Sustainable working capital management is not only about improving processes, having shiny-looking KPI reports in place, and fine-tuning your balance sheet. Working capital management is a cross-departmental discipline that poses particular challenges within your company’s organizational setup. Today, we want to take you through some ideas on how to establish working capital management as a foundation of your organization.
Divergent goals complicate working capital management
Let's first take a look at some usual departmental objectives and how their divergent goals complicate working capital management. Sales is there to generate revenue; to make sure your business is having a continuous cash inflow. For this, you need a high availability of products and often it’s considered to be a benefit to boast a large portfolio with multiple variants or configuration possibilities. Specifically, it’s your company’s perspective that your edge on your competitors is offering customized solutions with short lead times and extraordinary service (let me tell you something: your competitors are thinking the same thing). This typically just ends up with unnecessary inventory being held in stock to avoid the Supply Chain area being blamed for losing potential business. Paired with payment terms that favor your customers but increase your days sales outstanding, there’s no wonder that you are seeing poor working capital performance.
Another area of tension is Production. Production classically aims at minimizing production costs through high machine utilization, large batches and low number of variants- at odds with the sales department, at the very least. This typically leads to increased works-in-progress and finished goods inventories. As Procurement typically aims for low purchase prices (sometimes mistakenly called total cost of ownership), these large order quantities often end up as slow-moving or obsolete stock. Based on your negotiation power (not your supplier relationship), agreed short payment terms lead to quick cash outflows, increasing the necessity for external financing.
As the goal of working capital management is to ensure liquidity and financial independence, these dilemmas illustrate that sustainable working capital improvement requires an organization that manages working capital holistically.
Working capital management starts at top management
So, how can you establish working capital management in the groundwork of your organization? First of all, it has to become a top management priority. Working capital is a cross-departmental matter; it’s therefore top management’s responsibility to align diverging goals and to define an appropriate incentive scheme. Secondly, we recommend creating a central role within your Controlling function to manage and coordinate working capital. This role should act as an interface between all involved business units to monitor working capital KPIs, and to centrally push and manage improvement initiatives when necessary. This role should further be equipped with deep knowledge about the three domains of operating working capital - order-to-cash, forecast-to-fulfill and purchase-to-pay - and have a strong personal network across your business to ensure buy-in.
Managing working capital is not a year-end closing activity
Effective working capital management shouldn’t be a retrospective activity; it starts at the beginning of the year, when working capital targets should be set and agreed with the CFO. Here, concrete measures and responsibilities should be defined to hit the ambition level. In monthly touchpoints, the achievement of targets should be checked and countermeasures agreed when necessary. Towards year-end, additional short-term measures might be required to achieve the targets - but these should not become a matter of course. In order to establish a culture of continuous improvement, we recommend to additionally coin a “working capital community”. This community would consist of key stakeholders from all relevant business functions meeting in quarterly cycles to exchange the status of ongoing initiatives and any lessons learned.
It should be obvious that working capital can only be optimized when tackled holistically and with C-level attention. By positioning working capital management at top management level, it will not be jeopardized by conflicting departmental goals and misleading incentive schemes. Defining a concrete ambition level at the beginning of the year and initiating improvement measures that are continuously being tracked centrally will lead to effective and sustainable working capital improvements.
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