By Christian Michalak, Managing Director, Kerkhoff Consulting
During the financial crisis, many companies had liquidity bottlenecks due to operative losses. Even after the crisis, liquidity is tight since – for sales expansion in the course of newly rising demand – it increases inventories and financial assets and thus the working capital. Actually, safeguarding liquidity is one of the tasks of financial management, but even the purchasing department can make its contribution in close cooperation. In this respect, the reduction in working capital is an important step which must be actively controlled. The purchasing department here cannot only be a support but rather take over a central role as well.
Optimization of inventories
First measure for reducing working capital is the optimization of inventories. Bad communication and long supply times in the supply chain result in high inventories kept by companies so that they can meet short-term and highly fluctuating customer demands at short notice. A company can take different steps to counteract that: First, close supplier ties in terms of information will prevent the surprise effect of customer orders (bullwhip effect). A special manifestation of this measure is the supplier controlled inventory (vendor managed inventory). The supplier here takes over the control of the stock of goods of the buying company. Second, just-in-time deliveries can achieve a synchronization of supply and consumption. Furthermore, materials budgeting and order volume planning can be optimized – for instance by a review and adjustment of the safety reserve stock, as well as a reduction of storage levels.
Improvement of supplier management
The second measure for a reduction of working capital is the optimization in supplier management. The company's liabilities can be expanded through the adjustment of payment processes – for example, by delaying down payments and the resulting financing effect. Furthermore, the purchasing department should renegotiate guidelines for suppliers to obtain longer periods allowed for payment. Relative financing advantages can be utilized through close collaborations between company and supplier. For example, if the buying company has a lower rate of capital costs than the supplier, the period allowed for payment may be reduced and, in turn, the company will obtain a price reduction from the supplier. This price reduction firstly compensates for the additional financing costs on the buyer's side and secondly passes on to it one part of the supplier's savings obtained. Both partners will thus realize a gain from the net effect of financing costs.
Reverse factoring
Such a model can also be used through the integration of a credit institution for financing. A special form is reverse factoring. In this case, the buyer concludes a skeleton agreement with a factoring company in which it agrees to buy up the supplier's accounts receivable and provide advance financing for it. The factor here also takes over, for the supplier, the risk of delinquent payment by the buyer. This results in increased liquidity for both partners because costs will be equally shouldered and savings from the supplier's reduced payment period are split between them. |
