It’s essential for businesses to be able to show flexibility in order to survive, and when it comes to working capital optimization, organizations should deploy solutions effectively to minimize disruption and achieve the desired outcomes.

May 05, 2020
By Taulia
By Taulia

In order to remain competitive, companies need to be able to invest in infrastructure and research and development, but the necessary working capital is not always readily available. This can apply to companies of all stages and sizes. Tech start-ups may have the ideas and talent needed to bring new products and processes to life, but they can be constrained by a lack of cash reserves. Large businesses, meanwhile, may have considerable funds available within their balance sheets – but unlocking this source of cash is not always straightforward.

Working capital optimization is a strategy that can be rolled out to manage the balance between assets and liabilities – the two components of working capital – with the aim of maximising capital efficiency. A properly optimized approach to working capital management will ensure that a company always has appropriate cash flow to meet its debt obligations and overhead expenses.

Whilst adapting your approach to working capital management is straightforward in theory, this aspect of project management can be challenging – particularly for globally dispersed and decentralized organizations. But it’s not impossible. Here’s everything you need to know about optimizing your working capital.

Proactive working capital optimization

As freeing up cash has become a priority for companies around the world, organizations are taking a creative approach to unlocking working capital. Today it’s acknowledged that a good place to look is inside the business. This has the benefit of every leader, from CEO downwards, having a clearer insight into the company’s working capital management goals.

Taking a proactive approach to working capital may bring considerable benefits. Research conducted for Taulia by the Supply Chain Finance Community/Windesheim University estimates that the size of the global supply chain finance market could be as much as $14 trillion in annual spend volumes. The same research also suggests the finance costs across the entire supply chain could be as much as 6-8% of the cost of goods sold – indicating another area of opportunity for companies looking to optimize their supply chains.

The right working capital optimization team

In order to find sustained success, it’s often necessary to implement meaningful change at all levels of the business – taking a holistic view of the organization’s working capital goals and strategy. Businesses should make the most of what’s available to them: harnessing the power of technology and choosing the best people for the job should be a priority.

Those who lead the working capital optimization project should understand the benefit of a sustainable supply chain and see value in making the organization a preferred customer for innovative suppliers.

Any working capital optimization project should include several internal stakeholders from the outset:

  • Treasury – to take the lead in a cash optimization program
  • Procurement – as a critical player in relationship management with suppliers they should ensure that new arrangements are positively communicated
  • IT – to connect new tech solutions with existing systems
  • Legal – to rewrite contract terms and ensure that new practices are in line with legislation
  • Accounting/internal audit – to ensure the changes appear on the balance sheet
  • Financial control – to monitor impact
  • Accounts payable/shared services – to negotiate working arrangements with suppliers

Communicating with suppliers

Communicating with suppliers at this time is vital especially if your new optimization program needs their involvement – as changing a way of working to match new methods can be difficult at the best of times. Procurement departments would generally take on this responsibility, supported by Treasury as well as by the organization’s partner organizations.

Segmenting the supplier base is a prudent measure and allows you to ensure that messages can be communicated in a way that works for the supplier. For example, suppliers which represent a high spend may need more regular communication than long-tail suppliers.

Choosing the correct approach to working capital optimization

First and foremost, it’s important to be clear about your goals from the beginning of the project. Failing to identify the scale of the working capital optimization opportunity may lead to short-sighted and unambitious goals, resulting in a program which fails to deliver significant value.

Tactical vs strategic working capital optimization

It is also important to differentiate between a tactical and a strategic approach to working capital optimization. The differences between the two is not just semantic.

A tactical approach – such as using tools like reverse factoring or procurement cards in isolation – can enable companies to address specific issues, such as alleviating the impact of extended payment terms on suppliers. However, tactical measures cannot deliver the full potential of the supply chain opportunity.

In order to achieve a more meaningful change, companies need to focus on more strategic objectives:

Be clear on financials

You may lack a detailed understanding of your suppliers’ financial position – but the right digital tools can give you a clear view of both your own working capital position and that of your suppliers.

Enable flexible levers

You may be looking to improve working capital, capture more early payment discounts, get better returns on excess cash, improve margins or de-risk the supply chain. Or you may be looking for all of these things. Either way, you’ll need a flexible solution that can help you achieve your goals.

Communicate between departments

The goals of different departments can often be misaligned. By collaborating in a cross-functional team, goals and corporate strategic objectives can be aligned.

Include suppliers in your strategy

Suppliers shouldn’t be an afterthought in a working capital optimization program. It’s supply chains that compete, rather than individual companies – so a successful cash flow optimization strategy should encompass all suppliers.

Take a long term view

Any working capital optimization program should be flexible enough to adapt the source of funds as the business needs change. For example, being able to switch from a third party funded SCF program to a self funded dynamic discounting program. This shouldn’t however interrupt the supplier experience. In our most recent supplier survey,  56% of all suppliers, both small and large businesses, were interested in requesting early payments, with 34% of respondents citing managing cash flow as the core motivation.

