Part 1 in the 4-part “Working Capital” series
According to Gavin Swindell, managing director of the Working Capital Practice at The Hackett Group, “Working capital, or free cash flow, is often seen as a quick barometer reading of a company’s basic operating health.” (The Hackett Group, “The Working Capitalist,” Spring 2016.)
The point is that working capital is the lifeblood of liquidity. If you have a poor working-capital position, you will have trouble with liquidity, which will have a negative impact on your business. In short, working capital is one of the key KPIs every CFO must pay attention to.
But how can working capital be influenced?
The most important areas influencing working capital are payables, receivables, and inventory. Thus, collaboration between different departments – finance, purchasing in accounts payable and inventory, sales in accounts receivable, production, and certainly treasury – is also crucial. Besides that, highly automated processes with real-time information also have a positive impact on working capital, as we will see in this blog series.
What are best practices of leading CFOs?
The recent Oxford Economics study “How Finance Leadership Pays Off” clearly demonstrates that CFOs of companies that perform better than their peers – the “leaders” – emphasize collaboration within the company and beyond. Those CFOs have strong influence outside the finance function and collaborate regularly with business units enterprise-wide. The study also mentions that automation is a priority for those CFOs, and that their core finance processes are extremely efficient. All of these factors play an important role in maintaining working capital.
Companies need to get their cash cycle days, or the days of working capital (DWC), as close to zero as possible. A simple calculation for DWC is days sales outstanding (DSO) + days of inventory outstanding (DIO) – days payable outstanding (DPO). The formula is quite simple, but to influence it, not so much.
For CFOs and treasurers, real-time information in the global cash and working capital situation is crucial. A single version of the truth across all business units and entities will provide immediate insight that enables them to evaluate appropriate actions. This information is especially important for investment decisions – which will ultimately have a significant impact on working capital.
After this brief overview, my next blog will look at how working capital can be influenced in accounts payable.