In Business
Working Capital - or is it?
By John Mardle - Develin & Partners
Sep 15, 2009 - 9:44:17 AM

The issue of whether working capital is still a major concern for CFO’s is well documented in the financial press, and indeed tops the list of most financial professionals as a ‘must have’ to manage the cash flow of the organisation. Accurate, robust and timely cash flow forecasts that focus on working capital are also required by both the banking and business communities and indeed many stakeholders generally. Investors now want to see, following the credit crunch, the detailed reporting of working capital in quarterly statements and in the year end accounts.

However it seems working capital (debtors plus inventory less creditors) is now being ‘replaced’ by:-

1. factoring or similar of debtors 
2. inventory, where stock is reduced to a minimum by Just In Time, Kanban and ‘lean system’ techniques. Also work in progress will no longer be the subjective area it was, as new revenue recognition rules will be shortly applicable.
3. creditors where supply chain finance of the sort currently being pursued by Santander and Lloyds Bank  and payroll financing of  employees salaries/expenses means that creditors are sometimes out of the working capital equation too.

Furthermore it seems that management is not heeding the warning signs of customers delaying payments, suppliers not delivering all the goods /services on time or in fact of the banks indicating that loans, covenants are due or that overdraft limits have been exceeded. Is this because mangagement cannot see the wood for the trees? Is it because they have not considered the real working capital ‘drivers’ that can reflect how the cash in an organisation is going to perform in the future?

It is beginning to dawn on many corporate radar screens, namely in treasury functions, or even in the SME world within their bank statements that where they may have decided to factor debtor invoices, or provided some supply chain finance to creditors or indeed outsourced payrol functions including the payment of salaries/wages and expenses, to reduce ‘costs’, it is now becoming very challeging for them to manage the relationships with their customers, suppliers and even their employees. This arises as a result of harassment of customers by factoring agents to collect cash, when banks decide that a supplier is a ‘risk to far’ and will not allow ‘financing of the suppliers invoices’ (in some cases because the credit rating agencies have downgraded the suppliers credit status) and where employees have not been physically paid or in fact where their pension contributions have not been paid into the pension funds in a timely manner.

Besides the cost to the business of doing business with these ‘finance providers’ it seems there are many ‘hidden’ costs that will have long term strategic effects on how the business will perform. So how can management ‘wrest back’ control from such situations?

In many cases it is about appreciating the need for a robust, accurate and timely cash flow analysis say over an 6- 12 month rolling period that not only reflects (as a lagging indicator) where the cash is coming from or going to but also the need to have working capital drivers that give early warning signs of cash issues that are likely to arise.

For instance a metric that is managed by an operations director in the bowels of the business that portrays the top ten suppliers who have delivered less than, say 75%, of the goods/services ordered, over say a 6 week period is a good sign that those suppliers need investigating as to why they are struggling with the orders. It could be because of their own cash flow issues!!

Likewise with a metric that is ‘owned’ by a credit control manager that reflects the volume of complaints about quality/delivery or whatever received from a number of customers that belong to a certain corporate entity is possibly a sign of cash being squeezed by the corporate treasury function away from the subsidiaries and needs actions taken.

In conclusion, is the ‘engine room’ – namely working capital, of an organisation now no longer a good measure of whether it can finance organic growth, maintain spend on research and development, carry out merger and acquisition activities and is therefore a ‘metric of the past’?

Are venture capitalists, banks, business angels etc interested in cash enhancement? I welcome any response and any comments/observations used in future research will be duly accredited to the respondent should they wish this to be the case.

John Mardle
10th September,2009.