By Dennis Bouley
Working capital is a measure of both a company's efficiency and its short-term financial health. Top performers in managing working capital now collect from customers over two weeks faster, pay suppliers nearly three weeks slower, and maintain less than half the inventory of typical companies in their industry, according to new research from The Hackett Group. Overall, top performers convert working capital into cash three times faster, with a cash conversion cycle (CCC) of only 17 days, nearly 30 days faster than typical companies.
The 2017 U.S. Working Capital Survey, which examined the performance of 1,000 of the largest public companies in the US in 2016, reveal that typical companies now have more than $1 trillion unnecessarily tied up in working capital. In a separate research piece, The Hackett Group found a direct relationship between sustained working capital optimization and improved earnings and profitability. By reducing the key working capital metric of cash conversion cycle (CCC) by 7 days, companies can add 1 percent to earnings before interest, tax, depreciation and amortization (EBITDA) margin, increasing profitability by about 20 percent (for a company with an EBITDA margin of 5 percent), the research found.
According to Veronica Wills, associate principal, North America working capital practice lead of The Hackett Group. “Companies came out of the recession knowing they need cash to survive. But they continue to rely on financial instruments like cheap debt and supply chain financing rather than do the fairly straightforward tactical work of optimizing payables, receivables, and inventory.”
Working capital management is often considered finance-owned due to its relationship with cash. To an extent, this makes sense: The central measurement and governance of working capital performance is typically maintained and overseen by senior finance executives. However, a significant portion of the cash conversion cycle, the process of converting resource inputs into cash, is owned and influenced by operations. Without the support of operations, finance will have a difficult time achieving lasting
working capital improvements.
In order to drive working capital improvement, sales, procurement, supply chain, and others need to be on board within the organization as each group owns key parts of the underlying process.
Working capital optimization can have a significant indirect impact on a company’s profitability, depending on how the improved cash position is leveraged. If cash is invested in growth activities, such as acquisitions, enhancements to product and service offerings and new markets entry, it is generally safe to assume these activities will enhance revenue, margin or both. This is an indirect result of improvedworking capital. However, winning the support of the chief operating officer, the chief procurement officer and their reports may depend on convincing them of the direct impact of lean working capital on profitability. Without that understanding, they are likely to focus on targets other than working capital efficiency, such as reducing unit cost or increasing sales revenue.
A complimentary analysis of the Hackett Group survey results is available, with registration, at this link:
Dennis Bouley is Editorial Director of MyPurchasingCenter.com and special advisor to MediaSolve Group, a strategic B2B marketing services firm focused on helping companies and institutions leverage the web and social media to achieve business goals. He spent 18 years at Schneider Electric as Managing Editor of Global Publications, and was responsible for cross-division management of the corporation’s white paper and customer success story processes. Prior to that, he spent 10 years working for IBM managing both small and large accounts. He holds a Bachelor of Arts in Journalism from the University of Rhode Island and holds a Certificat Annuel from the Sorbonne in Paris, France.
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