An optimized working capital program isn't simply a way for business leaders to help attract investors and keep the board happy. It's also smart business.
CEOs are under constant pressure to grow, whether it's revenue, profit margins or both. This pressure can lead to certain costs or risks that aren’t always well-received, inviting pushback from employees, investors or boards of directors. And what’s worse, this can potentially distract a business from core competencies. It can be easy to overlook straightforward efficiencies when you're tasked with innovating at the speed of light.
But it becomes easier for leaders to find answers by refocusing on the fundamentals. While working capital optimization may not be the most exciting initiative you can pursue, its importance shouldn't be ignored, given the impact it can have on your company's bottom line and shareholders.
The State of Working Capital Today
Even as the economy improves, businesses appear to be struggling with working capital and achieving optimal levels of liquidity. REL Consulting, a division of The Hackett Group, releases an annual working capital survey; their 2014 survey revealed that, for the second year in a row, the top 1,000 largest US nonfinancial public companies have more than $1 trillion in excess cash tied up in working capital.
This may be because businesses overlook working capital in favor of short-term or higher profile tactics—sometimes the numbers associated with working capital improvement, when taken at face value, can seem marginal.
But the ROI for working capital can be anything but marginal. REL's survey results indicate that the excess working capital from the surveyed companies amounts to 6 percent of the entire nation's gross domestic product, meaning that there's a lot of opportunity for companies who are ready to make a few simple optimization efforts.
Top performers, according to REL, operate with about half the working capital of typical companies. They collect from customers in just over three weeks, which is more than three weeks faster than typical companies. They also take about 36 days to pay suppliers, which is more than 10 days longer than typical companies. And lastly, they hold just over two weeks of inventory—less than half that of typical companies.
Because it can be a good indicator of the company's operational efficiency, working capital is likely one of the first key performance indicators an investor or acquirer will want to see. It makes sense—an optimized working capital strategy can help improve your bottom line by reducing capital employed, increasing operating income and reducing interest expenses, among other things.
Take the example of Cabot Corporation, a leading specialty chemicals and performance materials company, which in 2013 improved working capital by more than $100 million in five months alone through optimization efforts—such as decreasing inventory, improving customer and supplier terms, establishing monthly and annual targets for each business, and communicating about the initiative from the top down—a priority for the entire company.
Working Capital: Not Just a Luxury
An ability to efficiently manage working capital can not only potentially save a company from an economic downturn, but it can also help to fund major growth projects and invest in future innovation. Efficient working capital management is simply smart business—it's a way for businesses to tackle both adversity and opportunity with the money that's sitting within their own organizations.