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Writer's pictureDr. Marvilano

3 ways to quickly increase returns from your working capital

This post is part of the 33 Ways to Amplify Your Profit Quickly.

When you are in need of cash to grow the company or turn the company's performance around, you can optimize your working capital by pursuing these three courses of action:

  1. Improve your account payables (i.e., paying suppliers later).

  2. Improve your account receivables (i.e., getting payments from customers earlier).

  3. Optimize your inventory (i.e., holding less stock).


Optimizing your AP, AR, and Inventory will release the cash to fund growth and increase profit.
Optimizing your AP, AR, and Inventory will release the cash to fund growth and increase profit.


1. Improve Your Account Payables (AP)

By paying suppliers later, you can use the necessary cash for other short-term initiatives.


The objectives:

  • Identify options for more favorable payment terms.

  • Execute initiatives to improve cash flow.


Steps to execute:

Identify the options for AP improvement:

  • Review the AP and terms by supplier.

  • Benchmark payment times with market level.

  • Map end-to-end AP management process and identify the room for improvement.

  • Review AP controlling/reporting system.


Prioritize opportunities and quantify the impact (i.e., the net working capital effect). Consider the following initiatives:

  • Eliminate early payments.

  • Reduce down payments as much as possible.

  • Review options for early payment discounts.

  • Negotiate temporary extra payment time.

  • Renegotiate terms with "expensive" suppliers.

  • Change payment run from ex-ante to ex-post.

  • Revisit product acceptance conditions.

  • Reject imperfect delivery performance.


Develop the re-negotiation plan.

  • Set re-negotiation targets supplier by supplier.

  • Set cash release targets.

  • Design re-negotiation process.

  • Design the war room to drive re-negotiations.


Execute the plan and monitor.



2. Improve Your Account Receivables (AR)

By getting paid by customers earlier, you can use the early cash injection for other short-term initiatives.


The objectives:

  • Identify options for more favorable receivable terms and cycles.

  • Execute initiatives to improve cash flow.


Steps to execute:

Identify the options for AR improvement:

  • Map the internal AR processes (e.g., via interviews) and collect the required data.

  • Analyze the complexity and the running speed of invoicing and dunning processes.

  • Outline weaknesses in AR management.

  • Conduct internal and external benchmarking of AR key metrics (e.g., payment terms).


Prioritize opportunities and quantify the impact (i.e., the net working capital effect). Consider the following initiatives:

  • Shorten invoicing cycle/process as much as possible.

  • Establish early reminders.

  • Set effective overdue prevention.

  • Optimize policies on factoring.

  • Ensure the early start of the dunning process with short cycles and strict consequences (responsibility should be outside of the Sales Team, e.g., with the Finance Team).

  • Re-negotiate and harmonize payment terms.

  • Revisit product acceptance conditions.

  • Eliminate early payments.


Prepare the action plan.

  • Determine the optimization target.

  • Prepare the action plans, including the customer re-negotiation plan.

  • Design the war room to drive re-negotiations.


Execute and monitor progress.



3. Optimize Your Inventory

By holding less stock, you use less cash and can use it for other short-term initiatives.


The objectives:

  • Reduce inventories (finished, WIP, raw material).

  • Set new targets for inventories, update process, and order sizes.

  • Set Key Performance Indicators to steer accordingly.


Steps to execute:

Identify the options for Inventory improvement:

  • Map the internal processes (e.g., via interviews) and collect the required data.

  • Analyze the complexity and the cycles of stock levels.

  • Outline weaknesses in inventory management.

  • Conduct internal and external benchmarking of Inventory key metrics (e.g., Days Sales of Inventory).


Prioritize opportunities and quantify the impact (i.e., the net working capital effect). Consider the following initiatives:

  • Organize a sales promotion campaign for the slow-moving finished goods and obsolete inventory.

  • Adjust order lot sizes to demand and inventories (considering order book, current parts inventories, and demand).

  • Introduce rigid order governance.

  • Review existing orders and make adjustments due to expected cancellations.


Prepare the action plan.

  • Determine the optimization target.

  • Prepare the action plans.


Execute and monitor progress.


 

Tips: Don't go overboard with the AR, AP, and Inventory optimization. Unless you are in a dire turnaround situation or have opportunities for quick returns from the cash, you may want to be careful with these initiatives.

  • Overly long AP will make many suppliers unhappy/don't want to work with you/charging higher prices when dealing with your company. This is especially true when your firm doesn't have any supplier bargaining power. I know various companies who, due to their overly long AP term, can only work with a restrictive set of suppliers that charges them higher prices.

  • Overly short AR will make many customers unhappy/don't want to work with you/pushing for discounts. Again, this is especially true when your firm doesn't have any customer bargaining power. I have seen companies who, due to their overly short AR term, can only work with a restrictive set of customers that are willing to pay early.

  • Overly low inventory levels can lead to poor service levels to the customers (i.e., cannot fulfill orders in time and on full).

 

To see other ways to improve your profit, check the 33 Ways to Amplify Your Profit Quickly.
Alternatively, to continue exploring winning strategy, click here.


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