Working Capital Management

• Working Capital Management

  How much cash can potentially be extracted from a company's working capital
• How to extract cash from a company's working capital

  1. The treasurer should take a hard look at unlocking cash that is trapped in working capital

  2. While working capital management calls for a considerable amount of tactical work on an ongoing basis, it can be a rewarding exercise if the result is a significant source of cash
• Working Capital


  A company's current assets minus its current liabilities
• Primary components of working capital


  • Cash
  • Accounts receivable
  • Inventory
  • Accounts payable
• Working capital components tend to vary in proportion to the level of sales, but not at the same time
• The treasurer should be aware of unusually high proportions of any one component of working capital, as this may be caused by improper management practices
• Treasurer's role in Scenario #2

  Allocate the surplus cash to other company requirements, such as debt reduction, investments, or returning value to shareholders through dividends or share buybacks
• Cash Management


  Cash is a key component of working capital
• Credit Management


  Proper credit management is key to the amount of funds that a company must invest in its accounts receivable
• Credit Policy


  The treasurer has direct control over the credit policy and the entire credit granting function
• Characteristics of a loose credit policy

  • High product margins
  • Intent on gaining market share
  • Eliminating a product line or exiting an industry
• Characteristics of a tight credit policy

  • Product margins are small
  • Industry is an old one with little room to gain market share
  • Recessionary environment
• Credit controls to reduce the probability of default by customers

  • Issue credit based on credit scoring
  • Alter payment terms
  • Offer financing by a third party
  • Require guarantees
  • Require a credit reexamination upon an initiating event
• Receivables Management


  The ability of the accounting staff to reliably invoice and collect in a timely manner has a major impact on the amount of working capital invested in accounts receivable
• Factors that can extend customer payment intervals

  • Invoicing delay
  • Invoicing errors
  • Invoice transmission
  • Collection management
  • Internal error follow-up
• Inventory Management


  Of all the components of working capital, inventory management is the most critical because it is the least liquid and therefore tends to be a cash trap
• Once funds have been spent on inventory, the time period required to convert it back into cash can be quite long, so it is extremely important to invest in the smallest possible amount of inventory
• Responsibility for inventory resides with the materials management department, which controls purchasing, manufacturing planning, and warehousing. None of these areas are ones over which the treasurer traditionally exercises control
• Areas in which inventory decisions impact funding

  • Inventory Purchasing
  • Inventory Receiving
  • Inventory Storage
  • Production Issues Impacting Inventory
• Inventory Purchasing


  The purchasing department orders inventory from suppliers, asks them for the lead time they need to deliver orders, and creates a safety stock level to at least match the lead time
• A company can install a material requirements planning system that automatically calculates inventory needs, creates purchase orders, and transmits them to suppliers electronically, then the ordering cycle is significantly reduced and corresponding lead times can be shortened
• Inventory Receiving


  The receiving staff's procedures can have an impact on inventory-related funding. A better practice is to reject all inbound deliveries that do not have a purchase order authorization
• Inventory Storage


  A better method is to avoid the warehouse entirely by using drop shipping. Under this system, a company receives an order from a customer and contacts its supplier with the shipping information, who in turn ships the product directly to the customer
• Avoid production Issues Impacting Inventory

  • Just-in-time (JIT) manufacturing system
  • Avoid volume-based incentive pay systems
• Bill of Materials


  The record of the materials used to construct a product. It is exceedingly worthwhile to examine the bills of material with the objective of reducing inventory
• Product Design


  The number of product options offered can have a considerable impact on the size of a company's investment in inventory
• Customer Service


  A company may feel that its primary method of competition is to provide excellent customer service, which requires it to never have a stockout condition for any inventory item. This may require an inordinate amount of finished goods inventory
• Inventory Disposition


  Even if a company has built up a large proportion of obsolete inventory, continuing attention to an inventory disposition program can result in the recovery of a substantial amount of cash
• Payables Management


  Payables processing is managed by the accounting department, and payment terms by the purchasing department. The treasurer does not have control over either function but should be aware of the following issues that can impact funding requirements
• Payment Terms


  As part of its negotiations with suppliers, the purchasing staff may try to extend payment terms. This is an advantage for the treasurer, since extended terms equate to free funding by suppliers
• Payment Processing


  The accounting department may pay suppliers only at stated intervals, such as once a week. Paying anything prior to its due date will shrink the funding normally made available through accounts payable