A company can free up liquidity by optimizing cash management. We will discuss 5 Steps to enhance net working capital (NWC). We often see that leadership teams tend to put their focus on the profit and loss statement, most frequently at the expense of the balance sheet. Business fail to make the most of net working capital (NWC). In most cases we see few leadership teams managing their liquidity with the same tenacity as they do their costs. However, with expert management of the cash conversion cycle organizations can rapidly free up liquidity often helping them avoid headcount reductions or operational restructuring. Efforts to optimize net working capital generally face the same hurdles. Often, leaders have minimal visibility into liquidity performance, P&L forward financial reporting doesn’t adequately measure NWC metrics, and leadership incentives are often misaligned with effective NWC management. Perhaps the largest challenge: Employees at all levels make daily business decisions that impact the cash conversion cycle, so any sustained improvement will require cross-functional cooperation and company wide focus on cash.
MCDA CCG’S 5 Step approach to NWC
To optimize NWC, organizations must take a comprehensive aggressive approach to target A/R, A/P, and inventory processes. Here is our 5 step approach:
1. RECOGNIZE NWC AS A SOURCE OF VALUE
A/R, A/P, and inventory management are the critical foundations of the balance sheet, yet they are frequently treated as an afterthought compared with revenues and expenses. It’s understandable: Optimizing NWC is not a straightforward task. While many of the tools for improving NWC are well-known, implementing them effectively is difficult. Many organizations already have put into place measures to improve receivables, payables and inventory with limited success. There is no one-size-fits-all approach, and guidance on what can be achieved through best-practice benchmarks is often scarce and often very industry specific.
However, the benefits are well worth the effort. Improved management of NWC preserves cash and can provide a critical lifeline when the business faces economic troubles, supply chain disruptions, or liquidity constraints. We encourage executive leadership to start driving a cash mindset throughout the organization by discussing cash topics in executive and management meetings.
2. UNDERSTANDING & MANAGING THE CASH CONVERSION CYCLE
It is important to fully understand the details of the cash conversion cycle to determine how much liquidity is tied up in A/R, A/P, and inventory. Business leaders following best practices provide visibility at the level of individual customers, vendors and SKUs, as averaging multiple transactions may camoflauge particular problem areas. Evaluate how core processes that influence NWC are running and assess whether the right policies are in place to provide oversight. This review will highlight the areas that are working well and those that need to be corrected or improved.
Leaders must collect information from multiple functions to understand the current state of cash conversion. Involve the teams that manage receivables, the procurement teams that drive payables, and the operations and supply chain teams that oversee inventory, as well as business unit or department leadership.
3. IDENTIFY AREAS OF OPPORTUNITY
A solid understanding of the existing cash situation allows companies to target potential NWC improvements. This step also requires cross-functional team collaboration, given the many daily decisions that affect NWC. To champion this effort, assemble a strong team of individuals who have a track record and passion for leading change. Task them to identify the “long-list” of potential opportunities.
Some basic examples to kick start the team:
- Managing A/R. Instill rigor in collections management by improving the processes to monitor collections, track slippage and identify emerging trends. Feed this analysis back to operations to tailor customer engagements.
- Managing payables. Improve payment discipline by overhauling internal supplier payment processes. Improve the timing of supplier payments, lengthen supplier terms and use the most efficient payment methods.
- Managing inventory. Pursue reduction opportunities without compromising on service levels or risking stock outages. Identify and rationalize underperforming SKUs to focus on core products and simplify operations.
4. PRIORITIZE AREAS OF OPPORTUNITY
Rank opportunities to increase NWC in order of priority and create an initiative roadmap. The roadmap should support the company’s strategy and broader business priorities. Start with actions that can be implemented immediately to preserve liquidity, while designing more complex longer-term initiatives in parallel. When creating the roadmap, it’s helpful to organize NWC initiatives in three groups:
- Rapid, “no-regret” actions. These moves free up working capital and can be executed immediately without detailed justification. They may be a first step in a broader initiative or a specific action, such as eliminating early supplier payments.
- Discrete, quick-to-execute measures. This group includes actions that can be accomplished with minimal system or process changes. Their value is backed by targeted, high-level analysis such as the return on selling slow-moving inventory, not an in-depth appraisal.
- Complex initiatives that warrant careful consideration. These initiatives may be dependent on the execution of system or process changes. A detailed analysis can validate the opportunity and indicate when teams need to seek cross-functional alignment, such as in rationalizing product lines.
5. LAUNCH NWC INITIATIVES
Using the roadmap as a guide, assign clear ownership of initiatives, set up an accountability structure to track and monitor progress, and launch the first wave of actions. Four elements will be instrumental to success:
- Engaged senior leaders. Ensure the NWC program is sponsored by senior leaders who can resolve delays, celebrate successes and act as cash role models.
- Clear initiative tracking. Use a dashboard with simple key performance indicators (KPI) to make progress visible and keep leadership informed.
- Agile team principles. Embed Agile principles across your delivery teams to drive accountability and enable quick feedback cycles to facilitate fast-paced progress.
- Aligned incentives. Add NWC metrics to managers’ incentives to expand their focus beyond pure P&L outcomes.
NWC CAN PROVIDE A LIFELINE
Disciplined management of NWC can help companies cope with unexpected disruptions to the business. Even if leadership teams have few external options to increase NWC, such as renegotiating contract terms, internal actions can deliver significant value. These include improving collections management processes, initiating daily spending review sessions to challenge purchase requests, developing best-in-class procurement practices, and adjusting inventory management. Such actions improve cash management, helping companies navigate through difficult times.
DON’T LEAVE CASH ON THE TABLE
Successful companies recognize the power of skilled cash management to strengthen the balance sheet. Improving the cash conversion cycle generates immediate liquidity to fund other transformative initiatives, increases enterprise value, improves credit rating and raises performance in the organization. Since the elements of NWC touch every part of a company’s operations, there are almost always opportunities to refine receivables, payables and inventory. However, there is no single recipe to optimize NWC. Leaders tailor their actions to their operating ecosystem and work to embed a cash culture. They know every day of operating with improved working capital can deliver significant rewards.
At MCDA CCG we have a team of experts ready to help you improve your NWC. Would you like to learn more? Contact us today for a free no-obligation discussion and see how MCDA CCG can bring extensive value to your organization. Did you know that we have a team of fractional CFO’s that can assist your organization with A/R, A/P, and inventory improvements. You can reach us at (657) 258-0577 or email email@example.com and one of our consultants will get back to you within 24 hours.
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