Successful Working Capital Initiative

Transcription

1 The Seven Secrets of a Successful Working Capital Initiative Optimizing the use of working capital is vital not only to ensure that companies have the funds they need to operate, but also put that capital to productive use. However, less than half of companies that embark on a working capital improvement initiative are able to sustain those improvements. New REL research has identified the critical success factors and reinforcing mechanisms that lead to better long-term outcomes. From obtaining cross-functional participation, to the involvement of C-level officers, to incorporation of working-capital targets into incentive programs, there are actions that every organization can take to make working capital improvement efforts more successful. Tremendous potential exists for improving working capital performance During the financial crisis, when the availability of financing was scarce or expensive, companies turned to optimizing working capital to release cash tied up in operations. Postcrisis, they have focused more on growth and globalizing their footprint, and have tended to assign fewer resources to improving or sustaining the performance of working capital. As a result, companies borrowed more money and increased their debt position, and with it, their cash position. During this period, companies working capital increased at a pace that was greater than their top-line performance, a confirmation of their reduced attention to working capital (Fig. 1). Clearly, opportunity exists for many companies to better manage their working capital and operate with less. In an uncertain environment, the key is to have the correct amount of working capital (and to increase forecasting accuracy so companies can know their true position and needs). Working capital performance has improved little in post-crisis period Where are these improvement opportunities to be found? The answer will vary by company, but the magnitude of the possibilities is unmistakable when comparing median versus top-quartile performance in days sales outstanding (DSO), days inventory on hand (DIO), days payable outstanding (DPO) and total days working capital (DWC) (Fig. 2). 1

2 Figure 1: Working capital has not adjusted properly to changes in business conditions Companies response to the recession (US$ billions) 2,800 20% CASH FOCUS COST FOCUS GROWTH FOCUS 2,600 15% 2,400 2, Working capital reduction: Less than rate of business decrease 10% 5% Working capital increase: Greater than rate of business increase 0 Q1 08 Q3 08 Q1 09 Q3 09 Q1 10 Q3 10 Q1 11 Q3 11 0% NET DEBT NET WORKING CAPITAL EBIT MARGIN % CASH ON HAND Source: REL and publicly available corporate data Figure 2: Working capital opportunity 51.9 DSO DIO DPO DWC 30% % 49% % 23.9 Median 1st quartile Median 1st quartile Median 1st quartile Median 1st quartile $42.3 million of cash flow per billion of sales $49.9 million of cash flow per billion of sales $44.1 million of cash flow per billion of sales $136.3 million of cash flow per $1 billion of sales 1st-quartile = Lowest DIO or DSO, or highest DPO in top 25% of companies Median performance = Median DIO, DSO, or DPO in all companies Source: REL and publicly available corporate data 2

3 With improvement gaps measured in tens of millions of dollars, it is no wonder that 93% of companies in REL s 2012 Working Capital Improvement study have undertaken a working capital improvement initiative in the past year. Today s focus is not solely about freeing cash; rather, it has shifted to increasing overall operational efficiency and effectiveness (Fig. 3). The pressure for working capital improvements is coming from within the organization, rather than external drivers such as a need to acquire additional credit or the views of financial markets. Working capital improvements are difficult to sustain While most companies undertake working capital improvement initiatives, few will succeed in sustaining their hard-won improvements beyond the initial year (Fig. 4), as business circumstances change and new pressures distract attention from improvement objectives. However, REL has found that the companies that are successful at sustaining improvements (called performance ) do a number of things differently from those that fail to do so (called the peer ). Fortunately, those things can be emulated by just about every company. These seven practices are not in and of themselves a guarantee of success, but they correlate strongly with the ability to sustain working capital improvements. These secrets to sustainable working capital initiatives are: 1. Executive sponsorship 2. Cross-functional ownership and collaboration 3. Reconciliation of conflicting functional objectives Figure 3: Most important reason for a working capital improvement project Figure 4: Sustainability of working capital initiatives* Need to increase operational efficiency/effectiveness Need to release cash for other purposes 67% 73% Still maintaining positive results Internal or external benchmarking results Executive mandate 33% 53% 40% 48% Need to maintain or improve credit rating 30% 14% Response to a downturn in the economy Need to reduce costs from or reliance on external financing Pressure from external financial analysts/negative press 7% 10% 27% No improvement yet Experiencing a decline * Companies with a working capital initiative in

