Great people, great ideas, great customers — most major companies have some combination of formidable advantages going for them. Like world-class athletes, where the difference between the best and the rest is measured in hundredths of a second, the companies that carry away the gold often do so not because of a single major advantage but through the cumulative power of doing many small things exceptionally well.
For athletes, the willingness to make tiny adjustments in their stance or their training regime gives them what it takes to be a champion. A similar factor for companies is taking pains with their working capital management.
Unfortunately, first-rate working capital management skills are not easy to achieve. The 2015 Working Capital Survey of the top 1,000 companies in North America and Europe found that only 1% of companies have achieved improvements in cash conversion cycle (CCC) — a key measure of working capital performance — for the last three years in succession. (The cash conversion cycle [days] equals days of sales outstanding plus days of inventory outstanding minus days of payables outstanding.)
Why do so few achieve excellence? Perhaps the biggest reason is that relatively few make the effort. As with social and environmental sustainability issues, most executives pay little attention to working capital except when facing a crisis, and their indifference is transmitted to the entire organization. Without pressure from the C-suite, no one collects metrics or designs incentives that have a working capital focus, and no one rushes to install the controls needed to manage working capital professionally, or to do the hard work required to simplify payment processes.
As a result, companies tend to lack a clear understanding of their cash cycle and, even yet, any shared organizational recognition of the importance of cash flow management to the enterprise. Their ignorance can be expensive: A significant portion of the top 1,000 companies in the survey waste 15% or more of their EBIT through inefficient working capital management.
Working Capital Maturity Ranking
Of course, working capital management competence is not a binary quality that companies either have or lack; it’s a set of attitudes and capabilities that can take years to develop. Typically, companies must pass through four stages to achieve working capital maturity:
Level 1. Lagging. Organizations have invested little or no time in working capital improvement. Cash and working capital were not previously a priority, and the organization does not understand what is possible in terms of financial improvements. Such organizations show these characteristics:
- Silo organization with limited cross-functional collaboration
- No working capital awareness or training, with little to no senior attention or incentives
- No standard working capital KPIs
- Disconnected and local policies and processes
- No visibility on standard terms
- One-dimensional objectives with conflicting or limited focus on working capital
- Little or no segmentation of customers, suppliers, or products – all are treated equally
Level 2. Achieving. Organizations keep cash and working capital in check at critical times of the year. They keep up with their peers, but have no competitive working capital advantage or disadvantage. At these companies:
- Informal cross-functional organization shows some working capital awareness and training at a senior level.
- Headline working capital metrics are measured with partial cross-functional visibility.
- Guiding principles with functional and regional adjustments drive policies and process.
- Standard terms are in place, but compliance is not monitored.
- Multidimensional objectives for senior executives are in place, with aligned incentives.
- Segmentation drives focus on top 80% of customers, suppliers, or products
Raising an organization’s working capital bar is typically a five-step process:
Identify key stakeholders.
Benchmark current performance.
Understand your environment.
Determine the potential for improvement.
Identify key outputs and next steps.
Level 3. Exceeding. Organizations at this level actively invest resources and intellectual capability to execute decisions aimed at changing current constraints. They hope to move to upper-quartile performance compared with peers, and they are evolving into an organization that values cash and working capital regularly and in a structured manner. At these organizations:
- Cross-functional organization shows high levels of cooperation, supported by working capital incentives at C-suite and below.
- Formal working capital training is given for all staff; working capital skills are well defined and capabilities are regularly reviewed.
- Global measurement standards are followed for KPIs, and metrics are partially automated.
- Intelligent driver-based modeling is employed to set targets at item, customer, or supplier level.
- Standard terms and policies are well embedded and compliance is monitored.
- Forecasts are developed cross-functionally, with more visibility around how they are derived and actions taken over variances.
Level 4. Leading. These organizations have begun to achieve competitive advantage through excellence in their cash and working capital management. They have embedded the importance of cash and working capital into the company’s culture, and are now aiming to make their processes even more transparent.
- Working capital training is provided on an ongoing basis to give personnel periodic refresher training and to instill principles in new employees; skill requirements are well defined and documented.
- Working capital metrics and performance are featured on regular executive and management meetings; the business understands the dynamic nature of the optimal working capital position.
- Central end-to-end policies and processes are in place, with clear governance structures to assess the working capital impact of a change in strategies.
- Global standards are measured; the cash management technology includes the ability to drill down to the subcategory at supplier, customer, and product level.
- Functional collaboration is prevalent, and staff have a collective understanding of the objective and total cost of ownership principles.
If you doubt your organization ranks very high on this scale, you’re probably right. We estimate that most companies rank Level 2 on our working capital maturity scale. They are at the point where they know working capital management is important, but they have yet to invest the talent, time, and money needed to achieve significant results.
Raising the Bar
Developing a higher level of working capital competence sounds relatively simple, but the execution can be quite complex. From the warehouse to the sales desk, from procurement to finance, everybody needs to work together to achieve a common working capital goal.
Two sets of factors prevent companies from achieving a higher level of working capital maturity. The first set is missing pieces. Often, companies lack all the people and systems they need to create a streamlined process for their cash management. Knowledge and involvement of many functions is required to embed changes at the level of execution.
The second set of factors is conflicting aims. Different parts of the company often want different things. For instance, sales often wants to give lax payment terms in order to close the deal, while finance wants tighter terms to speed up the cash cycle. All in all, more working capital in the system makes most people’s day-to-day jobs easier — a mentality that can be tough to break.
Greater working capital maturity won’t make all these tensions go away — cash management trade-offs are inherent in almost any business — but it will help the company make an informed decision about the best choice for the company as a whole, rather than for a particular silo.
Even when the main issues are resolved, don’t expect them to stay that way. As with any training regime, working capital management is always a work in progress. To stay ahead, the company needs to develop a true cash culture.
Jennifer Pinney is a director at REL, a division of The Hackett Group. She has more than 15 years industry experience in working capital management. Additionally, she has seven years project experience of total working capital, procure-to-pay, and customer-to-cash implementation experience, both in the United Kingdom and internationally.