Working capital management for investment in profitable growth
How cash management is key to facilitate profitable growth stories.
05.12.2022 | Article
During recent years, CFOs and their finance departments have faced several crisis situations that have forced them to react more quickly to changing economic conditions . This trend has kept resources busy developing faster planning mechanisms and shorter reaction times in order to come up with scenarios that show where investments promise the highest returns.
In this environment, working capital management (WCM) can ensure that all relevant processes are set up in the most efficient way. Cash available within operations can then actively be used instead of generating additional debt. This provides financial stability and facilitates crucial investments without more interest payments.
Due to a fundamental conflict of interest between the traditional “EBIT-focused” perspective and a more modern “cash-oriented” approach, some finance professionals still regard working capital management only as a necessary evil to avoiding bankruptcy.
Advocates of the “EBIT-focused” camp primarily focus on maximizing profitability by increasing sales and keeping costs at a reasonable level. They thereby often overlook the manifold benefits that sustainable working capital management can bring. Most importantly, funds that are not tied up in operations can be used to develop new business fields and opportunities without additional capital costs. Most traditional trade-offs due to contradicting targets of EBIT-focused steering and WCM can be found in procurement, production, and sales (Fig.1).
Although there are already various approaches for temporarily fixing cash leaks by taking a closer look at negotiated terms, invoicing, or payment processes, most companies struggle to implement working capital as a philosophy within their strategy and daily routines.
Current challenges such as the latest material shortages, price increases, and growing scarcity of skilled labor make it even more difficult for companies to leverage their financial resources effectively. Instead, past failings threaten to reach a tipping point where additional debt suffocates any potential business case as a consequence of the gloomy economic prospects in combination with the rocketing interest rates of recent months.
These times can become a golden age for best practice companies who have already developed an organizational framework and a supporting toolbox. However, companies without readily available tools and methods will eventually lose time and money. Either they must start from scratch, or they fail to use the full potential from funds tied up in operations. Taking a closer look at best practice examples can therefore help to speed up the launch: A global beverage manufacturer has, for example, established WCM as one of the key levers for improving free cash flow – one of its key metrics in the corporate strategy. Establishing free cash flow as a strategic key metric makes it a focus topic for the entire management team and especially the CFO. Achieving the strategic free cash flow goals was positively recognized by the capital markets, which reward competitive working capital ratios.
Inefficient use of working capital occurs in many places throughout value-generating processes. Detected insufficiencies can be dealt with in two steps: First, problems are identified, analyzed from a technical perspective, and then fixed in the short term. This typically happens by task forces and dedicated projects that concentrate on quick fixes. Typical quick fixes can be factoring or collecting outstanding debt and selling off obsolete inventories.
The second step must then focus on implementing WCM in the entire organization. This often requires profound adjustments within the organizational model and steering mechanisms, carefully considering any implications, e.g., on corporate culture. Since these changes affect the entire organization and not only sub-divisions within the finance department, they require far more finesse to excel in this step. However, if conducted correctly, this action is the crucial key to a successful and sustainable WCM approach. Coming from an end-to-end-view, critical processes in most cases involve interfaces with stakeholders in procurement or sales. To avoid complications during the roll-out of developed concepts, it is important to involve them at an early stage and make sure they are fully committed and contribute to all concepts and potential changes of roles and responsibilities. The set-up of cross-functional “reference point alignment sessions”, for example, has provided fruitful discussions in the past and helped to identify roadblocks ahead.
The major challenge to overcome when implementing a successful WCM approach is not only to extend the organizational model in a way that reflects the relevance of cash-related topics accordingly, but also to watch out for any resistance within existing management and leadership structures. The establishment and operationalization of steering mechanisms accompanied by the implementation of transparent key performance indicators can only succeed with sufficient support on all hierarchy levels. Therefore, it is critical to get all key stakeholders on board in an early phase and plan related change and communication activities in advance. This applies not only within finance departments but also in the neighboring departments along the value chain. The three dimensions of the cash conversion cycle (Fig. 2) indicate related counterparts within sales, procurement, and production that must be taken into account in order to ensure end-to-end process consistency.
Together with all relevant stakeholders, strategies throughout the whole cash conversion cycle can be developed to reduce inventories and receivables and to extend payables.
However, the journey to excellent WCM is not over at this point. The implementation of a comprehensive approach must be enriched by deploying continuous improvement mechanisms, such as recurring process reviews, an ongoing collection of improvement ideas and of course rigorous KPI and implementation tracking. A corporation must establish a mindset within all hierarchy levels that continues to generate corresponding initiatives after initial implementation of measures in order to really strive towards a best-in-class working capital and cash situation in the long term.
The major advantage of this approach is that it aims to create self-fueling structures instead of one-off effects. Every additional improvement frees up resources that can be invested in further growth, thereby compounding additional value instead of causing cash outflows due to interest payments.
Since the current challenging economic times can be expected to persist for a longer time horizon , ensuring long-lasting WCM excellence empowers corporations to generate a competitive advantage. Consequently, working capital management must be seen rather as a long-term investment and not just as a quick fix.
(1) https://www.ifo.de/fakten/2022-09-26/ifo-geschaeftsklimaindex-auf-breiter-front-gefallen-september-2022
(2) https://www.oecd.org/economic-outlook/september-2022/