4 4. Clear targets for improvement 5. Company-wide communication about the importance of working capital management 6. Integration of working capital goals in incentive programs 7. Integration of all of the above into normal course of business Among performance, 91% claim active management support, compared to 66% of the peer (Fig. 5). Active, organizationally powerful champions are key to driving cross-functional collaboration and reconciling conflicting functional objectives. Another area with a dramatic difference is the presence of clear improvement targets, as it is very difficult to achieve goals in their absence. And, the potential for success rises with specific company-wide communication about the initiative and its goals. are nearly three times as likely to have that communication in place. Plan to succeed, and build in reinforcement The way the initiative is established and capabilities are built to sustain the gains makes a difference in whether the results improve continuously or are short-lived. Getting the project structured properly and having reinforcement systems in place are the hallmarks of performance. Of course, it is also necessary to have good data-gathering methods and reporting in place to be able to assess working capital performance across the company. Secrets #1 & #2: Executive sponsorship; cross-functional ownership and collaboration REL found that the level and number of involved with the project are higher among performance (Fig. 6). Not only is the CFO involved a significant percentage of the time (82%), Figure 5: Key differences affecting the success of working capital initiatives Active management support 91% Specific improvement targets Company-wide communication 66% 38% 30% 73% 64% 44% 66% 49% 22% 191% 4

5 Figure 6: have key positions involved in improvement efforts CFO Regional/BU CFO Functional 82% 82% 47% 30% 74% 32% 49% 72% 55% 37% 122% these companies are also more likely to involve a business-unit or regional CFO as well. What is most striking is the performance greater involvement of functional process. This involves them as often as CFOs, and more than twice as often as the peer. Involving functional and ensuring that the working capital improvement initiative crosses organizational boundaries is not just a nice to have, it is a must for a successful, sustainable initiative. The functions most commonly included are procurement, supply chain management and operations (Fig. 7). A noteworthy result is that all performance include at least one other functional area in the working capital initiative, while those companies that made this a finance-only responsibility had zero success in sustaining improvements. The implication is unmistakable: finance cannot make substantive changes to working capital performance when its efforts take place in a functional silo. Secret #3: Reconciliation of conflicting functional objectives The evidence shows that engaging other departments in initiatives is not easy. In fact, 60% of companies responded that conflicting objectives between functions/departments is the top internal barrier to improvements. Since working capital touches so many internal departments, misalignment of functional objectives prevents optimization of the overall corporate objective of achieving working capital improvements. Companies must work through this obstacle because, without acceptance by all affected departments, any working capital improvements will be temporary. Secrets #4 & 5: Clear targets for improvement; company-wide communication about the importance of working capital management Sustaining improvement efforts requires both visibility to performance results and reinforcement mechanisms to align actions with the intended results. Given the critical role of working capital in 5

