Holistic Approach to Working Capital Management
By streamlining end-to-end processes, companies can, for example, reduce stock, decrease replenishment times from internal and external suppliers, and optimize cash-collection and payment cycles. The key is to uncover the underlying causes of excess operative working capital. In order to address the often hidden interdependencies among the different components and achieve maximum savings from a working capital program, companies must analyze the entire value chain, from product design to manufacturing, sales and after-sales support. They must also look for ways to simplify and streamline processes and eliminate waste, always keeping potential trade-offs in mind. For instance, cutting inventories of spare parts or reducing product customization could lead to a major reduction in inventory. But how would these measures affect service quality, market positioning, or other aspects of the business?
Managing the Three Operational Components of NWC
So, what are the relevant levers of working capital management, and how are they applied? In effect, receivables and payables are just different ways of financing inventories. Companies need to manage all three components simultaneously across the value chain so as to drive fundamental reductions in asset levels. Given the wide range of possible actions, focus is critical. A realistic plan with clear priorities is the best approach. An overly ambitious agenda can overstrain internal capabilities and deliver suboptimal results. Instead, companies should concentrate on the most promising actions that will not impair flexibility and performance. These actions will vary depending on industry and competitive situation, and have to be adapted to country specifics and regulations. In the following paragraphs some typical (but just exemplary) levers are described.
Excess inventory is one of the most overlooked sources of cash, typically accounting for almost half of the savings from working capital optimization projects. By streamlining processes within the company—as well as processes involving suppliers and customers—companies can minimize inventory throughout the value chain.
Enhanced forecast accuracy and demand planning: Improved forecast accuracy and regular updates of customer demand lead to a much more reliable planning process and help companies not only to reduce their inventory but also to improve the ability to deliver.
Advanced delivery and logistics concepts: In order to keep inventories at lower levels, top-performing companies establish advanced and demand-driven logistics concepts with their suppliers, such as vendor-managed inventory, just in time (JIT) or just in sequence (JIS), and collaborate with their suppliers in terms of a holistic supply chain management with mutual benefits.
Optimized production processes: An important lever to reduce work-in-progress inventory is the redesign of production processes. The main objectives here are to reduce non-value-adding time (“white-space reduction”) and excessive inventory between production steps. Promising measures are removing bottlenecks and migrating from push concepts to demand-driven pull systems.
Service level adjustments: An increased service level for products which are critical to the customer (and thus allow higher prices) and a decreased service level for products which are uncritical to the customer will not only lead to optimized stocks. A more sophisticated approach to calculating security stocks based on target availability and deviations in production and demand will also reduce out-of-stock situations for critical parts.
Variance management: Reducing product complexity and carefully tracking demand of product variants in order to identify low-turning products is one way to reorganize and tighten the assortment and concentrate on the most important products. Moreover, where applicable, components should be standardized. Customization of products should take place as late in the process as possible.