Make working capital work for you
This article was published in the February 2016 issue of The Business Magazine, where MHA MacIntyre Hudson is a proud sponsor of The Southern Manufacturing Top 100.
In a continuing uncertain economic climate, when one indicator signifies growth and another points stubbornly to a small contraction, the spotlight is well and truly on the manufacturing and engineering sector. Globally, the sector has faced challenging conditions for a number years, which to a certain extent represents ‘the new normal’, where successful businesses expect and plan for varied market conditions to ensure they are well placed to weather storms and capitalise on upturns.
The importance of working capital in business
One area that can dramatically improve the stability and success of a business is developing and managing an effective Working Capital strategy. Cash flow and working capital represent two critical measures of a company's ability to meet its financial obligations and is the life blood of every company. The idea of improving your cash flow and working capital is nothing new, but should not simply be considered accounting numbers, consisting of accounts receivables, accounts payable and inventory. Our MHA Manufacturing and Engineering survey indicated that in 2015, 25% of firms in the sector felt working capital constraints were one of their main barriers to growth. In companies where cash flows freely, investment opportunities can be capitalised on, whereas in companies where cash is tied up in working capital, their ability to grow is limited.
The importance of managing cash flow and working capital
How you manage your capital today will define your competitive position tomorrow. This is crucial for manufacturing firms, as they are traditionally more capital intensive and therefore sensitive to changes in the economic climate.
Take this simplistic example: a tool making company uses £1,000 to build up its inventory of components to make a particular tool. One week later, the finished product is available and ready for distribution. One week after that, payment is received from the customer. The original £1,000 has been tied up for two weeks and is essentially the company's working capital. The quicker the company produces and sells the tools, the quicker it can replace its inventory of stock to make more tools, or invest in the development of other tools. The longer the working capital is tied up, or ‘trapped’ by disputes or late payments, the longer it is unavailable to grow the business.
Good management accounts, as well as timely, accurate forecasting of future business, stock levels, creditors and debtors will all help to create a culture of focusing on cash flow within the business.
Drivers to improve Working Capital
The perception is that to improve a company’s working capital position, all that is required is to pay suppliers slower, reduce inventory and speed up customer payments. However, how do you ensure that the working capital improvements are sustainable long term and that cash flow is clearly visible?
The first step is to review all business areas to identify ‘quick wins’ and then longer term goals to work towards. It is important to consider your performance compared to others in your specific industry to develop a detailed action plan to optimise working capital and identify opportunities for releasing cash in the short and longer term. Keep cash flow and working capital firmly on the agenda at the highest level and seek opportunities for sustainable and continued improvements.
An example of specific areas to focus on:
- Accounts Payable
- Central procurement
- Payment terms between competing suppliers
- Standardised terms across all suppliers
- Accounts receivable:
- Develop optimised customer payment terms
- Dispute management to quickly resolve barriers to on-time payments
- Develop credit control procedures to reduce late payments
- Review credit risk policies
- Optimise the balance between cash, costs and services
- Focus on accurate forecasting to manage supply and demand
- Identify opportunities to reduce lead times
Clearly a strategy that is detrimental to your supplier relationship or terms of business is not sustainable, nor is a policy that reduces your inventory levels to the extent whereby customer service is compromised; there must be a balance. Managing payment terms with suppliers and customers to ensure good working relationships and future business is crucial to ensuring the on going health and stability of the business.
Our team have worked with a number of businesses to help assess their working capital improvement potential, benchmark their processes within the industry and investigate how the introduction of a cash-focussed culture could be elevated on the agenda.
We are able to perform a full cash flow and working capital review, to identify key areas for improvement, methods of delivering results and raising organisational awareness to ensure that on going management is firmly embedded in the company ethos. Our industry experience and ‘fresh set of eyes’ can have a significant impact to help manufacturing firms achieve their goals.
If you would like to discuss any of these issues in more detail or would like further information, please contact Kate Arnott.