Good Working Capital Management is More than Just Timing Payables and Receivables

A few years ago we ran a post on the essence of good working capital management. We noted that, at least from a basics point of view, all one really has to do is:

  • Get a grip on receivables.

    When are the customer payments for sales due? The reimbursements from suppliers for reaching volume tiers due? The tax rebates?

  • Get a clear picture on fixed payables.

    What is the average monthly payroll? Overhead? And projected supplier invoices?

  • Get a good estimate of average disruption costs.

    If a receivable isn’t received on time, what’s the impact? Especially if it could impact a supplier payment schedule which needs to be maintained to insure timely supply.

This is the foundation, but in today’s unstable and unpredictable business environment, that’s not enough to maximize working capital management. To maximize working capital management, one has to maximize the value of the capital. In order to maximize working capital, you need to know when to use capital for internal costs, for supplier payments, and for investments. This means one also has to:

  • Understand the value of early supplier payments.

    Not just the value of the early payment discount, but the overall value to the supplier. If they don’t have to borrow at a cost of capital two or three times the buying organization, and then pass that cost on to the buyer in their overhead, that’s a big potential savings to the organization — even if they have to borrow.

  • Understand the organization’s cost of borrowing.

    If the organization can borrow at a low interest rate of 3% or 4% a year in their home market, whereas a supplier can only borrow at a high interest rate of 12% to 20% in their market, the organization can save by borrowing. But you don’t borrow just to save on costs, you borrow to profit. If you can accelerate production and accelerate profitable sales, borrowing is sometimes a pittance. And if you have good investment opportunities, that could also be a good reason to borrow.

  • Understand the organization’s investment opportunities.

    How much from accelerating production? Improving the process? Investing in R&D? Investing in subsidiaries.

Then, when you have all of this information, you do one more step:

  • Build a Working Capital Optimization Model

    and run it. Input all the receivables, payables, disruption costs, early payment opportunities, borrowing opportunities, and investment opportunities and let an optimization-backed cognitive system help you put a plan in place to not only manage working capital, but profit from it.

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