, Associate Principal at REL, explains the strain placed on the supply chain by poor working capital management.
Our latest working capital survey revealed that 30% of the 1000 largest public companies in Europe have a deteriorating working capital position. There are of course a subset of these, which are suffering tough market conditions and yet are consciously working against the trend – and emerging successful. But there are others that continue to be oblivious to the importance of working capital to their company, and this is having a knock-on effect throughout the supply chain. Despite an improving picture in transparency within their respective organisations, it’s important to note that this is not necessarily the fault of the CFO.
In my view measurement and targets from across the enterprise have created this circumstance. Sales people, for instance, too often receive bonuses on revenue and margin without considering the impact of customer terms or late payments. For its part, the production side of the business is concerned with having enough products to meet demand, without any downside for having too much stock. Meanwhile, the purchasing team is obsessed with reducing cost as supply chains elongate across the global village. All the while, finance organisations are caught in the middle.
While accountants within the organisation understand the numbers they don’t necessarily have the power or insight to leverage the result. It is easy to claim that it’s just too difficult to manage working capital. But as the era of easy access to cheap borrowing is now over, more and more companies are being forced to consider making real and sustained change to ensure that they can source additional cash flows by reducing working capital.
Increasingly, company finance organisations are realising that the old tricks don’t work as well as before. Those knee jerk reactions, such as delaying payments to suppliers, especially at half year or quarter end, may provide some window dressing to the balance sheet and keep the analysts quiet for a few months. However, at a time of extraordinary economic weakness, this strategy can be downright dangerous. It is the suppliers to large corporations, which are suffering the worst effects of the credit squeeze. Their dependence on major customers maintaining their business and paying on time means they can no longer overrun their overdraft facility. In many cases, small suppliers are terrified that banks will curtail or withdraw their overdraft. Paying late in this environment can actually have the effect of sabotaging one’s own supply chain.
Experience demonstrates that there are steps organisations can take within their business to change their cash position. Sometimes these are slight modifications; often the answers to many working capital related issues are right under our noses.
With respect to the supply chain, we have seen a number of companies that have taken the opportunity to use their hoards of cash to pay suppliers more quickly in exchange for discounts. Further, they have worked out that earning even a modest discount provides an excellent return on the cash they have and is helping to keep suppliers afloat. In the long term this will lead to product cost reductions as the parties work even closer together in a stable supply chain.