- Jennifer Pinney
- Director, REL Consultancy
by Jennifer Pinney, director at REL Consultancy
Great people, great ideas, great customers – most major companies have some combination of formidable advantages going for them. Like world-class athletes, where the difference between the best and the rest is measured in hundredths of a second, the companies that carry away the gold often do so not because of a single major advantage but through the cumulative power of doing many small things exceptionally well.
For athletes, the willingness to make tiny adjustments in their stance or their training regime gives them what it takes to be a champion. A similar factor for companies is taking pains with their working capital management. Unfortunately, first-rate working capital management skills are not easy to achieve. The 2015 Working Capital Survey of the top 1000 companies in North America and Europe found that only 1% of companies have achieved improvements in cash conversion cycle (CCC) – a key measure of working capital performance – for the last three years in succession. (The cash conversion cycle [days] = days of sales outstanding + days of inventory outstanding – days of payables outstanding.)
Why do so few achieve excellence? Perhaps the biggest reason is that relatively few make the effort. As with social and environmental sustainability issues, most executives pay little attention to working capital except when facing a crisis, and their indifference is transmitted to the entire organisation. Without pressure from the C-suite, no one collects metrics or designs incentives that have a working capital focus, and no one rushes to install the controls needed to manage working capital professionally, or to do the hard work required to simplify payment processes.
As a result, companies tend to lack a clear understanding of their cash cycle and, even yet, any shared organisational recognition of the importance of cash flow management to the enterprise. Their ignorance can be expensive: A significant portion of the top 1000 companies in the survey waste 15% or more of their EBIT through inefficient working capital management.
Working capital maturity ranking
Of course, working capital management competence is not a binary quality that companies either have or lack. It’s a set of attitudes and capabilities that can take years to develop. Typically, companies must pass through four stages to achieve working capital maturity:
Level 1. Lagging
Organisations have invested little or no time in working capital improvement. Cash and working capital were not previously a priority, and the organisation does not understand what is possible in terms of financial improvements.
Typically, these organisations are comprised of several disparate sub-teams, largely disconnected from the processes and concerns of the wider business. While focus within a specific remit is not an inherently bad thing, siloing makes cross-functional collaboration extremely limited at best, and at worst, extremely difficult.
When it comes to working capital specifically, these organisations have several issues. They have little in the way of awareness, training, senior attention, and they are not incentivised to focus on it. This can be partially attributed to the lack of standard working capital KPIs, and their one-dimensional objectives which place little or no emphasis on it. It also does not help that they lack visibility on standard terms, and that customers, suppliers, and products are barely segmented if they are segmented at all. When organisations treat them all equally, it is invariably to their detriment.
Level 2. Achieving
Organisations keep cash and working capital in check at critical times of the year. They keep up with their peers, but have no competitive working capital advantage or disadvantage.
Accordingly, companies at this level demonstrate more competence than those classified as ‘lagging’, but leave considerable room for improvement. Firstly, they are not siloed to the same extent: the organisation is cross-functional, but only in an informal sense. Accordingly, their policies and processes are more flexible: they are driven by guiding principles, but functional and regional adjustments are entirely possible.
They have some degree of working capital awareness, and their senior personnel have received some degree of training. This improved cross-functionality allows visibility into their headline working capital metrics (which organisations at Level 1 entirely lack) and the training informs multidimensional objectives and aligned incentives. Standard terms are in place, but compliance is not monitored. Finally, Level 2 organisations make some efforts with segmentation, typically focusing on the top 80 percent of customers, suppliers, and products.[[[PAGE]]]
Level 3. Exceeding
Organisations at this level actively invest resources and intellectual capability to execute decisions aimed at changing current constraints. They hope to move to upper-quartile performance compared to peers, and they are evolving into an organisation that values cash and working capital regularly and in a structured manner.
These organisations build on the work of Level 2 organisations to demonstrate high levels of cooperation across the board, supported by working capital incentives at C-suite and below. This pan-business approach is extended to formal working capital training, which is given to all staff. The skills involved in this training are well defined, and capabilities are regularly reviewed and revised to ensure that processes remain up to date.
Global measurement standards are implemented and followed for KPIs; these metrics are partially automated. When it comes to segmentation, these organisations use intelligent, driver-based modelling to set targets at item-, customer- or supplier-level. Standard terms and policies are well-embedded, compliance is monitored, and forecasts are developed cross-functionally – and with more visibility around how they are derived and actions taken over variances.