Partner selection

Ascertain whether yours and your prospective partner’s goals are aligned. Where technology is concerned, it’s also important to look at factors ranging from ease of use and the availability of human support to whether the functionalities included deliver added value.

Likewise, your partner should be able to give you insights that may not otherwise be available. For example, AI technology can proactively identify the best time to make early payment offers to suppliers. The business case should be built on an ROI that considers the value the partner brings, rather than on cost alone.

Ensuring sustainability

Another point to bear in mind when deploying a working capital optimization solution is that cash optimization is an ongoing mission. To ensure that success sticks, you’ll need to be sure that people won’t slip back into old ways of working.

For example, when new suppliers are onboarded – or when new people join procurement – there may be a risk that specific suppliers are granted exceptions, undermining the goal of achieving standardized payment terms across the company. It’s essential to remain vigilant and ensure that the great processes put in place continue to be applied rigorously.

It’s also worth bearing in mind that competitive advantage will not last forever. As your competitors start to adopt similar strategies, the gap may narrow –it’s important to keep reviewing the project and exploring any new opportunities that may arise for value creation.

Avoiding the pitfalls

When going through big changes, company preservation is key. How do you ensure that clients, suppliers and workers are all on board to see through the change? Whilst managing existing relationships properly and softening the change with adequate communication will surely make the transition easier, a heavy-handed company-centric approach may also result in bad press.

Shared benefits should be made available across the supply chain as a whole, ensuring that voluntary codes of conduct are adhered to – demonstrating corporate social responsibility towards your supply chain.

Companies should also be aware of other industry developments that may have a bearing on their working capital optimization practice. Avoid legal issues by thoroughly researching payment codes, guidance with dealing with SME suppliers, and local business codes.

A strategic role

Going forward, businesses should prioritise their new ways of working. Strategic roles are crucial to maintaining new processes – whether that’s overseen by a specific person or by multiple people as part of their existing roles. Strategic roles would be involved in developing a plan, securing sponsorship from the CFO, delivering the plan and reporting on the results – as well as spearheading a culture change and building cash consciousness across the organization.

The person in this role would therefore need to look at how stakeholders’ performance metrics and reward mechanisms act as incentives or disincentives. They would also need to take responsibility for a system of governance embedding the desired practices, thereby making it necessary to argue a business case before any exceptions to the standardized rules can be agreed.

Measuring the success of working capital optimization

Setting clear goals and KPIs is a great way to measure individual and collective success as you seek to better optimize working capital

Working capital metrics

To determine whether your approach to working capital optimization is working or not, it’s important that you know what to measure. That’s what working capital metrics are for –visibility over these fundamental metrics helps you to build an understanding of benchmark performance and enables tracking of tangible improvements.

The basic measures of success in any working capital optimization program are as follows:

  • Days payable outstanding (DPO) – the number of days taken to pay supplier invoices.
  • Days sales outstanding (DSO) – the number of days taken to collect payment from customers.
  • Days inventory outstanding (DIO) – the number of days taken to sell inventory.
  • Cash conversion cycle (CCC) – the number of days that cash is tied up in inventory and receivables before being converted back into cash, calculated as DSO + DIO – DPO = CCC. The lower the CCC, the more efficient the cycle. Some companies may have a negative CCC – meaning that they receive cash from customers before their suppliers have to be paid.

While these standard metrics are useful in a game-changing cash optimization strategy, they only tell part of the story. That’s because they focus solely on the organization’s working capital strategy and do not take into account its other strategic goals – or, indeed, the impact of a working capital optimization program on the supplier base.

Measuring program success

While the strategic goals of the program should be regarded as the first measure of success, you can also use a number of other measures to assess whether a program has been effectively deployed and communicated to suppliers, and whether the offering has proved attractive for them.

Then, as the program is rolled out, you can monitor how many suppliers have been informed about it – and how many have enrolled. The difference between those numbers may shed light onto how attractive the opportunity is for suppliers and/or how effective your communication has been.

Finally, measures related to AP costs can give you a clear indication of the program’s success. These can include headcount, processing error rates, numbers of phone calls or email enquiries from suppliers and the proportion of invoices handled on the platform. Particularly important is the speed with which invoices can be approved for payment: the longer it takes to do the necessary three-way matching and sign-off, the longer suppliers will have to wait before they can avail themselves of any early payment opportunities.

Gathering feedback

As with any new project, it’s important to gather feedback to gauge feasibility and success. Arrange to speak with people at all levels of the business to get a well-rounded view. The list of internal stakeholders to involve above should act as a starting point.

Although meeting face-to-face might prove difficult, it’s relatively easy to set up a quick online survey. Try setting up one for your co-workers to provide feedback, as well as one for external collaborators like suppliers and manufacturers, too. This way, you’ll be able to honestly assess how the project is working, and where there is room for improvement.

Just remember – with any new project, there will be teething problems. The way to work through them is to plan, communicate and listen. From there, you can build the foundations of something that truly has the power to make an impact.