A transformative, enterprise-wide approach to managing working capital is now enabling companies to better optimize cash. Breaking out of silos — and applying new technology — are the keys.
Dramatic shifts are taking place in the understanding of how large corporations can manage their working capital. Old, siloed models, in which each division of a company seeks the efficient use of working capital, are being overturned by holistically managed efforts that focus on the effective use of working capital across the entire enterprise.
This enterprise-wide approach can’t be achieved by just tweaking processes around the edges, says Bruce Meuli, Treasury Advisory Executive at Bank of America Merrill Lynch. It requires sustained energy as well as investment in cross-functional collaboration and standardized data and metrics — which must then be put together with the latest technology and software to analyze that data and put it to use.
But while it’s true that companies are increasingly well positioned to make more informed choices in working capital, that doesn’t mean all firms are in that position or taking advantage of the opportunity. In fact, accounting and financial consulting firm EY estimated in 2016 that the top 2,000 companies in the U.S. and Europe have a combined $1.2 trillion in excess working capital, equivalent to 7% of combined sales. That means that for every $1 billion in sales, the opportunity for working capital improvement was $70 million.
It’s always been difficult to gain the truly clear picture needed for working capital management, because it involves analyzing an intricate web of widely dispersed micro-transactions across the entire value chain. But three evolving trends — greater access to multiple sources of data, increased data integrity, and big data
— have changed all that. As a result, it’s now possible to see and manage what’s happening across the enterprise.
As modern companies brought more of their operations into centralized operations, such as a shared services center (SSC) environment, they began introducing greater standardization and alignment of process, technology and data. Divisions that used to track and measure success based on disparate metrics started to collect and measure similar numbers, which generated evermore-useful sets of data.
But it’s the vast computational power of artificial intelligence (AI) and related analytical tools that now completes the transformation. “The difference today is that businesses are gaining access not only to the information but also the tools they need to evaluate working capital on a larger, enterprise-wide scale,” Meuli says. That ability to collect and analyze so much data across standardized processes, he suggests, “can lead to quantum improvements in working capital management. Companies can make more informed allocation decisions and assert better, potentially real-time control over their working capital.”
HOW WORKING CAPITAL CAN WORK
Capital that hasn’t been put to work can come with a price for any business, both in the form of interest and opportunity cost. That’s why the recognition that working capital can be a source of capital as well as a use of capital is so critical. Increasingly, Meuli says, one of the cheapest sources of capital is that excess cash that’s trapped in a company’s own operations.
The key objective is to deploy capital where it will deliver the most value. But such decisions should be considered carefully, Meuli warns. Any benefits should be weighed in terms of the relative cost/benefit ratio across the enterprise.
One option may be to feed the cash back into the working capital cycle. For example, companies can give preferential terms to certain providers, pay suppliers through a self-funded supply chain financing program or invest in a dynamic discounting program. A company might also invest in making itself more nimble and responsive: for instance, by redeploying the money in ways that provide a competitive advantage, such as holding greater inventory closer to targeted markets during an expansion drive.
THE KEY TO BREAKING OUT OF SILOS
True optimization of working capital requires coordination across the enterprise as a whole. But some companies still rely on divisions and departments to make local decisions, leading to actions that may not make sense for the whole company. The finance team, incentivized to minimize accounts receivable, often may not think about the effect that tighter payment terms could have on future sales. Procurement executives, seeking to optimize costs with bulk purchases, might not take into account the costs of carrying large inventories. Or more specifically, boosting inventory in one particular area, or against one particular product line to support a sales push, might run up against someone’s incentives to keep inventories lean across the company. Corralling these disparate players into an enterprise wide view isn’t easy, but without common purpose, gains tend to be scattered and unsustainable.
In order for any working capital initiative to be successful, says Meuli, it has to be clear that the effort represents a serious commitment from the very top of the organization. This is why Meuli feels that appointing — and empowering — someone to the role of working capital champion can be critical. This officer must take the lead in helping each part of the company see how choices made in silos can negatively affect the organization as a whole.
The development of critical metrics that are both aligned across functions and can be translated into actions, especially through technology, should be a key goal for the working capital champion. And it requires changing well-established incentives and performance drivers. In essence, this means changing the way teams work and are incentivized across the organization. He or she “raises awareness and cooperation and leads the group to more sustainable and optimized working capital decisions,” Meuli says.
