Discovering the
cash tied up in your working capital Working capital, represented by accounts receivable, accounts payable, and inventory, is a necessary requirement for any organisation. Whilst the balance sheet indicates the total value, further analysis allows for a more detailed view on exactly where cash is tied up. Once these areas are identified, steps to release cash can be planned and implemented, leading to sustainable and improved working capital management.
Customer-to-cash strategy Assessing the effectiveness of the customer-to-cash strategy in an organisation requires an investigation first into the process of acquiring and managing customers. Different contracting strategies inevitably lead to a differentiated customer base, along with varying payment methods and terms. Increasing standardisation in terms and conditions will reduce the opportunity for error and simplify management of the account.
How to analyse working capital A holistic approach to the analysis of an organisation’s working capital position requires evaluating all the steps included in the processes of customer-to-cash (accounts receivable management), forecast-to-fulfill (inventory management), and source-tosettle (accounts payable management). Any analysis of the total working capital position of an organisation should incorporate quantitative as well as qualitative aspects.
In parallel exists the requirement for effective credit and risk management. The credit-worthiness of a customer is ultimately a crucial indicator of the likelihood of payment and must be considered in order to increase the collectability of a receivable and minimise bad debt. Once a customer has been acquired, the steps of processing an order and creating an invoice need to be evaluated. From entering an order to
Customer-to-Cash Strategy (C2C) Sales and Quote Management
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Credit and Risk Management
Order Processing
Invoicing
Collections Management
Dispute Management
Cash Application
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Forecast-to-Fulfill Strategy (F2F) Product Range Management
Inventory Management
Forecasting & Supply Chain Planning
Sales Order Processing
fulfilling it, taking customer service into consideration, there are numerous opportunities for errors and delays within the cycle time of converting an order to an invoice. The same applies to the billing process itself, in which possibilities of self-billing as well as automated billing triggers should be considered in order to ensure the timely issuance of the invoice and therefore speed the collection of cash. Cash, however, is not actually received until it is collected as a payment. Any analysis of a business’s receivables management should therefore not exclude an investigation into its collections performance. Are cash targets set at the individual collector level and tied to overall corporate cash-flow and days sales outstanding goals? Are debtors contacted proactively to ensure the early discovery of disputes and other issues? Analysis of these processes can provide valuable insights into how to improve the collections strategy. Customer disputes, or issues related to the non-payment or short payment of an invoice, should be the next topic to consider. What is the most common reason for disputes? What is the frequency and value of credit notes as compared to revenue? Disputed invoices often indicate issues in the process upstream of collections and improvements should be considered to eradicate preventable disputes and eliminate reasons for customers to withhold payment.
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Materials Scheduling
Manufacturing Warehousing and Execution Distribution
Finally, allocation of payments received rounds up the process of customer-tocash. A high level of unallocated cash indicates issues within the receivables process, hinting at the requirement for a root cause analysis. Forecast-to-fulfill strategy Whilst the customer-to-cash analysis requires detailed process analysis, the inventory part of working capital can very often be identified with one closer look at the production sites of the organisation. Have the storage facilities been filled with raw materials for some time, seemingly never depleting and always on a rather high level? What about the production process? Does it show any bottlenecks in work in progress, which indicate that the different processes should be planned more accurately with each other? Is the warehouse full of finished goods which have not been moved for some time? Whilst each industry has its own unique processing and cycle times, any visual analysis of the production process gives invaluable insights into supply chain efficiency. One reason for cramped finished goods warehouses may be a product range that is too broad. Here, quantitative analysis is crucial. Products can be analysed according to their individual usage value throughout the previous year, as well as the variance of this usage demand. A product with highly variable demand, such as one required
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only twice a year, indicates a need for a different approach to its management than for a good which is continuously used throughout the same time frame. Concurrently, looking more closely into the life cycle of products over time usually reveals an opportunity for improvement.
inventory needs to be shipped. Mapping out the transportation system of the organisation, or even taking a closer look into returns management practices, can give valuable insights into supply chain efficiency.
Production, nevertheless, will not be efficient without appropriate forecasting processes and supply chain planning. Calculating the forecast error for each product group gives invaluable insights into the efficiency of the forecasting process, and thus a potential explanation for stock-outs and other supply chain issues. Supply chain planning equally applies to sales order processing. Who processes the order? What is the customer service level, and what are the terms and conditions for this customer? Service levels directly impact production planning and thus inventory management.
