“Cash is King” – Working capital management is fundamentally about optimizing cross-organizational processes and achieving maximum process excellence by freeing up tied-up liquidity. In a broader sense, however, such process optimizations also lead to increases in profitability and customer satisfaction, as well as the minimization of certain payment risks; since accelerating the cash conversion cycle, reducing inventory holding periods, or streamlining the process from customer order to product delivery leads to corresponding improvements for all parties involved in the process chain.
But what if the entire process chain is subject to the potential impact of a crisis or the associated uncertainties? At this point, the principles of working capital management may need to be “rethought,” and certain opportunities for optimization may need to be traded off for a higher degree of security.
Holistic Working Capital Management & Optimization Approaches
Through rigorous working capital management and corresponding optimizations of this metric, improvements in corporate performance amounting to approximately 5–10% of total revenue can be achieved. To identify the actual optimization potential, an end-to-end analysis of all factors and processes influencing working capital is necessary—though the general goal is to maintain the lowest possible working capital level while ensuring the highest possible liquidity status.
Ideally, the analysis of working capital should include both a full-year and a quarterly review—in both absolute figures and as a percentage of revenue for the period under review. The goal should generally be to achieve the lowest possible working capital ratio relative to revenue; however, there are no universally applicable thresholds, as these are highly industry- and company-specific. Therefore, it is advisable to compare the company’s own performance with industry or peer-group benchmarks to put the metrics into context and evaluate the company’s performance.
Once the respective optimization potentials in the relevant areas have been identified, the individual potentials should be classified. In this context, it is recommended to consider both the value potential of each improvement opportunity and the ease of its implementation. The combination of these two factors ultimately determines the prioritization of the measures to be implemented for optimizing working capital. The individual business units that influence the components of working capital should always be viewed as a unified whole within the context of such restructuring or optimization measures, so that the respective changes can be understood and correctly interpreted—because it is not uncommon for adjusting one factor to lead to an (unexpected) change in another component.
Simply optimizing all individual components does not necessarily result in an overall improvement in the working capital level unless the interactions between the “puzzle pieces” are taken into account or incorporated into the optimization process.
Developments & Changes Due to Crisis Impacts: Trade-Off Decisions
The fundamental and overarching goal of working capital management and related optimization approaches is the ultimate improvement of the liquidity situation and the optimal use of available liquidity to enhance corporate performance. However, the (relatively one-sided) optimization strategy in the context of working capital management—paying liabilities as late as possible, collecting receivables as quickly as possible, while simultaneously reducing inventory—has in recent years already given way to more holistic approaches, including working capital optimization viewed through the lens of the entire value chain as a “unified target.”
However, the crisis-driven developments over the past two years have once again presented entirely new challenges for the processes of (primarily manufacturing) companies, which in turn introduce new variables into the “formula” for working capital—variables that may previously have been viewed as less critical but now complicate optimization efforts significantly.
The (structural) factors influencing working capital are reflected throughout the entire value chain and, consequently, in the respective supply chain processes. The optimization approaches—which are normally obvious from the perspective of the individual company—always boil down to the parameters of reduction and acceleration. For example, reducing service levels, the number of suppliers, lead times, storage locations, etc., promotes a high degree of standardization, which in turn accelerates the process cycle and can thus yield significant gains in terms of working capital. However, this must be balanced against the factor of predictability and, above all, the safety aspect—the importance of which should not be underestimated, especially in times of crisis.
What if the top supplier cannot deliver? Or if deliveries can only be made to certain locations or at irregular intervals? These and related questions are currently preoccupying the majority of the industry and leading to a shift in priorities. This is because the overarching goal is, first and foremost, to maintain value-added processes—a prerequisite for which is ensuring the availability of all essential input goods. This is increasingly leading to a more risk-averse approach to inventory management and the selection of supply sources (e.g., maintaining multiple suppliers, having several or larger storage capacities, and ultimately increasing order quantities and inventory levels); in addition, there is a tendency to plan for a slightly higher safety buffer. However, these aspects—taken within the context of the overarching goal of ensuring supply capability to maintain value-added processes—come at the expense of working capital levels.
In general, therefore, the question arises as to what the absolute priority is or should be—a trade-off must thus be made between simple (theoretical) optimization and security; or, it can now safely be said that the optimal solution cannot be determined solely on a company-by-company basis, but rather that the entire process chain and other external (uncertainty) factors must be taken into account.
However, given the “new realities” brought about by the recent crises, a rethinking of the optimization approach seems sensible—and accordingly, the benchmarks for working capital should also be adjusted rather than relying on pre-crisis levels. This topic is also significant in the context of M&A and must be taken into account by both sellers and buyers—with regard to the general orientation of corporate structures as well as in the context of purchase price structuring and components (keywords: reconciliation statement and working capital adjustment).
