Hackett: Cash Analytics & Working Capital

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Author: Jennifer Pinney, The Hackett Group

How to make your working capital metrics work

A long time ago, in a land not too far away, a team of bright, young managers faced a crash course on cash and working capital management after their parent company made a surprise announcement that it would no longer meet their unit’s funding needs. The parent had decided the firm needed to become cash positive and announced it intended to remove funding for the following month, leaving a rather large gap that needed to be filled quickly.

It’s a common story, and one that may sound familiar. Whether you’re the new CEO on a mission to turn around a company, a business unit head given an ambitious growth target or the director of payables, you may face an immediate need to improve the quality of your cash and working capital management.

But how?

If, like most executives, you are new to advanced cash management practices, your team will need to overcome three challenges before you can get your cash conversion cycle (CCC) under control. First, you will need to develop better metrics for your working capital performance. Second, you will need to understand how those metrics are constructed, down to the transactional level, and tweak them until they make sense. Finally, you will need to learn how to use those metrics to analyze where you can make the most difference to your cash cycle.

Key challenge 1: Mystical metrics

Working capital performance terms tend to be thrown around in business meetings: free cash flow, working capital as a percentage of sales, days sales outstanding (DSO), days working capital (DWC), days payable outstanding (DPO), CCC, inventory on hand, etc. Analysts rely on them, too, to compare one company’s performance with its peers.

Yet, many teams struggle to create those headline metrics. Days may be spent researching and debating which calculation method to use and then the elements to take from the profit and loss or balance sheet to build the consensus key performance indicator (KPI).

The troubles do not end once the metrics have been calculated. Often, your colleagues will say that the result seems to be wrong and an unfair representation of what is happening at the account level. Sometimes, for instance, the KPI may not reconcile with the performance being recorded in receivables and payables.

The solution to the mystery is always found in the data. Whatever the anomaly, the underlying transactions invariably expose the cause of the problem. But bookkeeper, beware – don’t make an adjustment because a customer did not pay as expected or a supplier insisted on payment. Many companies lose time, effort and credibility by trying to adjust for underperformance.

In fact, headline metrics are only the first step in getting a grip on your working capital. Typically, companies require three levels of working capital metrics before they can gain a true understanding of their cash cycle.

Level 1: Headline metrics

The most basic level of metrics can be calculated using financial statements alone, and then used to compare your financial performance to that of your peers. Whether you are analyzing the group, region, business unit or operating company, these headline metrics can be very useful for understanding where your performance is weak and setting quantifiable targets for improvement. But as noted above, these are just the headlines; to understand the news you need to read the rest of the story.

Level 2: Adjusted headline metrics

Next, you exclude elements that don’t reflect your actual cash performance – intercompany, accruals, etc. – from your KPIs. These metrics operate as a bridge between Level 1 and Level 3. This exercise won’t improve your performance, but it will help your team screen out the noise that keeps you from understanding the actual cash performance of your business where you can have an impact.

Level 3: Operational metrics

Ironically, headline metrics are often completely unknown to the team who physically manages your cash. Talk to people in payables, for instance, about their DPO and you’re likely to get a lot of mystified looks. What does the balance sheet have to do with what we see on our enterprise resource planning (ERP) or customer relationship management systems? How does this help us take appropriate action at a transactional level?

To have a real impact on your cash cycle, you need to teach your cash managers why these metrics matter and translate them into language each department understands. For sales, that may be the name of the customer or contract ID. For collections, it may be the ERP customer ID. Most of the time – to reach this level of insight – you will need to pull transactional ledger data invoice and credit note, and then repackage it in a way that is comprehensible to the team handling that cash.

Key challenge 2: Transactional paralysis

In larger organizations, the next key challenge is to develop a consistent set of numbers. Different ERP platforms compile and generate their data in different ways, so you will need to find out how to create more consistency. Initially, you may need to take a quick-and-dirty manual approach simply to get started as soon as possible. However, as your process and working capital structures gain maturity, your ability to build a more comprehensive solution should improve.

Finding the optimal data to extract can take a lot of time, particularly if you need to reconcile multiple ERP systems. Some systems generate a variety of information, while others can provide only the bare bones. A good rule of thumb is to keep it as close to the cash register as possible: always extract everything that has been paid at a transactional level. Each file should equal zero because you are including both sides of the equation – invoices, payments, credit notes and journals. If files do not equal zero, then it’s likely we are missing a transaction because each file should show both debits and credits. Without that kind of baseline, the firm is likely to be locked in what we call transaction paralysis – able to see that something is wrong but unable to diagnose the true cause because figures do not reconcile across the three levels…

Jennifer Pinney, Director
Jennifer Pinney has over 15 years of operational industry experience in working capital management, driving short- and long-term improvements, in addition to expertise in business process outsourcing and driving compliance and change management (organization and process), with a focus on cost reduction and best practices. Since 2008, Jennifer has managed total working capital, procure-to-pay and customer-to-cash implementation projects, both in the UK and internationally. She has delivered €500m in sustainable working capital across over 50 countries, building strong, strategic and operational client relationships with on-time project delivery and results.

About Author

Procurement and Supply Australasia (PASA) is the leading provider of information and education to procurement and supply professionals throughout Australia and New Zealand. PASA supports the largest community of engaged procurement stakeholders in the region, through its renowned series of events, publications, awards, plus various community and network building activities. PASA is a trading name of BTTB Marketing, for many years recognised as the leading producer of conferences and events for the procurement profession in Australia and New Zealand. Whether producing under the BTTB, CIPSA Conferences or now PASA brands over the last ten years, our events have consistently led the market in terms of both educational and networking opportunities.

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