Show me your working capital and I will tell you who you are!
I love working capital management! Working capital management is a vital aspect of running a successful company, and its importance goes beyond just financial expertise. As the "garbage bin" of a company, working capital sheds light on how well a company is managed. While excelling at working capital management doesn't necessarily guarantee overall success, it does offer valuable insights, especially when analyzing financial statements with limited information.
High working capital can be a red flag, indicating underlying issues in various areas:
- Debtor problems may include quality issues, supply inefficiencies, pricing discrepancies, credit management, and more.
- Creditor challenges may relate to cash flow tensions, invoice approval issues, delayed accounting practices, and more.
- High stock level might indicate poor planning, poor inventory management, commercial ineffectiveness in selling off slow-moving inventory, sub-optimal suppliers, etc.
To start assessing working capital management, simple metrics are essential, but surprisingly, many companies lack these tools. Nowadays you can find many posts on LinkedIn recommending a long list of metrics for working capital management.
My experience: you do not need many, but the right ones for the right reasons:
- Use [Working capital/last twelve months' sales]% to measure the overall tendency. This is also a great KPI to benchmark with other companies.
- Then use Aging of overdue debtors and the Aging of stock to determine the scope of potential reduction. What I like about these metrics is that they are non-negotiable: if it is overdue or aged too much, it should have been on your bank account.
- Additionally, understanding the relationship between Days Sales Outstanding (DSO), Days Payable Outstanding (DPO), and Stock Rotation (SR) can offer valuable insights into the working capital % evolution.
It is important to set objectives for all metrics.
Monitoring and setting objectives is the easy part though… The most crucial challenge remains: how can you instrument change? Because usually, improving requires affecting numerous processes in the organization, from finance to commercial to operations, which makes it extremely difficult. You can go the traditional way and put pressure on your staff to reduce working capital, but that is not the most effective way. What is the alternative then?
It is at these crossroads where EquityBuilder comes in.
- EquityBuilder starts by conducting an overall health check of a company's working capital to identify areas for improvement and to isolate potential issues.
- Once identified, our proprietary expert library offers over 100 proven actions tailored to each company's specific needs.
We pursue both consistency in execution but also implement out-of-the-box changes, such as adjusting policies and processes, to reduce working capital
This guarantees that the improvements are deeply embedded in the business culture. By affecting various processes, from sales to logistics and finance, we ensure that the changes are not superficial fixes but have a lasting positive impact on the company's financial health and future growth.
And here is the bonus!
Optimizing working capital not only impacts day-to-day operations but also plays a crucial role in positioning a company for sale. Sustainable lower working capital levels translate to increased cash availability, which enhances the overall value of the company. This is like feeding two birds with one scone!