Companies with good levels of working capital are generally more profitable and more likely to attract investment. So what can businesses do to improve the state of their working capital?
Free-flowing working capital is the lifeblood of vibrant enterprises. Companies with healthy working capital on average boast higher revenue, investment and cash conversion efficiency (CCE), while firms with poor working capital management strategies can struggle to maintain financial stability. In fact, research by PwC finds companies whose working capital is in the best shape showed 14.1% better CCE than companies who don’t focus on improving their working capital.
Thankfully, there is a range of methods available for improving working capital. They broadly focus on the three key areas below:
- Receivables Performance: Tightening credit and collection policy is one of the most common methods of improving days sales outstanding (DSO). However, many other available strategies remain underused, such as improved payment and billing procedures.
- Inventory Performance: Expanding your inventory requires significant investment. Freeing up capital by reducing inventory can be an effective way of improving cash flow, but also means maximising supply chain efficiencies and is affected considerably by external economic and environment factors.
- Payables Performance: This is frequently the most neglected area of working capital management, much to the detriment of long-term financial fitness of companies. Similarly to accounts receivable, improvements to payments and billing procedures can work wonders for a company’s days payable outstanding (DPO) and remedy much of the long- and short-term damage in the event of a working capital problem.
Focusing on these three areas and restructuring where necessary can help to bring a company’s working capital under control, which can ultimately improve long-term financial returns. This all might seem quite daunting, but many companies already have cash on their balance sheet. All they need is an improved working capital management programme to help free it up.
After identifying what method suits your company structure, the next step is to create a system where your capital can start driving your business strategy. This will help you switch from relying on incoming cash flow to focusing on both long-and short-term business growth.
A company that has achieved a successful working capital structure is Aggregate Industries (AI), part of the LafargeHolcim group, a world leading company in the building materials sector. AI wanted to improve business growth, cash flow, cost-effectiveness and create a competitive difference.
To achieve these goals, AI partnered with American Express Global Corporate Payments, who came up with a working capital solution to offer AI’s customers a separate, unsecured line of credit, independent of their existing bank lending.
Due to American Express’ flexible payment terms, AI was able to offer customers the ability to extend their payment out to 90 days, considerably longer than their existing conventional arrangement. This acted as a point of differentiation for AI, which allowed them to expand their customer base and at the same time increase its sales to existing customers. In an industry where geographical location often determines choice of supplier, AI was able to offer potential customers another good reason to purchase from the company. As a result, AI was able to improve its working capital and accelerate cash generation two months ahead of plan.
AI’s approach is just one example of the methods a business can improve its working capital. By partnering with companies like American Express, businesses can overcome difficulties they face in improving their working capital.
Organisations should recognise that working capital problems are not only the domain of the CFO – improving working capital requires a succinct plan right across the business. Companies should explore all available options, not just conventional tried-and-tested methods. There is a common misconception that making changes to both assets and liabilities is a zero-sum game, since improvements on one side offset improvements on the other. This is far from the case, however, and businesses must be prepared to address all areas of their organisation, which relate to working capital.
The gains to be made from better working capital management and cash flow are substantial; the earlier you invest, the better you’ll be able to manage the changes to your working capital, leading to a more profitable and financially stable company.