5 Steps Finance Leaders Can Take to Improve Working Capital Efficiency
How the macroenvironment is affecting working capital efficiency today
Does your company’s working capital work as hard as it could?
We’re facing a macroenvironment unlike most of us have experienced or imagined: inflation at a 40-year high, increased capital costs, supply and labor constraints, and a lingering pandemic. In response to how costly debt has become, organizations are reassessing capital expenditures. CFOs and finance leaders want to understand how budget profiles may have changed, for example, and which investments should be postponed or canceled.
Businesses typically focus their response on allocating cash and refinancing debt. A third lever is improving working capital efficiency — that is, making working capital work harder. In a perfect world, this means your company organizes and coordinates financial resources in ways that help the business meet debt obligations and short-term operating costs and invest back in the business, all with as little waste as possible.
But we’re not in a perfect world.
What is working capital efficiency?
In very simple terms, working capital efficiency is a number that indicates how well a company is balancing both the money it’s owed from customer sales and the money invested in inventory against the money the company owes for acquiring that inventory. On this level, working capital efficiency can be displayed with clear measurements, such as ratios, benchmarks, and line plots. (We discuss working capital management in greater detail here.)
Improving working capital efficiency, however, is anything but formulaic. It asks finance organizations to take a close, critical look at strategy.
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What are some challenges to improving working capital efficiency?
How you gauge working capital efficiency — and improvements in that area — also depends on how your organization was holding on to cash before the pandemic hit. Some companies, for example, followed the path of de-risking and broad cost-cutting. Now they’re discovering they can’t necessarily revert to those pre-pandemic spend patterns. Another example: Companies which experienced astronomical revenue and margin growth and are now transitioning to sustainable growth. In many cases, their pre-pandemic working capital management was limited to safe R&D investments.
If you’re shifting your attention to working capital in your organization, you might encounter some obstacles. One is visibility — being able to see the complete financial picture in real time. And knowing where liquidity and cash are trapped (such as in inter-company payments) is just the start. Data silos and fragmented systems often prevent you from getting answers to questions like:
- What early payment discounts do we have, and are we taking advantage of them?
- How quickly can we switch to virtual cards to get control of spend?
- Do I have struggling suppliers who also pose a liquidity risk?
Visibility alone, of course, doesn’t make working capital more efficient. It takes a seamless mechanism to unlock those resources and make better decisions about how to deploy and conserve cash. Does your organization have the technology in place to increase yield on liquidity by working with, for example, procurement to apply and expand early payment discount programs? Or with AP to identify payment terms across all suppliers and optimize payment timing?
Five steps to optimize working capital efficiency
Despite the challenges, there’s never been a better time to manage your organization’s working capital more efficiently. Optimizing your strategy now pays off quickly, so you’re set to unlock liquidity and cash when you need it the most — during the next disruption, not after it’s already passed. Mid- and long-term, working capital efficiency also sets up businesses to thrive in multiple ways, such as providing the right resources at the right times to fund the right investments, pay down debt, or deliver returns to investors.
Working capital that works harder doesn’t necessarily mean that finance teams have to work harder, too — just smarter. This is where the right plan can help, offering fresh and intelligent takes on how finance organizations can improve working capital efficiency amid disruption. Our recent webinar with The Hackett Group outlines five of those hacks. Amy Hillcox, Senior Research Director of Procurement & P2P Advisory at The Hackett Group joined us to talk about:
- Ensuring finance organizations have visibility to risk exposure
- Teaming up with procurement to optimize supplier payment conditions and identify liquidity challenges
- Collaborating with supply chain teams to improve strategic stockholding positions
- Reconsidering cost versus cash trade-off
- Taking advantage of credit extension and rebate opportunities for tail spend
“The weighted average cost of capital in most organizations has been really low for a very long time, and a lot of organizations have not been focusing on working capital because of that. In this upcoming period as interest rates creep up, and debt becomes more expensive, more companies will start looking internally to their own working capital and seeing if they can use that as a source of cash." — Amy Hillcox, Senior Research Director of Procurement & P2P Advisory at The Hackett Group
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