By Udo Reuß
In March, it'll be time again: Balance sheet talks with the banker. With a critical mind, he'll plough through the annual statement of accounts. Ever more frequently, one focus will be the question: "How did your working capital develop?" If an entrepreneur has no good reasons for increasing inventories or accounts receivable, he'll have to listen to some serious words. Working capital management (WCM) is a permanent entrepreneurial task. During the economic crisis, it was vitally important for survival to ensure liquidity. Now, in the upswing of the economy, it's crucial to continue to do everything to strengthen a company's internal financing power. All units in the enterprise must be put to the test to develop optimization potentials – whether in Purchasing, Sales, Production or in Accounting. There are abundant adjusting screws to keep the capital tied up in the enterprise as low as possible. The reward: Greater independence from lenders.
Net working capital is defined as the difference between current assets and short-term outside capital. The affected balance sheet items are: Trade receivables; advance payments to suppliers; inventories; liabilities and advance payments of customers. "Greatest leverage is provided with inventories", explains Gerd Kerkhoff, chairman of the management board of Kerkhoff Consulting in Düsseldorf. The objective will always be to reduce tied-up assets to thus increase the available liquidity. "Output is to be optimized with as little tied-up capital as possible", explains Kerkhoff. He sees huge optimization potentials in purchasing and procurement activities of medium and small-sized companies. This is provided in the entire enterprise: Inventory, payment and supplier management provide the starting points for measures to be taken.
Using credit rating information
Typical measures in the area of accounts receivable are, for example, that standard payment terms are specified and the customer's credit rating is checked in advance – for instance by using Schufa or Creditreform information which are creditors' protection agencies. Credit limits should be set and tracked; and if they are exceeded, an escalation process will start. Businesses should reduce billing periods, make their dunning processes more effective and forcefully pursue faulty invoices.
"The company must find out why a customer doesn't pay", says Nina Luh who heads the competence center Working Capital Management at the Vienna-based consultancy Schwabe, Ley & Greiner. Had the company itself made mistakes, for example in the billing process? Is it a question of quality management? Is the reason a badly structured dunning system? Or are the reasons to be found on the customer's side?
Key figures and ratios
The most frequently used key figures in WCM are the DSO measured in days (Days Sales Outstanding = period of time from sales of finished products until receipt of payment by the customer) and DPO (Days Payables Outstanding = period of time from receipt of materials until payment outgoing to the supplier). The problem with an isolated view to such figures: It may entirely pass by market conditions or events. Thus, especially with raw materials, there are good purchasing opportunities which must be utilized to be supplied economically and on time. Even at the expense of higher inventories. "Our view of things is process-controlled. A sheer key figures approach frequently goes astray", Luh accordingly warns about bench markings and a blind trust in key figures and ratios. Yet, when payments are due, some companies don't really use their leeway. In practice, Luh quite often encountered the problem of invoices being paid too early. "Within the scope of their automatic control of outflowing payments, companies should take care that stipulated payment terms are utilized." On the other hand, with accounts receivables, customers' lack of payment morale is the most frequent weak point. Accordingly, it's an urgent and essential task to 'teach' customers to pay on time."
Financial officer controls project
But who in the company will be the one to take care of that problem? The financial officer. In 2008, Manfred Ertl, Head of Corporate Finance at the Munich-based technology group Giesecke & Devrient, set up a comprehensive WCM project together with Schwabe, Ley & Greiner. As a family-owned company, Giesecke & Devrient has only limited access to the financial market. To finance its growth, the company's internal financing power was to be reinforced. To this end, Ertl had the company's general management approve a low six-figure budget. An investment which now already paid for the technology company. Ertl: "We have been able to generate 50 million euros of additional cash in less than two years."
In internal training sessions, the Treasurer informed his colleagues about the unsatisfactory situation at that time; he campaigned for his project and motivated employees to make their contributions in one of many project groups. A steering committee controlled the project. Processes in the parent company and in two prototype foreign subsidiaries were scanned thoroughly by the consultants. Finally, of 92 presented measures, a total of about 80 percent could be realized.
Ertl also developed a working capital guideline which is binding for all. According to it, creditors as well as debtors must comply with uniform payment terms. Inventories are to be kept at a minimum. Transparency is provided by a comprehensive reporting system. Thus, sales staff receive overdue lists at regular, short-term intervals. They will thus see which of their customers did not pay the invoices on time, and they are urged to react. And they can profit themselves since the WCM leaves tracks all the way to an individual bonus. Target agreements for variable salary components also include to what extent certain liquidity-increasing ratios are achieved.
Central ratio is the working capital intensity, i.e. the absolute working capital in relation to sales. Giesecke & Devrient had been able to reduce it by three percentage points after the preliminary conclusion of the project in 2009. Ertl is convinced that employees will be additionally motivated by transparency and the desired internal competition by means of a ranking.
New employees
A lot has changed organizationally as well. In the areas promising highest sales, a special function of working capital manager was established. In parallel, debtor managers take care that WCM is "alive" and operating on a day-to-day basis. Payment flows were changed. Thus, sales invoices are settled on only two days per week and thus suppliers' waiting days are used. An interest benefit for Giesecke & Devrient.
The company achieved the maximum financial effect by means of warehousing measures. Inventories were massively reduced; warehouses centralized and central inventory coordination was introduced. At Giesecke & Devrient, WCM is a corporate value driver. Accordingly, it has become a continuous subject there. Measures introduced and organizational changes are continuously further developed. No simple work, but rather painstaking – and it's worthwhile because it concerns the entire company.
CASE STUDY (Source: Kerkhoff Consulting)Automotive supplier having been able to increase by 112 percent its corporate value (Economic Value Added) by having reorganized its inventory, supplier and payment management Starting situation: - Purchasing only considered as order processing
- No systematic, world market oriented procurement market research
- Few strategic purchasing activities
- Heterogeneous IT infrastructure and non-uniform processes in purchasing
- No unambiguous distribution of tasks between Purchasing and specialized departments
- No systematic supply management
- No systematic procurement controlling, and procurement reporting on partial level is possible only with high expenditures
1. Measures for inventory management
- Clear regulation of responsibilities
- Implementation o f uniform standards of work organization for scheduling
- Inventory management for all articles
- Introduction of uniform material numbers
- Interdepartmental definition for scheduling processes
- Avoidance of double warehousing
- Introduction of IT support for scheduling
- Taking into account service degrees and reordering quantities in ordering policy
- Differentiation of service degrees on the basis of reliable supplier evaluations
- Implementation of a cross-divisional requirements planning process
- Comprehensive collection and maintenance of key figures
- Introduction of a supplier evaluation system
2. Measures for payment management
- Reduction and standardization of payment terms
- Increasing the share of discount agreements in the procurement volume
- Optimization of payment processes and expansion of payment terms
3. Measures for supplier management
- Increase in tendering quota and volume bundling
- Performance of company-internal location benchmarks
- lnitiation of renegotiations
- Research regarding alternative suppliers
- Award of volume-based framework agreements
- Streamlining product ranges and standardization of materials
- Introduction of e-procurement for specific product groups
- Determination of fixed prices for external services
- Conducting supplier workshops to ascertain cost reduction potentials
- Building up suppliers from low-cost countries; worldwide procurement
- More cost-effective purchasing
- Consolidation of the supplier basis as well as its expansion for the intensification of competition
- Carrying out price structure analyses
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