21 January 2009

The Benefits of Working Capital Optimisation

Working Capital – the amount of cash tied up in accounts receivable, inventory and accounts payable will be the No. 1 issue for many businesses in the months ahead as they fight deteriorating market conditions.

Whilst it will be critical to keep a tight control on working capital, as a deterioration in accounts receivable days or stock turnover will have serious impacts on cash flow, there are always significant opportunities to improve the current level of working capital to improve cash flow.

The following is an example of the level of cash that can be released:

Average Receivables $10M (55 days/sales)
Average Payables $7M (40 days/sales)
Average Inventories $3M

By reducing accounts receivable collections by 5 days (or 10%) we would improve cash flow by $1M. By increasing accounts payable by 4 days (after negotiation) we would improve cash flow by $0.7M. By reducing stock levels by 10%, $0.3M cash would be released.

There are a range of strategies which can be deployed to achieve these results which could result in an improvement in cash flow of $2M or more. This “released” cash could then be used for debt reduction, capex/re-investment or return to shareholders.

As a result of making the improvement this business becomes more efficient, return on capital is increased, and management’s cash flow targets are exceeded.

Our experience in running Working Capital Optimisation in a range of different businesses shows that a 10% improvement tends to be at the lower end of the range achieved. Some of our client businesses have generated up to 25% improvement in their working capital - equivalent to a release of up to $4.5M in the above example.

As a business process, working capital is driven by an interlinked series of activities we refer to as a working capital chain (purchasing stock, manufacturing goods, selling the goods, and collecting and making payments etc.)

Working Capital Optimisation uses what we call a holistic approach – exploring the processes along the chain and improving the management of working capital from end-to-end by working with the key people who drive it to enable them to discover improvements.

The key features of this process are:

 it involves the people driving the working capital chain;
 it raises their awareness of the value of time in relation to working capital;
 it shows them the processes they are involved in and how they are performing financially;
 it provides a structure within which they can identify and explore problems and opportunities;
 it enables them to discover how to change permanently what they are doing in order to release cash, both through improvements in internal processes and through changes in the way they trade externally;
 and, crucially, it motivates them to implement those changes.

Improving working capital management by as little as 10% can generate significant cash flow, and this is possible even when no obvious working capital problem exists.

If you would like more information on the range of initiatives which can be implemented please do not hesitate to contact us.


Michael Fingland
Managing Director


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