Working capital represents the hard cash that is required to run a business day-to-day. Effective working capital management can be the lynchpin to making growth profitable – it’s what Dell Computer has focused on in order to dominate the computer industry. But because it doesn’t show up in the P&L or divisional budgets, working capital typically receives less attention from management than it deserves.
The result is excess working capital, and that means that too much cash is tied up in running the enterprise, too much capital is required to grow the enterprise, and the business faces unnecessary exposure by holding on to assets that are much riskier than cash.
Cash in the form of working capital gets tied up in two primary areas:
- Accounts receivable. Significant cash can be tied up in receivables, and in particular by invoices that generate exceptions. In case studies, 60 to 80 percent of invoices are clean and handled within 30 days. The remaining 20 to 40 percent have exceptions and take 100 days to process. Fixing this problem means that the equivalent of twenty days of sales tied up in accounts receivable can be turned into free cash flow. And there can be even more cash available by identifying and contracting for the non-price terms that will motivate your customers to pay immediately.
- Inventory. Excess inventory is often embedded within the enterprise due to poor systems for tracking inventory, sub-optimal replenishment policies that lead to over-purchasing, and unmanaged supplier lead times. In a case study, over 50% of the inventory investment generated only 13% of the total gross profit, while a select 30% generated 70% of the gross profit. Changing systems and policies means that the equivalent of nine days of sales tied up in inventory can be turned into free cash flow.
Co-Plenish’s approach to working capital reduction
Coplenish helps clients reduce receivables as well as inventory. We tackle both types of opportunities using a three-phase approach. The first phase is Value Assessment, where we audit current performance, identify root causes of excess working capital, and determine how much working capital can be unlocked from the business. The second phase is Business Process/Rule Redesign, where we develop solutions and a plan of attack. The third phase is Implementation, where we work with clients to realize results.
Here’s what our three phase approach looks like for reducing accounts receivable and for reducing inventory.
Reducing Accounts Receivable
Phase 1 - Value Assessment During this phase, Coplenish focuses on identifying where cash is tied up in the enterprise. We use segmentation approaches to identify which areas of working capital have the best potential for significant reductions, including root causes of delay and potential terms to accelerate payment. For example, we analyze invoices to determine how quickly they are turned into cash and segment them by process, customer, product, and/or service type to find the types of invoices that result in long receivables. We then identify and analyze the root causes are for the delays in receivables. Figure 1 illustrates an example from a manufacturing enterprise.
Figure 1: Manufacturer Case Study
Based on this analysis we can make an initial determination about the amount of cash that can be turned into free cash flow and about the business process/rule changes required to release it.
The output from this phase is a map of where cash is tied up unnecessarily and what root causes need to be attacked in what sequence.
Phase 2 – Business Process and Rule Redesign During this phase, Coplenish works closely with client staff to develop solutions to the root cause problems found in Phase 1. Each new procedure or business rule is documented with specific goals to be reached. We work to develop a program for managing the changes required including training, incentives, measurements, human resources, and potentially systems. From this program a detailed implementation plan is developed with project staffing, timelines, milestones, responsibilities, budgets and decision points.
Phase 3 – Implementation During the implementation phase, Coplenish acts as guide and monitor of the implementation process making sure that the results are achieved. We bring particular expertise in ensuring that implementation efforts yield financial results, and employ a highly effective distributed project management tool to make sure implementation programs stay on track and reach the desired results.
Reducing Inventory
Phase 1 – Value Assessment We start by segmenting inventory into categories based upon turns, sales levels, lead times, return on inventory investment and/or service levels to identify pockets of excess inventory. An example of this for a distributor’s inventory is shown in figure 2.
Figure 2: Distributor Case Study
We then identify and analyze the root causes for the excess inventory by examining inventory policies, systems and behaviors. Based on this analysis, we can make an initial determination about the amount of cash that can be turned into free cash flow and about the business process/rule changes required to significantly reduce inventory.
The output from this phase is a map of where cash is tied up unnecessarily and what root causes need to be attacked in what sequence.
Phase 2 – Business Process and Rule Redesign During this phase, Coplenish works closely with client staff to develop solutions to the root cause problems found in Phase 1. Each new procedure or business rule is documented with specific goals to be reached. We work to develop a program for managing the changes required including training, incentives, measurements, human resource and potentially systems. From this program a detailed implementation plan is developed with project staffing, timelines, milestones, responsibilities, budgets and decision points.
Phase 3 – Implementation During the implementation phase, Coplenish acts as guide and monitor of the implementation process making sure that the results are achieved. We bring particular expertise in ensuring that implementation efforts yield financial results, and employ a highly effective distributed project management tool to make sure implementation programs stay on track and reach the desired results.