WORKING CAPITAL - THE UGLY CHILD

We all make assumptions. It’s human nature. And we have to, to live our daily lives – we assume that people will behave in a civilised way, obey the law, do the right thing, work toward a common goal, do a good job.

But sometimes, assumptions can be wrong. And in a business context, this can have significant impact. Jeff Bezos, not someone normally associated with failure, is a case study in false assumption with the example of the Amazon Fire Phone in 2014, costing the firm $170m in write downs.

There is one false assumption that may cause some controversy within the Finance community, but it needs to be said:

Most CFOs will think they know how best to optimise working capital because working capital management is seen to be a key finance responsibility. Unfortunately, this premise is fundamentally wrong.

OK, I admit that suggesting to a CFO that they need help with their working capital management is akin to suggesting to a parent that their child is ugly. No parent will ever admit that, and it’s an awkward conversation to say the least…however, let me make our case:

POINT 1

We all know that working capital manifests itself on a company’s balance sheet and hence its control and reporting sits within Finance. But it is managed predominantly by operations not finance. And therefore the ability to optimise working capital resides primarily within the business.

So, to continue the ugly child analogy, working capital is not the CFO’s child! CFOs are only babysitting on behalf of the parents - namely procurement, supply chain and sales/commercial operations. Yes, this child may pick up some bad habits from finance when they are babysitting them…. but the core of their education come from their parents. Unfortunately, some of their parents are at work and do not have full visibility of what the child is doing most of the time when they are at school (i.e. data quality and management reporting).

Maybe it’s not the fault of the CFO that working capital is wayward. It’s the parents.

POINT 2

A picture paints a thousand words and with the power of process mining technology, we can literally illustrate point 2.

Have you ever seen a process that looks like the image above on the left? No matter how much a business would like to think that all their processes follow the happy path, it is highly likely that a company’s processes around inventory, order to cash or procure to pay will look something like the one on the right. Or, of more concern is the bowl of spaghetti of a the full process ecosystem highlighted below...

If so, then there are opportunities to optimise working capital.

The power of process mining technology (visualised above courtesy of Celonis) is such that you can shine a spot light on an organisation’s process maturity very efficiently and utilise it to diagnose where the challenges really lie.

POINT 3

But what if your processes do indeed look like the ‘happy path’, what else can be done? There may still be opportunities [depending on your industry] upstream within your processes, such as contract management, terms and conditions, trade discounts strategy and optimisation. Or, the opportunities may exist downstream and where improvements can be made e.g. supply chain finance.

POINT 4

Finally, if your working capital dashboard or management reporting does not contain transactional level KPIs – e.g. weighted average payment terms, weighted average days to pay/collect etc…but only relies on DSO, DPO and DIO then Finance cannot be in a position to say their working capital is optimised..…this is just a false statement (or an illusion) by definition.

POINT 5

We started off talking about assumptions, but just for the sake of this article, let’s assume a company passes all the above tests and none of our points are applicable, then your working capital is super-optimised. But, working capital may come at the expense of operating margin. Therefore, some trade-offs could still be considered to improve operating margins or there could be opportunities to embed flexibility to pick and choose when to push for better margin versus working capital or vice versa, but based on your business’ strategy, priorities or timetable.

TO CONCLUDE

Now, I would never want anyone to tell me that my kids are ugly. But, when you want your little ones to go to bed, parents and babysitters need to work together to ensure consistency, supporting each other on bed time routine (could we describe that as an “end to end process”?) and never assume that it will go smoothly!

Similarly, I would not want to make assumptions that lead me or my business down the wrong path and the reality is that many businesses have poor visibility of performance across end to end process, not just around payment terms but a range of other levers that can be complex to identify and even harder to optimise.  Therefore, we think discovery is a better path than assumption and the first step to success. A clear diagnostic session can help a business develop the right plan to improve their working capital performance (and other finance or business processes) as the first step on the journey.

Please comment, agree, disagree, share or get in touch to discuss further how we can help you improve your business performance.

Written by Alberto Baldan, UK Lead for Working Capital Management at Protiviti UK and Mark Gardiner, Vice President at Protiviti UK