Level 4. Leading
These organisations have begun to achieve competitive advantage through excellence in their cash and working capital management. They have embedded the importance of cash and working capital into the company’s culture, and are now aiming to make their processes even more transparent. Working capital training is not only implemented, but provided on an ongoing basis to give personnel periodic refresher training – and to make sure these principles are instilled in new hires. Skill requirements are well-defined and well-documented. Central-end-to-end policies and processes are in place, with clear governance structures to assess the working capital impact of a change in strategies. Global standards are measured, and any cash management technology can encompass sub-categories at supplier, customer, and product-level.
Raising an organisation’s working capital bar is typically a five-step process
Working capital metrics and performance are a staple of executive and management meetings, because the business understand the dynamic nature of the optimal working capital position. Accordingly, staff collectively understand the objective and total cost of ownership principles.
If you doubt your organisation ranks very high on this scale, you’re probably right. We estimate that most companies rank Level 2 on our working capital maturity scale. They are at the point where they know working capital management is important, but they have yet to invest the talent, time and money needed to achieve significant results.
Five steps toward working capital maturity
Raising an organisation’s working capital bar is typically a five-step process:
1. Identify key stakeholders
The first step is to gather the information needed to assess the current state of working capital performance. This stage should focus on developing a deeper understanding of the overall organisation, and should include local and corporate stakeholders from finance, procurement, accounts payable, supply chain (planning, execution, storage and distribution), customer credit, order placement and billing, cash collection and dispute management. Working capital is managed at the level of execution and requires an operational, as well as strategic, perception of the performance and process.
2. Benchmark current performance
Create a short list of appropriate publicly listed peer organisations to benchmark against your working capital performance for the past five years. The external benchmarking should be supported by an internal look at the historical performance and trends of various business units and geographies. At the same time, try to assess the environment to understand which best practices and capabilities really are making the difference in performance.
3. Understand your environment
The next step is to study your process and management framework. What is the strategy and governance structure? How is the organisation set up? What metrics do the team collect and what incentives do they offer for superior performance? What kind of technology do they use? How seamless is the company’s cash cycle? What elements of best practice are in place, or are missing in the end-to-end process? If some aspect of the system is underperforming, is there a legitimate strategic reason for the underperformance?
4. Determine the potential for improvement
Working capital performance is measured by the amount of time (days) cash is tied up in the different elements of the cash conversion cycle. Accurate, meaningful, real-time information is essential to create a solid foundation for change and to focus your organisation on the right corrective actions. Translating this into meaningful metrics and targets, based on the external and internal benchmark, will give you a clear understanding of the overall potential and which areas offer the best ROI.
5. Identify key outputs and next steps
Once all this knowledge is assembled, the desired outcomes should be clear. Which area offers the greatest value? What are the key elements driving lagging performance – are they in a specific process element or are they enablers such as strategy, governance, training? When those outcomes are visible, company strategists can begin to make informed choices about which aspects of their working capital process should be refined first, and how much effort is needed to embed practice changes throughout the organisation.[[[PAGE]]]
Raising the bar
Developing a higher level of working capital competence sounds relatively simple, but the execution can be quite complex. From the warehouse to the sales desk, from procurement to finance, everybody needs to work together to achieve a common working capital goal.
Two sets of factors prevent companies from achieving a higher level of working capital maturity. The first set is missing pieces. Often, companies lack all the people and systems they need to create a streamlined process for their cash management. Knowledge and involvement of many functions is required to embed changes at the level of execution. The second set of factors is conflicting aims. Different parts of the company often want different things. For instance, sales often wants to give lax payment terms in order to close the deal, while finance wants tighter terms to speed up the cash cycle. All in all, more working capital in the system makes most people’s day-to-day jobs easier – a mentality that can be tough to break.
Greater working capital maturity won’t make all these tensions go away – cash management trade-offs are inherent in almost any business – but it will help the company make an informed decision about the best choice for the company as a whole, rather than for a particular silo. Even when the main issues are resolved, don’t expect them to stay that way. As with any training regime, working capital management is always a work in progress. To stay ahead, the company needs to develop a true cash culture.
