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Working Capital Management

The COVID-19 pandemic raised significant working capital challenges and uncertainty for organisations in trying to manage their cash flow. Supply chain disruptions have been a major challenge, along with consumer demand, inflation and interest rate rises, the impact of a collection of Receivables, and the rate of insolvency increases.


This article aims to outline to the readers how the proper management of working capital is critical to achieving growth that generates value and strengthens returns across sectors. Companies are refocusing efforts from recovery and survival to growth, with a closer focus on liquidity and working capital efficiency.



What is Working Capital?

Working Capital is the lifeblood of any organisation, whether it is a small business, Small-to-Medium-Enterprise (SME) or Enterprise organisation. As a financial metric, it measures a business’s ability to cover upcoming costs (short-term obligations) and to fund its day-to-day operations; helping to plan for future needs.


· Working Capital is calculated by subtracting Current Liabilities (include Accounts Payable, Taxes, Wages and Interest Owed) from Current Assets (include Cash, Accounts Receivable and Inventory) as listed on an organisation’s Balance Sheet.

· Positive Working Capital means the organisation can pay its bills and invest in its operations to fund its business growth.

· Working Capital Management focuses on ensuring the company can meet day-to-day operating expenses, while using its financial resources in the most productive and efficient way.


Why is Working Capital so important?

Working Capital is used to fund operations and meet short-term obligations. If a company has enough working capital, it can continue to meet its short-term obligations, even if it runs into cash flow challenges.


Working capital can also be used to fund business growth, without incurring debt. But if an organisation needs to borrow funds (due to seasonal factors or other reasons), by demonstrating “positive” working capital can make it easier to qualify for loans or other forms of credit financing.


For a CFO and finance teams, the goal is simply the following:


1. Have clear visibility of how much cash is on hand (at any given time).

2. Work together with your key stakeholders to maintain sufficient Working Capital to cover Liabilities, any unforeseen contingencies, and growth objectives


How to improve the efficiency of your Working Capital processes?

Working Capital Management is the process of improving the Cash Conversion Cycle (CCC) in any organisation across Accounts Payables, Accounts Receivables, and Inventory. The Cash Conversion Cycle (CCC) is typically represented in days, and simply is the amount of time it takes a business to convert expenses into cash flow. The Cash Conversion Cycle (CCC) is defined as: CCC = DSO + DIO – DPO.


· DSO = “Days Sales Outstanding” (a “receivable” is outstanding sales)

· DIO = “Days Inventory Outstanding”

· DPO is “Days Payables Outstanding”


The liquidity of any organisation (small business, SME, or Enterprise) can be tied up in each of the above areas. Effectively, the cash is “trapped” and cannot be used for other purposes (time), as it is moving through the supply chain process. How can this be avoided? Well, accelerating cash flow, is a straightforward process – decrease DSO, decrease DIO, and increase DPO – and all contribute to lowering the Cash Conversion Cycle (CCC).


“When Executives describe that their organisation is in ‘growth mode’, this means that their Finance and Treasury teams are working closer than they ever have been previously. With a laser focus on forecasting, visibility around liquidity improvement, and generating cash flow, Executives can make better decisions and help position their organisations for performance improvement (and growth).


It is a ‘top-to-bottom’ approach for Executive to align organisational strategy, to goals, and with alignment to Working Capital initiatives to build a cash-excellence culture” said John Field, CEO & Founder – Reworq Consulting. ”With simple analysis and initiating process improvements, these can be immediately executed to help Working Capital. Also, introducing specialist SaaS / AI automation (with short ROI) in the areas of Accounts Receivables and Accounts Payables to minimise manual (and outdated) processes and the possible introduction of financing solutions, all contribute to transforming the end-to-end processes that influence effective cash flow management.”


Financing: Is it a viable option (or not)?

Supply chain financing can benefit customers and suppliers but if used in a responsible way. Facilities can be extremely attractive and have limits that change with the level of trading activity and of course with seasonal funding requirements. When used well, facilities help bridge the “funding gaps” that some businesses must manage (where suppliers are paid in advance of sales being converted into customer collections).


The same for invoice financing (debtor finance, cash flow finance, Accounts Receivables finance), which is another way businesses can improve their cash flow. While more businesses are using invoice financing to “unlock cash” from the value of their unpaid invoices to improve working capital, it does not come without a cost.


This is about balancing “Risk” v. “Benefit” since each organisation and its industry sector are vastly different. Think ‘fit for purpose’ and not a one (1) fit all mentality.


Any financing may also be a risk. A facility should only be considered, BUT once a business has managed (and optimised) the efficiency of its Working Capital cycle, so that the requirement for the facility is clear, sizing, and benefits are appropriate. Supply chain finance or invoice finance will not solve issues associated with ‘poor’ Working Capital Management. In fact, it can often exacerbate these issues as access to financing may typically decrease due to ‘poor’ internal processes and risk frameworks.


