Optimising working capital requirements is key to assessing the efficiency of profits, and something CFOs are expected to manage at all times. Do you know how well working capital is managed in your business and where improvements could be made?
Cash remains a scarce resource for many businesses across the world, and Thailand is no exception. According to Grant Thornton’s International Business Report (IBR) 2018 Q1, shortage of finance among businesses in Thailand is up to 38% from 28% in the previous quarter.
Releasing cash tied up working capital remains the cheapest and most accessible form of finance, which is why the effective management of receivables, payables and inventory, should be on every CFOs agenda.
But what represents an 'optimum' level of working capital for any given company? Clearly the company's size, sector and geographical diversity all have a major impact.
For example, if we look at two of the key sectors in Thailand of construction and retail, businesses in these sectors will have a large variance in working capital requirements. Construction businesses typically have complex supply chains, projects that span multiple years, and payments linked to milestones that can often experience delays resulting in a long cash to cash cycle. Whilst retailers are at the other end of the spectrum, with the cash nature of their business and ability to negotiate supplier payment terms typically driving a negative working capital requirement.
Taking this a step further, even businesses within the same sector will have different levels of optimal working capital, influenced by factors such as the geography of their suppliers or automation of finance processes. Therefore, it can often be difficult to identify where your working capital management could be improved without an understanding of key drivers in your business, or view of industry benchmarks.
There are some key themes and traits that are commonly seen in businesses where working capital is effectively managed, which we recommend for any organisation seeking to optimise:
You can’t manage what you don’t measure
One area businesses often overlook is the effective use of data to understand and manage the operational drivers of working capital. By taking a holistic view, operational metrics such as average days to pay can be used to support more timely and effective actions, as opposed to just being used for reporting purposes.
The process of defining and implementing appropriate metrics will also assist in communicating the right measures of working capital across each layer of the organisation. This, in turn, will help ensure there is a consistent view of ‘what good looks like’ and how this can be achieved. That said, the approach to implementing these may need to be altered to fit each organisational layer’s financial awareness and behavioural tendencies.
Taking ownership of working capital across the business
Ownership of working capital, especially through the cycle, should be closely linked to the metrics and reporting. Whilst finance will have ultimate accountability for working capital management, many people in non-finance roles play an important role in the chain – from procurement and operations, through to sales and logistics.
Proactively assessing the different responsibilities and accountabilities of all of the individuals who ‘touch’ the working capital cycle will not only identify areas of ineffective practice, but also ensure that a strong cash culture is embedded in the business.
Best practice in this area suggests that the concept of ownership should be driven from the top down, not just by finance, to ensure maximum engagement. The entire organisation needs to understand that best practice working capital management is a business priority.
Why working capital management should be a proactive exercise
Part of creating a 'cash culture' involves having a consistent, day-to-day focus on working capital. All too often, working capital management is simply a reactive, tactical exercise focused on a particular reporting milestone (whether that be month, quarter or year-end).
Without a constant working capital 'drum beat', businesses can be driven towards short-term tactical actions, such as the extension of supplier payments at year-end. The benefits from these types of actions are typically short-lived and may create tensions with clients and suppliers – and could even impact margins as a result.
Companies should focus initiatives towards addressing operational and structural efficiencies, which will provide longer-term sustainable improvements.
These are just three of the areas we would recommend reviewing in order to either assess or improve working capital management. Of course, there are many more which can be relevant depending on your company's sector and the strategic focus of the business.
What is clear, however, is that if you are in need of cash, there is very likely to be untapped opportunity sitting on your own balance sheet. The secret is knowing how to unlock it. In our next article we will discuss the key steps and considerations to optimising working capital for your organisation.