TOOLS OF THE TRADE
New technologies such as business intelligence and artificial intelligence (AI) are key allies in developing optimized working capital strategies. “You’ve got to try to understand your business end-to-end,” says Meuli. “Understand your cash flows: Where and how does cash enter? How do the business units fund their activities? Where is cash trapped within the operating cycle, and where are the trade-offs?” Such an understanding can help free up considerable cash flow.
The next — and potentially more disruptive — frontier is AI. Machine learning, an AI outgrowth, helps interrogate data, identify patterns and associations, formulate rules and make decisions. For example, advanced algorithms and updated rules “facilitate even faster, more accurate electronic matching,” says Meuli.
Of course, it isn’t only companies that are waking up to the technology-driven opportunities to improve working capital. Banks and other providers are also devising new means for helping clients optimize working capital enterprise-wide, in some cases by combining different products into an integrated working capital solution.
For example, corporates are combining their use of virtual commercial card accounts into broader supplier-financing-and-payments solutions in conjunction with payments automation. This dynamic approach leverages the different benefits of multiple payment methods. For example, a supplier may desire early payment to match its working capital cycle and therefore take advantage of a corporate purchaser’s considered offer of virtual cards, dynamic discounting, or simply early payments for terms.
The same holistic enterprise approach to process design and solutions can apply to receivables. Virtual accounts, for example, are a solution that can work for both payments made and received. Through them, enriched, segregated data is obtained while at the same time reducing the number of “physical” bank accounts. As a result, says Meuli, the company gains a treasure trove of detailed, easily sourced data that it can analyze to improve working capital management: “Which customers are paying on time? Where are we encountering delays, and what can be done to accelerate payments? How do changes in credit terms impact specific customers?”
TIME TO TRANSFORM
Without question, working capital management is becoming a critical focus for more companies. “It used to be when we spoke to CFOs, they would focus on traditional allocation of capital models,” says Meuli. “But today, we are having more conversations about working capital as both a source and use of funds. They’re thinking today’s data-infused business models and technologies can lead to remarkably better-optimized enterprise-wide working capital frameworks.”
Looking ahead, as more companies drive success with an enterprise- and technology-led approach that leverages data-rich, interactive and integrated solutions, working capital management will continue to evolve. “For many years, working capital decisions have been made in silos or with insufficient data,” says Meuli. “Today, companies have an opportunity to overturn those silos in order to implement enterprise-wide strategies and tools that are truly transformational.”
A CASE IN POINT
A holistic overview combined with close analysis of enterprise-wide working capital operations can deliver remarkable results. For example, a large company in the pharmaceutical sector was able to reduce its working capital footprint by more than $2 billion through a coordinated and actively managed enterprise program, says Bruce Meuli, Treasury Advisory Executive at Bank of America Merrill Lynch. The company started by looking closely at trade receivables, identifying opportunities to tighten credit terms, address slow payment, and, where appropriate, use factors (a third party that discounts the invoice, thus taking on the collection risk).
On the payables front, the company was able to slow working capital consumption simply by doing more to adhere to existing payment terms. “In the name of operational efficiency,” says Meuli, “payments were actually being made before their due dates.” The group also conducted a thorough overhaul of its end-to-end inventories, ranging from basic inputs to finished goods, in each case seeking the optimal level. Inventories, Meuli explains, “have to be financed, so to the extent that they can be reduced, it frees up cash.”
Then, to ensure the benefits were sustained, the company created a working capital scorecard and dashboard, which provided greater visibility and focus for both the corporate team and local managers. Similarly, the company developed a working capital optimization tool kit for those managers to reference. Overall, says Meuli, “this approach provides a solid example of what can be achieved, and the steps they took provide a blueprint for others to leverage.” There were two keys to success for this company, Meuli suggests. One was developing a sustainable, cross-functional enterprise approach that targeted the key levers and utilized all available tools: process, technology, data and organization. The other was giving one person — and the team that person assembled — the authority, executive support and accountability to deliver.
Case studies are for illustrative purposes only and intended to demonstrate the capabilities of Bank of America Merrill Lynch. You should not consider these case studies as an endorsement of Bank of America Merrill Lynch. Case studies do not necessarily represent the experiences of other clients, nor do they indicate future performance. Results may vary.
- Greater access to multiple data sources, increased data integrity and big data improve insight into working capital
- Artificial intelligence and related analytical tools are powering up the working capital process
- A dynamic new approach combines the use of virtual commercial cards and supplier finance solutions with payments automation