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Four strategies for better working capital management

Focus on profitability as a corporate's overarching goal can mean that processes such as working capital and the cash conversion cycle are often overlooked in big organisations. That's according to an article just published by McKinsey, which discusses some of the strategies and logic used by large companies to manage working capital and the cash conversion cycle.

Cultural shift

In Transforming the culture of managing working capital, authors Michael Birshan, Michael Park and Matt Stone argue that a cultural shift in thinking is required to really make the most efficient use of working capital. To do so, companies need a coordinated approach to inventory, receivables and payables, which can be “exceptionally difficult” to achieve in practice. The authors explain: “Many variables are in play, and responsibility is spread unevenly across finance, operations, supply chain, marketing and sales, and procurement.”

The aim is to reduce working capital and inventory to minimal levels (thereby deploying cash effectively in other areas) while at the same time maintaining quality of service and goods and keeping risks within acceptable levels. Much of McKinsey's suggested approach to this involves investing in human capital. The authors say companies should “nurture awareness and conviction, reinforce mindsets and behaviours with formal mechanisms, and deploy the right talent and skills”.

They outline four approaches to improving working capital:

1. Cash conversion as a measure of 'doing a good job'

This acknowledges that to really improve working capital, a large number of people in the organisation need to support the aim. A persuasive way to get employees and managers 'on board' with a working capital programme is to defining working-capital improvements in terms of being great at one’s job, or achieving functional excellence. The authors explain that the cash conversion cycle can therefore become “an indication of operating discipline: how well the company manages suppliers and customers, cycle-time speed, and even things such as sending out invoices on time”.

2. Realistic targets

Formal mechanisms, such as performance targets, are an important way of keeping employees across the organisation working towards the same goals, say the authors, although they add that “targets need to be tailored to the circumstances of specific units”. The article gives an examples of one North American manufacturer that shifted its primary performance metric from sales earnings to cash flow received from operations. “That prompted one business-unit CFO to stop pushing the sales staff to sign contracts before the end of a quarter in order to show a growing backlog regardless of the payment terms. Instead, she started to push for advantageous receivable terms to ensure a faster time to cash.”

3. Celebrate success

This sounds cheesy, but McKinsey's authors say that sharing stories of successful results from performance targets and employee motivation is also an important way to consolidate and inspire the organisation to continue working towards the goal of improved working capital management. They suggest that appointing someone in the organisation to be a central point of reference for this is effective: “We’ve found that a standard initiative-pipeline methodology works well, including simple, principles-based valuation, stage gates, a regular cadence of initiative review meetings, and a user-friendly digital platform. In one recent transformation, managers tracked more than a thousand initiatives. Each week, they sent an email to the entire company celebrating the most successful stories and the people behind them—and inspiring others to tackle similar challenges.”

4. A small core team

For large organisations, it's necessary to appoint a central team to manage the working capital programme and provide specialist expertise, say the McKinsey authors. They write: “Yet in our experience, too large a central team can make the rest of the organization feel like the transformation is being done to them, not something that they should own and deliver themselves.” They recommend a core team of around 10 employees, preferably headed by a C-suite executive.

CTMfile take: There's almost always room for improvement in working capital but it's something large organisations often overlook. This article by McKinsey is well worth a read for ideas on how your working capital improvement programme could take shape.

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