Improving working capital management (WCM) can generate cash to fund value-creating opportunities and reveal insights that improve other aspects of business performance, a recent McKinsey report reveals.
Ryan Davies and David Merin of McKinsey in their report titled “Uncovering cash and insights from working capital” point out working capital is often undermanaged simply because of lack of awareness or attention.
Working capital management – Quick way to free up cash
The McKinsey consultants make the point that working capital management is often painstakingly technical. They highlight they often observe companies generating tens or even hundreds of millions of dollars of cash impact within 60 to 90 days, without increasing sales or cutting costs.
They cite the example of the global aluminum company Alcoa Inc (NYSE:AA) which made working capital a priority in 2009 in the aftermath of the global financial crisis. Interestingly, over that time, the aluminum major has been able to reduce its net working capital cycle by 23 days and unlocked $1.4 billion in cash. Recently, the company also celebrated its 17th straight quarter year-on-year reduction in net working capital.
Davies and Merin note the process of improving working capital can also highlight opportunities in other areas, such as operations, supply-chain management, procurement, sales and finance.
As evidenced in the following graph, the McKinsey consultants’ research reveals that working capital needs vary by industry:
Clean-sheet approach helps
Davies and Merin point out that several companies don’t systematically track or report granular data on working capital. Though getting data into a consistent and usable format can be a tedious exercise the first time, they point out that ideally managers should build data collection into their core IT processes.
Elucidating the importance of data with an example, the consultants highlight that more successful managers of working capital start by re-creating business processes as if there were not constraints and explicitly testing their assumptions – a so-called clean-sheet approach.
For instance, managers at a global manufacturing company had long held an average of 60 days’ inventory of a critical raw material at a certain plant to ensure that disruptions to supply won’t affect production. However, by adopting a clean-sheet approach, they ultimately determined that they only need to keep 30 days’ inventory, translating into tens of millions worth of dollars annually.
They also suggest including a finance function to involve operations managers while setting the targets. They suggest managers can make considerable headway by focusing on those areas of working capital with the largest dollar values, estimating clean-sheet targets, and then focusing on those places with the largest gap between incremental and clean-sheet targets.
The McKinsey consultants highlight that though areas of opportunity can differ by business, many companies can find WCM value in inventory, accounts payable, and accounts receivable.