Uncovering Cash Through Dynamic Working Capital Management

by Sven Lindemann, CEO, Hanse Orga

Efficient working capital management is generally known to be key to releasing valuable liquidity and to making the best use of a company’s own resources. In fact, with the right approach, CFOs can release significant levels of liquidity depending on their individual situation and on their industry sector. Working capital management is a hot topic that keeps going up and down on the corporate agenda worldwide. During times of crisis, significantly more companies are concerned with getting more out of their internal resources and focus on efficient working capital management. In times when cash is readily and cheaply available on financial markets, working capital often drops to the bottom of the corporate agenda. So, what keeps companies from taking greater control of their valuable internal resources?

One answer can be found, among others, in the source of the data that is usually reverted to in order to measure the typical working capital KPI including Days Sales Outstanding (DSO), Days Payable Outstanding (DPO) and Days Inventory Outstanding (DIO): in most cases, these are derived from the annual financial report or quarterly or monthly financial balance sheet and P&L figures. While a monthly analysis is already much better than an annual analysis, the limitations of even monthly reports become clear instantly: the analysis can only deliver a snapshot of the processes at a certain reference date. It doesn’t tell you, however, what your metrics and your cash position were like a few days or even just one day before or after that particular date. In essence, this approach lacks dynamic reporting!

And what’s more: somebody has to actively, in many cases manually extract the data and analyse it, which is why some companies are reluctant to measure their working capital KPI altogether.

According to the experience of Hanse Orga, which offers tools and consultancy for working capital management, companies that keep a firm hold on the processes affecting their working capital are usually much better prepared for when the next crisis hits and can get through turbulent times without major difficulties. Additionally, companies with efficient working capital management are in a better position to streamline their internal processes so that they profit from much greater efficiency. Moreover, they also achieve optimal levels of liquidity and they become more independent from external funding.

Higher levels of working capital management processes provide transparency of data for management decision-making, ensuring the short-, medium- and long-term liquidity needs of the business are met in the most cost effective way. Instead of maintaining high bank account balances as protection against an unexpected cash shortfall, working capital is better used to further the strategic development of the company. You just need to know exactly how much cash you need and how to enhance your processes to ensure that you maintain optimal levels of cash at all times. Through exact cash forecasting companies will know how much cash they will need, in what currency, when and for what purpose. Consequently, defining the optimal level of working capital they need to fund the daily operations of their business securely is vital. Working capital management matters to every company regardless of size or industry sector.

So what is it that companies seek to achieve when they embark on the project of optimising their working capital management? Their aims usually are:

• to ensure sufficient liquidity at all times for their business
• to increase profitability of their company
• to release value cash for investments or for reducing external funding
• to enhance processes

But how can organisations best accomplish these aims and reach optimal levels of working capital management?

Real-time data and continuity are key to success

What is really needed to get your working capital working for you is a broad, sound and dynamic analysis of your processes. So if you start a working capital management project for the first time or if you want to improve the one you already have, make sure to overcome the limitations of traditional working capital analysis which is static and historically focuses on DSO, DPO and DIO.

To be able to reap the benefits and uncover the trapped cash, it is essential to identify the cost-drivers in accounts receivable and payable. For this, you will need to look beyond the key metrics of DSO and DPO and analyse the details of your financial processes in a holistic way. That includes amongst others:

• Billing and settlement processes
• Payment conditions in purchase and sales
• Revenue management and dunning process
• Control and steering of outgoing payments

To obtain the data to properly evaluate these processes, you would normally have to manually go through a lot of paper work including, in particular, your invoices and transaction data. Modern technologies, however, like the new analysis tool Hanse Orga has developed, can lift the processes to an entirely new level: collating the above-mentioned parameters is done automatically by drawing all the necessary information from your documents and transaction data. In that way, companies can achieve a truly dynamic analysis of their processes relevant to an efficient working capital management model. Instead of comparing static data on certain reference dates, such tools can give you in real time all the data you need to enhance your processes.[[[PAGE]]]

For optimising inventories a lot more work is necessary, as more departments are involved in buying, selling, managing and accounting for them. By focusing on the accounts receivable and payable processes however, companies can already uncover significant amounts of cash. Measures that will help reduce working capital levels give you better control over your cash and create positive effects for your balance of accounts including the acceleration of collection processes and better control over the payments processes.

