Due to the challenging economic environment of today, Logistics departments continuously strive to have leaner and more flexible organizations whilst maintaining a heavy focus on cost management. Levers to improve overall cost management can easily be detected. Examples of these can be found in the following 4 areas:
- Operational efficiency – flow improvements as a result of optimizing logistics processes and raising quality & effectiveness levels across operations
- Procurement – savings through strategic sourcing, supply base consolidation, enhancement of contractual conditions as well as reducing inventory levels
- Supply Chain – redesigning of the logistic chains, distribution networks, scoping and managing inbound and outbound fueled by volatile customer demand
- Working capital management – unlocking cash flow to ensure sustainability and reduction of the dependency on short-term funding
With specific focus on Working capital management (WCM) : what role can Logistics play and contribute to WCM improvement ?
Why manage Working Capital
As working capital has a significant impact on the measurement of a company’s liquidity and profitability, WCM is one of the top priorities on the corporate agenda to be monitored and improved. This on the one hand to get a grip on enterprise performance and on the other hand to reinforce the position within the market. Below some examples of corporate benefits of healthy WCM results which might be found in various cross functional areas:
- Monitoring of liquidity levels – free up cash flow that can be invested in operations and capital intensive projects, and to avoid overall insolvency
- Supporting expansion plans – ensure funding to expand production capacity levels, and enabling to enter new markets
- Boosting competitiveness – reinforce market presence / competitive position in the current markets, with improved positioning of own products and brand recognition
- Raising stakeholder image – increased stakeholder value, and ability to support strategic supply and demand
Working Capital Requirements
The amount of Working Capital a company requires can be derived from the balance sheet figures. The total amount of liabilities a company owes to the shareholders and the debtholders is counterbalanced by the company’s total assets it owns. The following equation details the components of total assets :
Total Assets = Non-Current Assets + Current Assets [1.1]
Non-Current Assets in equation [1.1] are all investments a company has made to run its operational cycles, for example PPE (Property, Plant, Equipment). Current Assets are the means at hand with which a company can fund investments in operations as well as run their operations on a daily basis.
Current Assets – Accounts Payable = Net Current Assets [1.2]
‘Net current assets’ in equation [1.2] is an indication of the amount of liquidity and the working capital requirements – either known as the operating assets – a company needs to pay for maturing debt obligations, to fund operating cycles and inventory values.
Figure 1 – highlights the influencing factors on Working Capital Requirements
In order to be able to influence Working Capital one needs to understand the main influencing factors that do so as it affects both cash management and inventory levels:
- Cash management refers to liquidity – profit streams and pure cash holding – and the continuous in- and out flow of cash due to payments of receivables (+DSO) from demand & payments of supply (-DPO) which can be converted into liquidity
- Inventory management consists of raw materials, component parts, work-in-process, and finished products that are stored at locations across the Supply Chain – covering the cost of purchasing, ordering and holding these items in stock (+DIO)
These influencing factors MINUS pure liquidity are mainly expressed as the Cash-to Cash cycle (C2C-cycle). Figure 1 – outlines the connection between Working Capital Requirements and the Cash-to-Cash cycle. A company’s objective is to reduce DSO and DIO, and to increase DPO to obtain a minimal Cash-to-Cash cycle. Differences can exist in Cash-to Cash performances across industries due to specific payment conditions, sales strategies and inventory policies.
Improvements in WCM
By optimizing the Cash-to-Cash cycle companies can realize improvements in three specific areas while generating cost avoidance benefits that affect the entire organization. These three areas are:
- DPO – Procurement area – within the Procure-to-Pay process, the order processes can be optimized and improved together with overall commercial procurement conditions within the Supply Base. These improvements are measured in terms of DPO – days of payments outstanding being the total time it takes a company to pay back its creditors.
- DIO – Inventory area – within the Forecast-to-Fulfill process, reduction of ‘waste’ in the physical and storage related processes together with a strong focus on storage cost management. Measurement in terms of DIO – days of inventories outstanding being the total time it takes a company to turn its inventories into sales.
- DSO – Sales area – within the Order-to-Cash process, focus on improved billing process, more efficient and reduction of days overdue. Follow-up on DSO – days of sales outstanding being the total time it takes until a company gets paid by its debtors / customers.
Logistics’ contribution to WCM
Many aspects in Supply Chain operations are potential elements with influence on WCM.
Figure 2 highlights the essential building blocks within the material flow that must be given the appropriate attention.
Top areas for Supply Chain organizations to focus their review efforts on are necessarily demand and the impact on the Supply Chain, planning of replenishments, Supply Chain network structure, vendor management, lean in manufacturing, supply network planning, and supply chain visibility (tracking and tracking).
Possible examples for WCM improvement within the Cash-to-Cash cycle are listed below by C2C-area:
In the area of Procurement (DPO):
- Restrain volatility in material prices
- Reduce bottlenecks in supply and delivery dates
- Increase payment terms
- Global sourcing (lead time and supply set-up)
- Automation of processes & lead time to enhance cash discounts
- Supplier integration by means of Vendor Managed Inventory (VMI)
- Category strategy (standardization)
In the area of Inventory (DIO):
- Reduced lead times
- Planning capabilities & reactivity to respond to supply / demand
- Product complexity & diversity
- Production flexibility & lean management
- Network design & transportation routes / modes
- Process accuracy and supporting technologies
- Capacity utilization and inventory levels (safety stocks)
- Integrated Inventory Chains
In the area of Sales (DSO):
- Adequate payment terms
- Demand planning & forecasting (visibility)
- Billing and cash collection process (e-Invoice, pro-forma billing, factoring)
- Risk mitigation strategies
- Policies and procedures (notifications, reminders, deductions, disputes)
- Early payments (incentives)
Working Capital requirements are important because they provide an indication of all necessary investments and cash for conducting normal business operations, including Logistics. While companies make capital investments there is also a necessity to sustain the cash drain that is required by normal operating cycles as well as maturing debt obligations. Companies need financial resources to counter these cash drains. Across the Logistics eco-system many WCM improvements are available to support a significant part of that objective.