Recent studies from The Hackett Group show show a trend toward deterioration of working capital management in many U.S. companies. This comes even after great efforts were taken to reduce the risk of cash depletion following the financial crisis in 2009. The effects of the easy credit years, during which companies lost focus on their ability to manage cash, are now becoming more apparent, resulting in a decrease in overall operational efficiency. Unfortunately, many department heads are gearing toward “good enough” working capital processes instead of working toward the continual improvement of such well-known financial ratios as DSO (days sales outstanding), DIO (days inventory outstanding), and DPO (days payable outstanding). See the figure below for more details.
Industry insights from working capital benchmark
The Hackett Group published the 2016 Working Capital Scorecard showing company rankings of best in industry versus worst in industry for the cash conversion cycle indicator (DSO + DIO – DPO). Quite significant differences can be seen within industries, with stunning gaps between the performance of the median and the first-quartile companies.
Although having a benchmark of your performance relative to competition is useful, it is important to focus on optimal targets of important ratios.
So the question becomes: how should you set optimum targets? If you analyze the data closely and compare industries, you can see a relatively small bandwidth for the cash conversion cycle (CCC) of best-in-class industry companies. The average median and average value of best in industry is around zero. This demonstrates that a balanced set of ratios is achievable independent of industry-specific business models and industry behavioral patterns. (Note that utilities and oil and gas companies are exceptions and are excluded from the picture.) There is a much bigger spread for the worst-in-class companies, which indicates more individual challenges.
The scoreboard gives a clear picture of which numbers for the CCC are realistic and achievable using state-of-the-art processes. Of course, the underlying ratios, DSO, DIO, and DPO, can differ widely, but ultimately, the balance of all three ratios is the key to success.
Data from 2016 US Working Capital Survey
The effectiveness of managing business partners, namely customers and suppliers, has a large impact on the performance of working capital ratios. As business rules and CCC ratios differ from one industry to another, having transparent processes for managing business partners across all departments becomes important. Siloed thinking can negatively impact the optimization of working capital management processes. A well-known example is a sales department that fears an aggressive dunning approach from the credit and finance area. Best-in-industry companies set targets across departments and – more importantly – appropriate training, ensuring that all departments understand the business needs, process flows, and information quality requirements of the other departments.
Improve collaboration and transparency
The adoption of business networks facilitates the close collaboration and transparent processes among departments and companies. This collaboration is the foundation that leads to trustworthy data integration, eliminates media and data-flow breaks to speed up automation, and frees up capacities to enrich business process quality.
Business networks do not just enable point-to-point connections, but are also marketplaces for modern business. A supply chain network, for example, creates frictionless exchanges between millions of buyers and suppliers across the entire source-to-pay process. Business objects such as orders or invoices are transferred and enriched by the network. Suppliers have access to their data on the customer side; for example, an invoice will be provided using all relevant data to approve and process it from the customer side.
In addition, customers’ master data can be enhanced by real-time information delivered by third parties on the business network. Automation and data quality improvement have significant positive effects on DPO and DSO, since process times due to media break inefficiency and the need to clarify requirements are eliminated. This frees up time to spend balancing the incoming and outgoing payments and for analysis.
The cost of offshoring
High DIO values are often a challenge in reducing the cash conversion cycle while companies continue to offshore production. The lower maturity of infrastructures in offshore countries results in inefficiencies across the supply chain, bearing the risk to reduce the turnover rates of inventories, since companies have to have enough raw material in stock to streamline their production process. Full integration of the sourcing process via a supplier business network provides transparency of inventory positions across production sites that can be expanded to suppliers to ensure on-time delivery of raw material.
Analytics is key
To create a continuous optimization culture of working capital, powerful analytics are needed to help set and monitor key metrics. In addition, high-data quality, which is available internally and externally to enable collaboration and transparency, helps improve efficiencies and break down silos.
The next financial crises will expose the companies that have – and haven’t – adopted continuous monitoring and optimization of working capital processes. A sound strategy to improve working capital management capabilities is not a topic organizations can afford to overlook, and business networks can play a significant role in this context.
To learn more about how finance executives can empower themselves with the right tools and play a vital role in business innovation and the value chain, please visit the SAP finance page.
For additional research and valuable insights, check out Aberdeen’s recent report “Digital and Automation Enable Finance Operations Efficiency.”