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In the final blog of the series author Brian Plowman brings you his top tips when looking to achieve working capital optimisation and summarises this series of blogs.

By Brian Plowman

Avoiding the pitfalls

Top ten tips when looking to achieve working capital optimisation:

1. WCO programmes must extend beyond the finance function and engage the company’s entire managerial team. Do not think that all working capital management problems can be addressed by treasury alone.
2. Do not artificially adjust working capital levels through delaying payments to suppliers or indiscriminately stepping up collection activities in order to boost quarter- or year-end performance metrics. In business, as in physics, every action is met with an opposite reaction. Delaying payments to vendors may reduce working capital over the short term, but that improvement is likely to disappear over time as vendors adjust their pricing accordingly.
3. Incentivise people to achieve their WCO targets by compensating staff accordingly, particularly at managerial Level
4. Make a consistent effort to optimise working capital. It may be tempting to take the focus away from working capital when the company is growing as there may be less immediate need for it. Equally, in times of crisis, attention can be diverted elsewhere. Ignoring working capital during a downturn could significantly inhibit a company’s ability to grow and meet demand once business rebounds.
5. Ensure all hopes are not pinned on ERP implementation. Although ERP systems can provide significant benefits in the working capital arena, in the near-term they can cause deterioration in working capital performance as key managers and employees are distracted from their daily routines and forced to fine-tune the new ERP system.
6. Connect suppliers and customers across the enterprise to achieve maximum benefits. Demand chain management is now very much to the fore in ensuring suppliers and customers are collaborating effectively
7. Negotiate before it is too late. Use the company’s leverage as a prompt-paying customer to help your bargaining position for better discounts or extended payment terms. This could not only provide cost benefits but also retain the goodwill of your suppliers. Supplier chain management is how major organisations are now using web portals and the like to deliver seamless accounting transparency for all their suppliers and their financial transactions too, wherever they might be in the world.
8. Do not allow debt to become overdue before identifying and resolving disputes. Contact customers before payments are due to resolve any potential disputes and for delinquent payments, assign collection responsibilities to individuals and escalate the responsibility to more senior employees as invoices become further overdue.
9. Develop forecasting techniques that incorporate intelligence from all relevant business segments, including not just sales but manufacturing, distribution and marketing. Evidence from these forecasts will assist in the production of company financial statements to investors.
10. Look holistically at the supply chain. For example, there is a direct correlation between inventory management methods and the level of customer service that a company can provide. Do not allow one area to suffer as a result of focusing attention on another.

Summary

Working capital management is often seen as the responsibility of the CFO though the CEO will we held accountable for any poor corporate performance. But the reality is more complex as working capital is influenced by people in every function.

The art to making a real difference is to find ways to engage everyone in using appropriate tools to analyse and improve the position.

Brian Plowman, author of Activity Based Management, brings you penultimate part in his series of blogs on Working Capital Optimisation, this week looking at The CapCut® approach.

By Brian Plowman

The CapCut® approach to Working Capital Optimisation

A working capital optimisation project requires discipline in terms of analysis to determine the root causes of problems, propose improvements, model the benefits and implement the changes.

What are the current and future challenges that CAPCUT1 addresses

1. Liquidity is an issue for every organisation. Credit is tight and credit ratings are in disarray. CAPCUT offers an understanding of the ‘drivers’ that are affecting why an organisation may not be seen in the best possible light by investors/credit agencies re historic measures of WC ie DPO/DSO/DI
2. CAPCUT offers a semblance of KPI’s that a bank/PE/VC/financial institution can appreciate as we work with organisations in delivering realistic performance measures of the cash conversion cycle (CCC)
3. As experts in understanding lean processes we deliver as part of the CAPCUT programme a series of workshops, supplemented by relevant questionnaires that ensure that the organisation has robust procedures in place and that all stakeholders from employees to stakeholders obtain visibility of the issues to address. These issues include process failures/breaks in chains of responsibility and can even highlight potential fraud
4. CAPCUT employs a methodology that addresses change in culture through a simple diagnostic tool called CCM – Capacity, Capability and Maturity of the employee, the function, the site, the entity and the corporate structure to ensure that Working Capital can be improved in a timely manner
5. The organisations future working capital strategy may require refocusing and CAPCUT delivers the Demand Chain, Supply Chain and Reverse Supply Chain areas in the new ‘to be’ environment so that it dovetails with Corporate Social Responsibility in areas like Green and community based initiatives
6. Through the CAPCUT programme we can also address issues that may impact profitability as our ‘lean’ approach can utilise a Full Cost Model (FCM) and Risk Review Report (RRR) that highlights at a very early stage whether that customer/supplier is a ‘net positive margin’ generator
7. Finally CAPCUT assists in the disclosure requirements that are needed within company accounts to reflect a robust and ‘going concern’ organisation re cash flow, liquidity and future actions needed to support and service the debt commitments undertaken.

