Achieving Working Capital Maturity: The Secrets of the Champions
by Jennifer Pinney, director at REL Consultancy
Great people, great ideas, great customers – most major companies have some combination of formidable advantages going for them. Like world-class athletes, where the difference between the best and the rest is measured in hundredths of a second, the companies that carry away the gold often do so not because of a single major advantage but through the cumulative power of doing many small things exceptionally well.
For athletes, the willingness to make tiny adjustments in their stance or their training regime gives them what it takes to be a champion. A similar factor for companies is taking pains with their working capital management. Unfortunately, first-rate working capital management skills are not easy to achieve. The 2015 Working Capital Survey of the top 1000 companies in North America and Europe found that only 1% of companies have achieved improvements in cash conversion cycle (CCC) – a key measure of working capital performance – for the last three years in succession. (The cash conversion cycle [days] = days of sales outstanding + days of inventory outstanding – days of payables outstanding.)
Why do so few achieve excellence? Perhaps the biggest reason is that relatively few make the effort. As with social and environmental sustainability issues, most executives pay little attention to working capital except when facing a crisis, and their indifference is transmitted to the entire organisation. Without pressure from the C-suite, no one collects metrics or designs incentives that have a working capital focus, and no one rushes to install the controls needed to manage working capital professionally, or to do the hard work required to simplify payment processes.
As a result, companies tend to lack a clear understanding of their cash cycle and, even yet, any shared organisational recognition of the importance of cash flow management to the enterprise. Their ignorance can be expensive: A significant portion of the top 1000 companies in the survey waste 15% or more of their EBIT through inefficient working capital management.
Working capital maturity ranking
Of course, working capital management competence is not a binary quality that companies either have or lack. It’s a set of attitudes and capabilities that can take years to develop. Typically, companies must pass through four stages to achieve working capital maturity:
Level 1. Lagging
Organisations have invested little or no time in working capital improvement. Cash and working capital were not previously a priority, and the organisation does not understand what is possible in terms of financial improvements.
Typically, these organisations are comprised of several disparate sub-teams, largely disconnected from the processes and concerns of the wider business. While focus within a specific remit is not an inherently bad thing, siloing makes cross-functional collaboration extremely limited at best, and at worst, extremely difficult.
When it comes to working capital specifically, these organisations have several issues. They have little in the way of awareness, training, senior attention, and they are not incentivised to focus on it. This can be partially attributed to the lack of standard working capital KPIs, and their one-dimensional objectives which place little or no emphasis on it. It also does not help that they lack visibility on standard terms, and that customers, suppliers, and products are barely segmented if they are segmented at all. When organisations treat them all equally, it is invariably to their detriment.
Level 2. Achieving
Organisations keep cash and working capital in check at critical times of the year. They keep up with their peers, but have no competitive working capital advantage or disadvantage.
Accordingly, companies at this level demonstrate more competence than those classified as ‘lagging’, but leave considerable room for improvement. Firstly, they are not siloed to the same extent: the organisation is cross-functional, but only in an informal sense. Accordingly, their policies and processes are more flexible: they are driven by guiding principles, but functional and regional adjustments are entirely possible.
They have some degree of working capital awareness, and their senior personnel have received some degree of training. This improved cross-functionality allows visibility into their headline working capital metrics (which organisations at Level 1 entirely lack) and the training informs multidimensional objectives and aligned incentives. Standard terms are in place, but compliance is not monitored. Finally, Level 2 organisations make some efforts with segmentation, typically focusing on the top 80 percent of customers, suppliers, and products.