Inextricably linked to the supply chain process of an organisation is the process of paying those creditors who provided the organisation with the goods required for production, as well as general organisation spend. A first point of analysis is the planning and sourcing strategy of the organisation, which can give an insight into the portfolio of suppliers. How many suppliers are there, and how much is spent with them every year? How many suppliers are there for the same material? Qualitative analysis of supplier contracting allows for insights into the efficiency of accounts payables processes.
Lastly, inventory necessarily accumulates due to the design of the production process. The way production materials are ordered, and inbound supply is handled, invariably affects the level of inventory. The same applies to the execution of the manufacturing process itself. Quantitatively, this is shown in production data, and qualitatively through an analysis of the entire process itself. Once produced,
Once suppliers have been identified, orders are placed. The execution of these, with consideration to order channels, may indicate areas for improvement and an opportunity to expand purchasing leverage. The same applies to the process of receiving and evaluating the goods that are received. A high level of unmatched purchase orders can indicate an opportunity for greater efficiency.
Source-to-settle strategy
Source-to-Settle Strategy (S2S) Planning and Strategy
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Sourcing and Supplier Management
Requisitioning and Ordering
Receipting and Evaluating
Invoice Processing
Discrepancy Management
Settlement
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Qualitatively, payment behaviour can be analysed by comparing the days stated in the payment term to the days required for actual payment. Payment terms may also be split into their respective value to give an overview of the different terms under which contracts are made. Vendor master file management is crucial to this process, and thus analysing the integrity of the data can reveal at a detailed level the accounts payable efficiency of the organisation. As with orders sent to customers, there may be discrepancies in the invoices received from suppliers. Data analysis enables an overview of the root causes of these, enabling their resolution. Settlement of an invoice is the last step in payables management. Investigating the payment methods employed can reveal an opportunity for more costeffective payment methods or more optimal payment runs. Action steps Once identified, areas of improvement in working capital are approached in different ways. Customer analysis leads to a segmentation of their payment performance and respective value of accounts receivable, using the Pareto principle. Different sections can be distinguished and approached accordingly. Customer service toward good payers of high value could be focused at keeping these customers content and willing to pay on time. Large, poor payers, however, could be approached with an emphasis on pro-active calls and ensuring that disputes are resolved before payment becomes due. The key will be
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differentiated strategies for different types of customers and their respective behaviours. Actions to optimise inventory can also be based on differentiation, segmenting inventory by stock-keeping units variability and value of demand. Lowvalue, high-variability items should be allocated planning and production priorities different from items which are continuously used and of high value. Similarly, this segmentation, again following the Pareto principle, allows more specific management measures to be attached to the different categories of inventory. Forecast error, for example, should be as low as possible for the high-value, low-variability items, but may be allowed to be higher for lowvalue, high-variability items. Payables management invariably includes the streamlining of payment terms agreed upon with suppliers. It may also imply the introduction or improvement of payment clock methodology which assesses trigger points within the terms and conditions. Standard payment terms will facilitate the selection and contracting of suppliers, as well as optimising the payment process. When payment terms are to be extended, the supplier base needs to be segmented into categories allowing for differentiated treatment of the suppliers in each category. This will ensure that the most important as well as the more sensitive suppliers receive additional attention. It will also require end-to-end process optimisation to ensure that any process can support on-time payment to customers for sustainability.
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Sustainable results
Julia Schippers Consultant REL
Identifying where cash is tied up in working capital and implementing segmented and differentiated management measures, however, is only the first step towards operational efficiency. Long-term sustainability can be achieved only through creating a company-wide cash culture initiated and supported by executive leadership.
Regular steering committees are crucial for organisational alignment and collaboration. Measurement of and accountability for working capital levels need to be assigned. Consequently, at the same time as working capital stretches across an organisation, only a cross-functional cash culture will allow for it to be managed effectively.
To receive a complimentary cash flow assessment, visit www.relconsultancy.com/ cashflow/ or call us at 1 866 614 4059 (North America), +1 770 225 7500 (International) or +44 20 7398 9033 (Europe) and take the first step toward releasing more cash from your operations today.
www.relconsultancy.com About REL REL, a division of The Hackett Group, Inc. (NASDAQ: HCKT), is a world-leading consulting firm dedicated to delivering sustainable cash flow improvement from working capital and across business operations. REL’s tailored solutions balance client trade-offs between working capital, operating costs, service performance and risk. REL’s expertise has helped clients free up billions of dollars in cash, creating the financial freedom to fund acquisitions, product development, debt reduction and share buy-back programmes. In-depth process expertise, analytical rigor and collaborative client relationships enable REL to deliver an exceptional return on investment in a short time frame. REL has delivered work in over 60 countries for Fortune 500 and global Fortune 500 companies.
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