The CapCut approach is built on years of experience. In its generic form it is outlined in the plan shown below. Clearly all organisations are different so an early stage is to ensure that the worksteps are designed to fit the business and the key objectives of the project.

A key output from Phase 1 is a broad identification of the Working Capital Model of the Business that forms the basis for analysis and subsequent proposals for change. A financial model of the current cash flows is also prepared. Later steps in the project use both models as the basis to assess the risks and benefits of proposals to change processes, terms of business and the like when considering options to improve working capital.

The business is analysed ‘against the flow’ that delivers outputs to customers. In other words the principle we adopt is to understand the major issues at the end of the business (ie Receivables) and uncover the possible root causes upstream in the processes.

Continuing further upstream uncovers more upstream problems in the same parts of processes previously identified or in completely different areas and functions. The severity of the root cause will also be assessed (ie High, Medium or Low). For example a problem with trying to collect cash after invoicing may be due to poorly defined terms in the contract. At various points upstream the reasons for a downstream problem should start to become more apparent and thus solutions to the problems will start to form.

A matrix like that shown below is completed during the analysis. Here we see that at the point ‘Inv’ (invoicing) the perceived root causes of invoicing problems lie at the process stages of ‘CP-AC’ (Commissioning Pre-Acceptance Certificate), ‘P&SC’ (Purchasing & Sub Contracting) and most seriously at the ‘Contract’ stage. The matrix below shows that the Contract stage has been identified as a serious root cause for many other stages of the working capital processes.

At each stage the team members will use check lists to assess the process and look for issues and root causes of problems.

An example of investigating ‘Contracts’ is shown below on the left hand column. Each numbered item can be further analysed as shown for ‘Terms of payment’.

The analysis can go further into the detail. For example, under Terms of Payment #4 is ‘Credit Period’ which could be assessed against a checklist as follows:

1. Is the Credit Period expressed as a fixed number of days after a defined event? eg date of order, invoice or shipment
2. Does the procedure avoid referring Credit Period to events over which you have little control? eg. Receipt of invoice, goods arrival on site.
3. Does the procedure avoid uncontrollable delays in the banking system by stating explicitly when payments shall have reached the account?
4. Does the invoice spell out the Due Date, bank account number and also name and SWIFT address of the bank?

Working with a client project team we share a ‘helicopter view’ of the entire scope which exposes stage to stage issues and provides the evidence to develop ideas to make improvements. The team produces a set of ‘blue prints’ that together have to meet the overall working capital business imperatives that are the objective of the project. In particular the team has to be confident the project will deliver the desired outcome within any other imposed constraints.

At the outset the outline working capital model of the business was used to prepare a financial model of the current cash flows. During the immersion session the team model the impact on working capital of making the sort of improvements that have emerged during the immersion session. They will be able to assess the risks and benefits of making various changes and compare these with the general level of difficulty, cost, timing and so forth of making the changes. A summary of the emerging recommendations is prepared for discussion with the board who assess the evidence and team recommendations and thus be in a position to outline their view as to what needs to change and in what priority.