Executives and their Management Teams should challenge their own organisation (and key stakeholders, teams) and do their homework – firstly, to optimise the working capital cycles of their businesses, putting in place robust processes to drive not only responsibility but also accountability for delivering (v. target) Working Capital metrics. This helps to provide a clear understanding of the underlying gaps in Working Capital Management and clarity in terms of any residual “funding gap” that may need financing.


Best Practices for Managing Working Capital

Any optimisation of Working Capital requires a holistic and comprehensive approach and organisations that excel at Working Capital Management also excel in the continual search for improvement.


Recognise Working Capital as a source of value


Working Capital is not a straightforward task, but many organisations have put into practice robust measures to improve Accounts Receivables, Accounts Payables, and Inventory management. But guidance on what is ‘best practice’ is scarce and industry-specific.


Despite these challenges, the benefits are always worth the extra effort. Better management of Working Capital preserves cash and can provide a critical lifeline when the business faces significant trading or liquidity constraints. CFOs and Executive Teams must embed a ‘cash excellence’ mindset throughout the whole organisation.


Identify Areas of Opportunity


The potential Working Capital improvement will eventuate but only with a solid understanding of the existing cash situation. This step will always require cross-functional collaboration across the organisation and identifying all opportunities, by assembling individuals (or teams) who are enthusiastic about leading change and with a history in Working Capital deliverables.


· Accounts Receivables

Install rigorous collections and risk management by improving the processes to monitor collections, track slippage with predictive metrics, and identify emerging trends. Provide constant reporting analysis back to sales and operations to tailor customer engagements and remediation action.

· Accounts Payables

Improve payment discipline by overhauling internal supplier payment authorisations and processes. Improve the timing of supplier payments, lengthen supplier terms to navigate short-term gaps in cash flow and manage rebates to derive customer support (and growth).

· Inventory Management

Inventory reduction opportunities without compromising on service levels or risking stock outages. Identify and rationalise underperforming SKUs, stock cycle counts, and slow-moving stock lines with action plans to focus on core products and simplify operational efficiency.


Prioritise Areas of Opportunity


Working Capital opportunities are ranked (by priority) and create a Working Capital Roadmap, with actionable planning. This roadmap must support the company’s strategy and business objectives – actions that can be implemented immediately to preserve liquidity while designing more complex longer-term initiatives in parallel.


· Rapid Actions

Will free up Working Capital, and can be executed immediately without justification.

· Discrete Actions

Actions accomplished with a minimal system or process changes, by “value-driven” and backed with high-level analysis, but not an in-depth appraisal.

· Complex Actions (Initiatives)

These are initiatives that will be dependent on executing system or process changes. A high-level and detailed analysis is required to validate the opportunities and then, who leads this team engagement.


Undertake a Working Capital Project


The Working Capital Roadmap is your guide to assign clear direction and ownership of your initiatives. Set up a compliance governance structure (track and monitor progress) you are your success will be measured by four (4) items:


· Engagement from the Executive Team

Ensure the Working Capital program is sponsored by the CFO and Executive Team, who function as ‘cash-excellence’ role models for your organisation.

· Clear Tracking

Use a Dashboard with simple but robust Key Performance Indicators (KPIs) to make progress visible, and keep your Executive Team and the whole organisation informed of progress.

· AGILE Principles

Embed AGILE principles across your key stakeholders, and teams, and drive accountability with quick feedback to facilitate remediation action (if required) but to fast-track progress and alignment.

· Realign Incentives

Align your Incentives Plan to include ‘new’ Working Capital metrics for Managers and individual teams. This is indicative of focus beyond just P&L (Revenue, Expenses) to provide transparency of the importance of Working Capital.


A simple question. Is your organisation using ‘best practice’ in Working Capital Management to maximise your cash flow?


What is next in 2022?

Managing Working Capital will be harder in 2022. The pandemic is fading but the rebound is uneven and risk of further increases in inflation and interest rates. There is an uplift in trading activity across most sectors but the key challenge for most businesses is to manage Working Capital effectively and to take advantage of any growth opportunities.


So, it needs to be given the appropriate focus and strategic alignment with an organisation’s objectives. CFOs and Treasurers will use excess cash reserves for debt repayment, capital investment, and other activities. Management teams need to focus on strong financial and

operational processes integrated forecasting, and with real options to diversify supply (including domestic sourcing and manufacturing).


However, business conditions remain unpredictable. There is a constant fear of further disruption and with unstable supply chains, the challenge is to find the right optimisation process for Working Capital. With the deterioration of the Cash Conversion Cycle (CCC) across most industries, organisations have no alternative but to switch focus from profitability to cash management and to improve Working Capital Management to support their growth initiatives.


As we navigate the road through economic recovery, a top priority for CFOs will be optimising and managing Working capital, now, more than ever.


How can Cathro & Partners assist?

Cathro & Partners are experts in providing insolvency and restructuring services that help to create and preserve business value. With a reputation for delivering high-quality results, Cathro & Partners can assist your business to overcome strategic and financial challenges.


Founder and Managing Principal Simon Cathro has over 25 years of experience in the field of insolvency and corporate restructuring services.



This article was written with John Field of Reworq Consulting

https://reworqconsulting.com.au/


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