Accelerate collection processes

There are a number of options to speed up the collections process in order to ensure faster and more reliable incoming payments such as shorter payment terms, early payment discounts and reducing the time it takes between delivery and billing. You also need to know the payment behaviour of your customers to ensure that you have the right approach for your individual customer and consequently achieve better payment morale across the breadth of your customer base.

Getting your customers to pay on time is a key step towards optimising your working capital. To take the right measures for that you need to know which of your customers usually pay on time and which do not; by how many days the payment typically comes in late and whether a customer always pays late or only sometimes. The latter is particularly important as you do not want to risk confrontations with your valued customer who usually pays on time.

You need to know whether the payment terms you grant are too generous or whether there is the opportunity to shorten them without offending customers. Through shortening the terms you can start chasing any bad debts earlier and ensure better cash position for your company.

   Click image to enlarge (opens new window)

Offering early payment discounts can help improve cash collections. But at what cost? At the current times of low interest rates everywhere, an early payment discount allowing one or two per cent off the invoice amount is very favourable for customers. For the vendor, that may mean that he is getting the cash in very early, because his customers are likely to take advantage of the excellent conditions. For the vendor however, an early payment discount always means a loss of profit. This can be seen in figure 1 which shows the case of customer no. 62625 who is one of the fastest to pay his bills, but who is at the same time the one that causes the greatest expense through high cost for the supplier in areas unrelated to a specific invoice. It is therefore advisable to evaluate exactly how the costs of the discount are offset against the cash that comes in early and whether he can afford to offer such discounts. This is what specialised technology can deliver with a mouse-click. Beyond the consideration of the price components, modern business intelligence tools can automatically calculate the effects on balances and on profit & loss accounts.

Optimise outgoing payment processes

There are also a number of areas in the payments processes that can be enhanced. For example, the number of payment runs per week or per month can reveal interest potential, if the working capital analysis shows that outgoing payments are frequently made too early. Due to such early payments, a company loses out on interest opportunities. The same goes for early payment discounts. If companies do not make use of such discounts they give away opportunities for saving money, money which they could use for investment returns. Particularly in times when interest rates are low on the market such early payment discounts present significant savings opportunities.

Another area which is easily overlooked when it comes to optimising working capital is the identification of the due date. It is not unusual that the due date is calculated based on invoice date. It is common however that due date calculation only begins from the day the goods are delivered or the invoice is actually received. By identifying such discrepancies and adapting the internal processes accordingly, companies can further optimise their working capital level.

New methods and tools for analysing working capital

One of the greatest advantages of using new working capital analysis methods is that for the first time, companies will be able to obtain comprehensive real-time data and to achieve dynamic analyses and enhance management decision-making. Such a broad data set empowers companies to evaluate their working capital metrics over time and track any improvements through changes in processes. Moreover, they will be able to compare metrics for their corporate entities, for individual customers, for sectors and other criteria which can be flexibly selected depending on the individual corporate situation. In summary, these are the most valuable benefits of the new methods and tools:

• Dynamic working capital management
• Based on comprehensive real-time data (transaction data and documents)
• Continuous analysis
• Flexible selection of criteria for individual reporting
• Comprehensive reporting – from aggregate to highly granular level
• Immediate identification of process inefficiencies
• Ability to react quickly and improve processes instantly

[[[PAGE]]]

Value of the new approach

Companies can release valuable liquidity and sustainably enhance business processes by using new dynamic, comprehensive analysis tools for working capital modelling which had not been possible before. Manual efforts that used to be involved in such analyses are eliminated, and automated analyses are now available to companies by a mouse-click. This new approach is optimal for companies who do not see working capital management as a one-off project, but who are instead seeking to foster continuity in their working capital management to shed light on the hidden potential within historic and incomplete working capital management methods.