The most obvious objective of optimizing net working capital is the concrete release of cash from the balance sheet. Processes are fine-tuned to turn the inventories faster, commercial agreements are re-negotiated in order to agree on more beneficial terms, such as, payment terms, freight terms and inventory related agreements.
But is that all?
In an economy with low interest rates, is the target of capital release itself enough to qualify working capital optimization as a must win battle, a key strategic initiative?
In addition to capital optimization there are distinct benefits we should consider. Let’s discuss the top 5 reasons to focus on working capital management – on top of just generating a pile of cash.
1. Working capital is the best indicator of a company’s operational effectiveness
Companies with less tied capital are more profitable. This is a fact. Optimizing working capital equals to optimizing a company’s core processes. This again translates to operational efficiency and effectiveness in everything, i.e., a more profitable company. Sounds good?
2. Companies with poor working capital management are wasting their EBIT
This is not a surprise at all. When a company has poor focus on working capital, they are producing wrong products at the wrong time, leading to lower margins due to discounts and eventually to scrapping of inventory. On the other hand, strict and proactive collection processes prevent the need to write down bad debt. To name a couple of examples.
3. In today's fast-paced markets, flexibility is a competitive advantage
Profitable companies shorten their lead times. Working capital optimization is a lot about shortening lead times, removing or improving non-value adding tasks, and preventing commitment on inventories in advance of actual customer demand information. This all means improved flexibility. As speed of change is continuously increasing, a more flexible company wins the game.
4. Top management wants peace of mind on core operational performance
The focus on optimizing many of the companies’ core processes is not only about improving cash and profitability. Structured processes and a cash-focused culture translates to improved control on processes, robust management model, and simply enhanced organizational capabilities with better project management practices. This all means that top management can trust the organization in managing the basic operations, and their daily focus can be directed on other important business decisions.
5. Finance your growth or strategic development initiatives by releasing cash from your own operations (instead of using external financing)
Fine, you are right. This is kind of the same thing as releasing capital. But not 100% the same. Due to the internal politics or just personal relationships among stakeholders, sometimes it is just easier to finance the growth initiative or the strategic development program by using internal financing. Although external financing on a development idea would make sense based on a business case calculation, it is just not always possible to get your hands on that money. But, if you release it yourself, that might change the situation.
“Companies with less tied capital are more profitable. This is a fact.”
Working capital programs are about releasing cash. But on top of that, much more. That is why companies with less tied capital typically beat the competition.
What other benefits are there when you focus on improving operational capabilities and capital efficiency?
Mikko Myllys is Capacent's sales and marketing director in Finland. Mikko holds over 15 years of experience in working capital management, management consulting and change consulting from various industries.