6 allowing the business to operate and maximize returns, it is also important to be able to make accurate projections about working capital levels over time. At present, forecasting working capital requirements is most companies weakest link. The median company has 80%-89% accuracy one month out; accuracy gets progressively worse three and six months out. This rate trails forecasting accuracy for other key financial metrics such as cash and earnings. Companies need to better understand how business factors today drive working capital results tomorrow. They also must thoroughly know their own their internal capabilities (e.g., manufacturing output) along with relevant external factors (e.g., market demand, customer payment schedules and supplier payment schedules) in order to forecast their working capital needs. While this might sound simple, companies struggle to get it right. To start, companies should measure the their current forecast accuracy and identify specific improvement actions targeting the quality of forecasts. Many have found that they need to educate their workforces about working capital what it is, why it is important, how it is measured, and what each department can do to optimize it for the benefit of the business overall. The most important factors in establishing a culture of working capital improvement are: Establishing a common language for working capital initiatives and benefits. Creating end-to-end process ownership, including accountability for working capital. Cascading specific improvement targets to functions. Changing company communications to increase awareness, focus and attention on working capital. Figure 7: Cross-functional involvement in working capital initiatives Areas of the business with accountability for working capital Success rating of finance-only working capital projects Finance 92% 0% Successful Procurement 58% Supply chain management 58% Operations 53% Sales 36% 100% End-to-end process owner(s) Treasury 14% 22% Unsuccessful Other * 11% *General management & partners of legal firm 6

7 Figure 8: Most performance build working capital-related incentives into improvement projects into improvement projects No incentives related to working capital 27% 73% Incentives relating to working capital at company and/or individual level Secret #6: Integration of goals in incentive programs REL believes that the working capital metrics, processes and awareness need to be reinforced in a tangible way. Nearly three-quarters of performance build targets for working capital into their incentive programs to instill working capital discipline in day-to-day activities (Fig. 8). Secret #7: Integration of all of the above in the normal course of business The focus on improved working capital performance is not over when an improvement project reaches the end of its timeline. To impart lasting change, behavior and practices must be permanently altered. Most of the tenets that make for working capital initiative success need to be woven into regular measurement and feedback systems. For example: Executives should continue to make working capital a point of discussion in management meetings and a part of performance measures. Finance should continue to work collaboratively with operations and supply chain to monitor working capital performance in inventory, receivables and payables. Working capital should be included as a topic in new-hire and other developmental training so that the entire workforce is exposed to its components. Strategic implications To increase the likelihood that the working capital improvements will be sustained, it is important to: Develop executive sponsorship. Foster cross-functional ownership and collaboration. Reconcile conflicting functional objectives through communication between executive sponsors and functional owners. Set clear targets for improvement and related ongoing metrics. Educate the workforce about working capital concepts and where they can contribute. Integrate working capital measures into incentive programs. Integrate sponsorship, collaboration, metrics and education into the normal course of business. Working capital is the lifeblood of an organization. Senior executives need to signal to the rest of the organization that working capital and initiatives to improve it are important. To enable the 7

8 Veronica Heald Director REL Lynne Schneider Senior Research Director The Hackett Group whole organization to get behind the initiative and make it successful and sustainable, it should be driven by a cross-functional collaboration among finance, procurement, operations, collections, supply chain and sales. In this way, companies can better educate their employees about how their actions contribute to the improvement of working capital, no matter what their individual role is. Because so many people will be involved in the ongoing success, tools must be in place and accessible to monitor and measure working capital. Consistent and accurate forecasts help guide actions, and incentives and communication reinforce the need to make the right choices. Prathima Iddamsetty Senior Manager, Forecast-to- Fulfill Practice REL To receive a complimentary cash flow assessment, visit cashflow/ or call us at (North America), (International) or (Europe) and take the first step toward releasing more cash from your operations today. About REL REL, a division of The Hackett Group, Inc. (NASDAQ: HCKT), is a world-leading consulting firm dedicated to delivering sustainable cash flow improvement from working capital and across business operations. REL s tailored solutions balance client trade-offs between working capital, operating costs, service performance and risk. REL s expertise has helped clients free up billions of dollars in cash, creating the financial freedom to fund acquisitions, product development, debt reduction and share buy-back programmes. In-depth process expertise, analytical rigor and collaborative client relationships enable REL to deliver an exceptional return on investment in a short time frame. REL has delivered work in over 60 countries for Fortune 500 and global Fortune 500 companies. 8