For example, the ‘Credit Period’ analysis [shown above] together with the team’s views should lead to a set of guidelines from the board which might be in the form shown below:

Examples:

“10% of the amount shall have reached our bank account within 15 days from date of order (contract signing)”

“85% of the amount shall have reached our bank account within 30 days from the date of delivery as per shipping documents”

“5% of the amount shall have reached our bank account within 30 days from the date of PAC, however no later than xx days from the date of order/shipment”

Based on the outcome of the immersion session and the sign off by the board of the main features of the ‘To-Be’ working capital target measures, the team prepares the agenda for a series of meetings where the participants develop detailed cross-functional proposals to deliver the changes required to improve working capital. Some decisions to work in a better way can be implemented early on. Other changes will take longer and may require multifunctional teams to be set up. We bring a disciplined approach to record proposals, to develop business cases where needed, and to track implementation.

We disaggregate the high level financial model to create a series of KPIs for various stages along the Working Capital model of the business. The rigour in monitoring these KPIs in each part of the business provide the Executive Team with the assurance that the stretching goals concerning working capital in the strategic plan will be delivered.

Come back after easter when Brian will bring you his top ten tips when looking to achieve working capital optimisation and concluding this series of blogs.

1 Trade Mark 2472440: Pharos Informatics Ltd – Alliance Partner, Develin & Partners.

In the fifth part of his series on Working Capital Optimisation Brian Plowman, author of Activity Based Management, looks at the profound affect late payment can have on SMEs and what they can do about it.

By Brian Plowman

Can Supply Chain Knowledge save a debtor situation?

…..and avoid an internal credit crunch!

CEOs and CFOs regularly review sales figures and apply metrics that provide them with some visibility of how their organisations are performing in relation to Days Sales Outstanding (DSO). However this number can still mask serious supply chain issues that need immediate attention.

Why?… Because DSO is a lagging indicator in that the problem has already occurred for it to be reflected in the DSO. And even the DSO report date can itself be 30 days old. The real need is to get one step ahead of the causes of problems so you control the DSO. And as the following cases indicate, only a thorough review of the whole supply chain can reveal the true cash cost and extent of the risk an organisation is exposed to.

Getting Hobbs over the hurdles

The recently appointed FD of a large firm of Builders Merchants was alarmed to discover that an old established customer, a contractor, Hobbs, had expanded to take on a large contract which in turn caused cash flow problems which now delayed payments for materials. The FD decided that the Sales Director should try to resolve the matter of delayed payments as he had known Peter Hobbs for years. Peter was the MD, majority shareholder and head of the family firm. Peter provided sets of annual, management and contract accounts that showed that the new large contract represented 70% of all Hobbs’ activity. Peter maintained that if nearly all suppliers extended their credit terms a little and his company paid the workforce from the limited remaining bank facilities, then he could complete the next stage of the contract.

Peter asserted that this would allow the architect to certify that the work has been completed satisfactorily and that the client will pay the next stage of the progress payment schedule. This cash inflow would then enable Hobbs to pay the suppliers, purchase more materials and complete the contract on time. Peter mentions that the contract will however generate a loss and Hobbs will probably only be able to trade on a much reduced scale thereafter.

The Sales Director suggests that Peter’s personal cash assets be used to fund the release of materials to Hobbs to complete the contract by paying them into, or guaranteeing them to, the Builders Merchant. Then when Hobbs receives the stage payment from the client, Hobbs will pay the Builders Merchant for the outstanding invoices which repays Peter’s ‘loan.’

Peter agreed the proposal and the Sales Director tells the FD that this is the only way to avoid Hobbs going into liquidation which would mean nothing being recovered to pay for the outstanding invoices. At that moment the FD received a call from another of Hobbs’ suppliers that warns that Hobbs may go into liquidation and that they too are owed substantial amounts of cash.

So what actions did the FD take to alleviate the problem and satisfy ethical concerns?

