Working Capital Optimisation in SME’s Part III

accountingcpd.net author John Mardle brings you the third, and final, part in his series of blogs looking at Working Capital Optimisation (WCO) in SME’s. In this post he looks at the 10 most common mistakes with regard to WCO and concludes the series.

by John Mardle

Common Mistakes

Listed below are ten common mistakes companies make when they set out to improve their working capital management practices without paying attention to the need for key success factors. This should be used as a short checklist that SME’s could start to action to improve their working capital; however one should employ independent, experienced practitioners in this field to obtain optimum results.

1. Believing that working capital management problems can be fixed solely by the finance department. Since the levers that most directly impact working capital are operational in nature, working capital optimization programs must extend beyond the finance department. Accordingly, the CEO must function less as a business unit watchdog and more as a strategic partner, balancing the diverse priorities of the company’s entire managerial team.
2. Engaging in artificial efforts — such as delaying payments to suppliers or indiscriminately stepping up collection activities to boost quarter-end 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. A haphazard, ill-managed collection push is unlikely to achieve any long-term results, and may alienate customers.
3. Beating the “cash is king drum” internally and to Wall Street, but not linking executive compensation to cash flow and comprehensive working capital metrics. For most managers, compensation drives behaviour.
4. Waiting for a business recovery before trying to improve working capital processes. Just as growth should not be used as an excuse to ignore working capital, neither should a crisis. Doing so can significantly inhibit a company’s ability to grow and meet demand once business rebounds.
5. Believing that ERP (enterprise resource planning) systems and technologies are the silver bullet for working capital improvement. In fact, large investments in ERP systems generally do not, by themselves, bring working capital improvements. Over the near-term, they can actually cause deterioration in working capital performance as key managers and employees are distracted from their daily routines and forced to fine-tune the new system. The hard truth is that ERP installations don’t improve processes, but merely enable processes that need to be improved before the new system is installed.
6. Failing to connect suppliers and customers across the enterprise to gain significant, mutually rewarding benefits. Companies can improve working capital performance while treating suppliers, customers and the corporation itself as three distinct entities, but maximum benefits are achieved when business processes mirror the inextricable ties between the three entities.
7. Delaying payments to suppliers as a tactic to increase cash flow before fully exploring how your company can negotiate better terms or gain discounts for prompt payments. Once you become a late payer, your bargaining position is severely compromised. Instead, use your leverage as a prompt-paying customer to your advantage. You’ll not only save more money, but retain the good will of your suppliers.
8. Reducing inventories without improving the overall supply chain process. There is a direct correlation between the amount of inventory a company holds and the level of customer service it can provide. If you reduce inventory levels too much without addressing your core processes, customer service can suffer.
9. Letting debt become overdue before identifying disputes and contacting customers to resolve them. A better practice, by far, is to contact your most valuable customers before payments are due to resolve any potential disputes. For payments that do become delinquent, develop a proactive, systems-based, event-driven procedure to resolve disputes. Assign collection responsibilities to specific individuals, and escalate that responsibility to increasingly senior employees as invoices become further past due.
10. Having a business model geared around making-to-stock when you have the capability of making-to-order or making-to-demand. “Build it and they will come” is a movie cliché, not a sound business practice for most companies. Gearing your business model to customer demand is simply more efficient and logical, than gearing it to sales projections. At companies that must rely on sales projections, develop forecasting techniques that incorporate intelligence from all relevant segments, including not just sales but manufacturing, distribution and marketing.

Conclusion

In conclusion steps need to be taken to reduce working capital, but not at the expense of losing profitable customers or quality suppliers. Also the fact that better forecasting of the cash requirement is needed in the SME sector should bring accountants and directors of these SME’s into a scenario that makes daily cash balances being published a fact of life, and these should be religiously compared to the anticipated cash position. The issue of trapped cash being reviewed and then resolved is paramount to ‘cleaning-up’ the balance sheet and can also lead to curtailing non-profitable business with certain customers and identifying suppliers who are able to support the SME in the long term.