Journal 1/2015

It is time to start focused exercise and mobilize idle money in operations. With the right methods, every company can improve its working capital performance. The rewards are measured in the millions.

Working capital is just like fat in the human body. Fat is vital, but most of us have more than we actually need.

Kimmo Kauranen, Vice President, O2C Business, encourages companies to put idle money into action and optimize working capital through focused exercise.

His message comes at the right time. Financing from banks is expensive and difficult to come by, so companies can no longer rely on banks for help with investments or momentary liquidity crises. The optimization of working capital tied up in operations is an effective way to ensure sufficient funding over the long term.

“Companies are no longer expecting the good old times to return. They realize that they need to get serious about developing processes to ensure financing in the future,” says Kauranen.

The three key indicators of working capital development are DSO (Days Sales Outstanding) for measuring the efficiency of sales receivables management, DPO (Days Payables Outstanding) for monitoring the company’s own payment performance and DIO (Days Inventory On-Hand) for monitoring inventory turnover.

While these concepts are familiar to financial professionals, they are neglected in practice surprisingly often. In the early 2000s, when the availability of financing was not yet a problem, it was easy to forget all about these concepts. Kauranen illustrates the business impact of the indicators with an example.

“Let’s assume that your company is at the median level in terms of working capital, but your competitor is in the top fourth. Your competitor receives payment for its products more than two weeks earlier than you, its inventory turnover is faster than yours by a third and its terms of payment for its purchases are more than two weeks longer than yours. This means that the working capital tied up in your competitor’s net sales is up to 60% smaller than yours.”

“No wonder your competitor’s financing expenses are just a fraction of yours and its bottom line is considerably higher, even though your net sales are on a par. This enables your competitor to finance new technology, for example, and continue to improve its competitive position.”

The difference between the median level and the best fourth can be surprisingly large.

“The difference is easily dozens of millions of euros of assets lying idle in processes or kept as buffers, just in case. In a large corporate group, this difference can add up to hundreds of millions of euros.”

Kauranen illustrates his message with another example:

“Let’s take a group of companies that generates 300 million euros in net sales and has numerous subsidiaries in many countries. Its units operate independently and have their own functions: production, storage, transport, sales, purchasing, financial administration and ERPs—and a few million euros tied up in working capital. Investments and loans are managed locally. Intra-group invoicing is significant, meaning that it also poses a currency risk.

“Because the group has a decentralized business model with no shared systems, the financial managers of the units each submit a weekly Excel report and liquidity forecast to the group treasury.”

However, the group has no way of knowing where the assets of the units are tied up, and a lack of indicators means that the units do not know either. The units are isolated, and their expenses cannot be scrutinized.

“The money needed for an investment of 30 million euros, for example, may easily be hiding in processes and buffers in the units. With no transparency, the required funding must be sought from banks or other channels. However, external funding is often uncertain and always expensive.”

The above example is simplified, but it describes a type of company that abounds in the market.

However, the example is encouraging. According to Kauranen, every company can improve process efficiency and quality and be among the best by streamlining, standardizing and automating its processes.

“By automating and harmonizing its processes, the group treasury at the company described in the example was able to tackle idle money and reduce the share of working capital in its net sales from 10% nearly down to 1%,” says Kauranen.

In freeing up working capital, transparency and the use of the DSO, DPO and DIO indicators are the keys to improved performance. Cash hides in processes and consistent end-to-end processes that run beyond departmental boundaries can make this cash visible.

“Automation and transparency enables a corporate group to examine costs by category, such as its purchasing process. Why are cleaning services acquired from 20 companies, even though the company has signed a framework agreement with one company? Is the group making use of its centralized equipment acquisition agreement even in spare part purchasing?”

Kimmo Kauranen says that the share of indirect purchases in annual net sales can be hundreds of millions of euros. When improving efficiency, the hypothesis is that indirect expenses can be cut by 2–10%.

“You should calculate what this means for your company. As a bonus, you will also get tools for continuous process development.”

DSO, an important O2C process indicator, helps companies ensure fast and efficient receivables management.

The transparency of the O2C process is reflected in the customer experience, especially if a customer has questions about an invoice.

“The more visible the various phases of orders, deliveries and invoicing are to Customer Service, the faster any issues can be examined and resolved. This improves cash turnover and reduces customer attrition.”

Published in OpusCapita Journal 1/2015.
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