1. First he analysed the age of all debts owed by Hobbs and prioritised them based on net margin worth to the company.
2. He then developed a payment programme that resulted in high margin sales being paid first and agreed a timing schedule for Hobbs to pay.
3. He analysed the timings of payment due dates to his own suppliers to alleviate his own creditor situation and ascertain from his suppliers their cash flow issues re discounts on purchases for prompter payments.
4. He married cash receipts from Hobbs to cash payments to his own suppliers.
5. Once the above had been ascertained he agreed with Peter on a way forward without him having to pay any funds out himself as the company was a legal entity and the only cash he should pay should be into his directors loan account, but only after negotiating with his bank for better finance arrangements
6. He suggested factoring of Hobbs invoices so releasing some cash.
7. And the phone call? The FD suggested to that firm that though steps were being made to alleviate issues it would be wise to meet Hobbs as a group to understand all the problems.

Finally for a win/win situation to occur it was in all parties’ interests to understand the extent of the potential loss and rather than let Hobbs drift into insolvently it would be wise to persuade Hobbs to appoint a specialist who could turn around the large contract and establish processes to ensure this commercial debacle did not occur again.

Olympic hurdles

On a totally different project namely the Olympics, suppliers and subcontractors to a tier one contractor could face the same situation of non payment of invoices for some years to come and for years after the Olympics has finished.

The Olympic Delivery Authority says that standard payment terms apply on all primary Olympic contracts, but it has no power over its primary contractors to enforce good terms further along the supply chain. As a result, smaller subcontractors may need to make provisions for later payment terms. This has led various finance providers to start offering firms alternative forms of funding.

Invoice financing can look particularly attractive in such circumstances. Invoice finance providers will advance a proportion (usually 60-70%) of issued invoices up front in order to improve cash flow and cover late payment problems.

Most Olympic projects will have firms incurring start-up, mobilisation costs and increased wage bills but these will not be fully reflected in initial contracts and therefore these firms Working Capital will be hit.

Although most contracts offer a 30 day payment period, SMEs may find they are exposed to late payers. The primary contractors should not have difficulties but their subcontractors need to be especially concerned.

When hurdles become a high jump

So what has the Credit Crunch got to do with these different types of scenarios? A lot is the answer.

Banks, financial institutions, lenders (personal as in Peter’s case) or any organisation that is being asked to ‘find cash’ to finance something must be able to answer the following questions totally, and without any hesitation:

1. When can I expect to get some/all of my cash back into my bank account?
2. What legal basis/redress do I have to reclaim any monies owed?
3. Are there performance bonuses or the opposite by way of penalties should a particular payment not materialise?
4. Do I trust this particular customer and what steps can I take to know that I will be paid on time? (ie visits to places of work, meetings with directors, management and contract accounts regularly available)
5. How can I avoid being reliant upon one particular customer for one large payment of cash that may never materialise?
6. If all else fails what other sources of income do I have to maintain my business?

So is the UK Government or indeed the EU helping? The answer in short is No!

UK SMEs spend 17 working days a year chasing debtors and each SME is owed on average £30,000. One in four insolvencies in Europe are caused as a direct result of late payment even though the EU passed directives and the UK implemented late payment charges for invoices paid more than 30 days late. Sadly 80% of SMEs did not apply these rights for fear of losing business.

Undaunted the European Union has put together 16 ideas for a new directive and these include:

1. Enabling companies to charge late payments against tax, and not making late payment interest charges subject to VAT;
2. Significantly increasing the statutory penalty that should be charged to act as real deterrent;
3. Making all payment periods the same across the whole of the EU (eg pay within 30 days should be stated within all contracts);
4. A European Fund where struggling businesses can obtain support;
5. Forcing companies to declare how much they are owed to enable identification of repeat offenders.

However all this requires a lot of red tape and legislation and the flexibility to compete may be impeded. Some firms are calling for a league table to shame companies and institutions that are frequent late payers.

Meanwhile Credit Insurance Companies are withdrawing their products and insurances policies that cover suppliers and subcontractors for not receiving payment for the materials or services that they have provided. The claim is that the supply chain cannot be properly managed as it becomes ever more ‘invisible’ behind legal contracts.

A thorough review of the whole supply chain can reveal the true cash cost to an organisation and save a debtor situation becoming an unmanageable risk.

In the next part of this blog, available next week,  Brian will look at The CapCut® approach to Working Capital Optimisation.