Cash released from working capital is the lowest-cost and lowest-risk form of funding for a business. Neal Dempsey explains why businesses must challenge embedded ways of working or risk leaving cash locked up in debtors and inventory that could be put to more-productive use.
As the global economy recovers, businesses need to be able to respond to changing customer behaviours; costly restrictions on, or changes to, working practices; and ongoing risk in the supply chain.
At a time of such ongoing volatility and uncertainty, the ability to release working capital from operations into cash quickly and efficiently will not simply offer a competitive advantage, but will be essential to sustain the business and support future growth.
This isn't news for finance professionals. Cashflow and working capital performance are central to decision making and our reporting to stakeholders.
What is often overlooked is the significant influence our internal processes can have on our ability to generate cash from operations efficiently. In good times, growth and a buoyant economy allows inefficiencies and inadequacies in our processes to be masked. During a downturn, the state of the economy and customers holding on to cash can similarly overshadow chronic issues within our own processes.
Short-term measures can lead to additional risks
It is a natural response for businesses to seek to preserve cash, and while there are notable exceptions, average days to pay suppliers in the UK have increased by almost a quarter since March1. Short-term tactical measures, like extending payment terms, may release pressure now, but they can increase risk in the supply chain and, potentially, be more costly over time.
A consistent and balanced approach, based on a detailed understanding of the drivers of working capital performance and cash conversion is essential to achieve sustainable cashflow improvement, enable the business to:
optimise cash release from operations
enhance control and discipline in business processes
plan and manage investment effectively
manage funding and debt requirements pro-actively
reduce exposure to write offs and associated risks.
As business begins to return to higher levels of activity, there's a real opportunity for many to release cash from working capital faster and more efficiently, but there is a need to question and challenge current ways of working.
Does our management information help us influence working capital in a timely and meaningful way?
Building a more-detailed view of what drives efficient cash conversion is an essential first step. Taking customers and cash collection as an example, monitoring days-sales-outstanding and aged debtors are common tools that are easy to measure and report on, but are ultimately backward-looking. By the time there are reported issues, these have often crystallised into overdue debts or disputes.
To actively manage and influence cash conversion, businesses need to develop a more-dynamic picture of what affects performance across customers, products, and internal processes. Good management information will include relevant leading indicators of performance, which will highlight bottlenecks or points of failure before they become a problem. Examples might include, number of customers outside standard terms; orders dispatched with shortages, invoices issued with errors.
Are our processes lean and effective, or are we managing high levels of disputes, errors and delay?
Complex and fragmented business processes build delay, and mask leakage in the cash-conversion cycle. A rigorous approach to understanding and eliminating potential points of failure in our internal processes and interaction points with customers will contribute to improved operational performance, cash conversion and working capital.
On average 7% of invoices raised to customers will contain errors, and it will take between 10 and 22 days to resolve an error once it has been identified. Not only are we adding four to five weeks on to the time it takes to receive payment. The time and effort involved in investigating and resolving a dispute will be disruptive and time consuming2.
Do we have effective controls to prevent or capture errors before they impact working capital?
Compliance with basic disciplines in end-to-end business processes is an essential part of good practice. Investing time and effort in robust and efficient processes only to allow controls to be bypassed adds complexity and puts the business' cash-conversion at increased risk.
Embedding appropriate control, automating wherever possible, and building compliance monitoring into regular management information not only supports improved cash conversion, but helps build resilience and efficiency into operations.
Cash conscious culture
Are we considering the working capital impact of every decision we make in the business?
A rigorous focus on process and control may seem onerous but aligned with a business-wide focus on cash, which informs behaviour and decision making, it underpins sustainable change.
Embedding a cash conscious culture and the right behaviours at all levels of the organisation is a complex and multi-faceted process, it requires leadership to set the 'tone from the top' and to inspire greater ownership and accountability. Incorporate working capital targets into your business' performance objectives, wherever the individual has influence over cash management can also help to build awareness of how our own actions have an impact.
Working with a large law firm, incorporating achievement of working capital metrics in their core performance measures raised its profile as a key business matter, alongside review, profit and quality/risk management, improving billing and collections processes and having an impact on timing of drawings being paid.
Improving the efficiency of your internal processes is not only the best opportunity to free cash tied up in working capital, it can also help improve performance and resilience across the business; reduce overheads and financing costs; and build stronger commercial relationships with customers and suppliers.
To achieve a sustainable improvement requires management to address a variety of challenges from complexity in processes and poor-quality data through to a lack of ownership and accountability for results. To be successful, it needs a consistent focus for the whole business, but the benefits in terms of resilience during periods of volatility and the headroom to take advantage of new opportunities can be significant.
For help embedding working capital management processes into your business, contact Neal Dempsey.