Consistent working capital management

Particularly in difficult economic times, such as during the economic crisis of 2008/2009, SMEs get into turmoil due to a lack of working capital management. Following the abandonment of the minimum Swiss franc exchange rate in January, Swiss companies are currently facing the risk of a similar scenario. This makes it all the more crucial for entrepreneurial success to address the management of net working capital at an early stage. This also applies in times of low interest rates. This is because ineffective and inefficient processes are often hidden behind tied-up capital, unnecessarily driving up costs.

Study shows: Potential for improvement in WCM

However, there is often a lack of concrete recommendations for action for SMEs in WCM. Existing studies on the topic often focus on a comparison of key figures, especially along the cash-to-cash cycle. Much more important for companies, however, is the question of what characterizes "successful" WCM and which methods, processes and objectives distinguish best-practice companies. A study on performance excellence in WCM conducted in 2014 by the Supply Chain Finance-Lab (SCFLab) at the University of St.Gallen addresses precisely this question. In a comprehensive survey of more than 60 Swiss companies, valuable recommendations for action to improve performance in WCM were also identified for SMEs. "The study results show that there is still considerable potential for improvement in WCM, especially among SMEs, and provide important impetus for learning from best-practice companies," says Adrian Brönnimann, Head of Individual Customers at PostFinance and sponsor of the SCF Lab.

What is working capital management?

WCM deals with the management of net working capital as the difference between current assets and current liabilities. Key components are trade receivables, inventories and trade payables. As net working capital increases, the self-financing capacity decreases while capital commitment costs increase. By freeing up liquidity, WCM has a direct positive impact on the company's success. At the same time, a successful WCM also has indirect effects through changes in fixed assets and profits. On the one hand, a noticeable reduction in inventory usually reduces the need for storage space and can thus lead to a decrease in fixed assets. On the other hand, efficiency increases result in reduced manufacturing costs (e.g. through accelerated lead times). This makes it all the more important to operationalize WCM on the basis of concrete fields of action. The cash-to-cash cycle as a holistic working capital cycle enables an integrated view based on four fields of action (see figure). The management of net current assets is complicated by the large number of functions involved in the company and their often conflicting objectives. For example, the sales department usually demands higher inventories and longer payment terms in order not to jeopardize customer satisfaction, while the logistics and finance departments try to reduce inventory costs and payment terms. Similar conflicts of objectives also arise in the interaction with production and purchasing.

SMEs also face the challenge that they usually do not have the same market power as large corporations. The latter often shorten their capital commitment period at the expense of upstream and downstream partners in the supply chain, e.g. by extending payment terms to suppliers. The results of the study on performance excellence in WCM show a large number of alternative courses of action that can be implemented independently of the specified payment terms.

Define WCM strategy and goals

As already described, the management of net working capital affects a large number of functions with often conflicting objectives. In order to avoid conflicting objectives, a common WCM strategy with clear guidelines for the individual areas of WCM is therefore indispensable, even for SMEs.

In contrast to large corporations, SMEs are characterized by much shorter distances and thus facilitate coordination between the individual functions. An additional organizational unit at SMEs therefore usually increases complexity unnecessarily. However, balanced goal setting does not happen by itself despite shorter paths. Joint workshops for WCM strategy development help to establish a common language and coordinated objectives.

Focus on relevant WCM areas

Since WCM encompasses diverse processes from procurement to distribution, there is a risk of getting lost in the details of improvement efforts. In addition, the human resources at SMEs are limited. Accordingly, it is important to focus on relevant WCM tasks and processes. Not all sub-areas of WCM listed in the figure always offer the same potential. This makes an initial analysis to identify weaknesses all the more important. However, SMEs in particular often lack explicitly defined key figures for this purpose, which can be used to measure performance in WCM and initiate the implementation of appropriate measures. Such key figures go beyond the individual elements of the capital commitment period. For example, lead times for individual process steps can help to identify and eliminate sources of error or cumbersome processes.

However, concentration can also mean that sub-processes are outsourced to external service providers in order to focus on the company's own core competencies. A possible example is a payment factory by external service providers. Up to the transfer of the due invoice to the company, all common process steps are taken over by the service provider (e.g. invoicing, invoice dispatch and dunning). For SMEs in particular, this often involves a professionalization of the processes, as the external service provider brings in additional expertise.

Use innovative methods

It is also apparent that SMEs often rely on traditional approaches to WCM and that innovative methods, such as accounts receivable or accounts payable platforms and dynamic discounting, are not used. In addition to banks, there are increasingly new service providers offering alternative solutions to previous financing approaches. Dynamic Discounting, for example, replaces the classic staggered discount rates. The earlier the customer pays, the higher the discount rate. This means that an earlier payment can be worthwhile for the customer at any time and not only at the end of the period of a discount level. This approach is supported by online platforms on which open invoices can be viewed, thereby significantly increasing transparency for both sides.

What most of these innovative methods have in common is a high degree of automation. In this context, standardized automation offerings that are specifically targeted at SMEs offer the advantage that they are associated with significantly lower investment costs and already pay off for smaller volumes. Another example of this is the introduction of e-billing, which can significantly reduce invoicing costs but is still comparatively rarely used by SMEs.

Motivate and empower employees

Last but not least, motivation for the topic of WCM is also a decisive success factor. On the one hand, this involves building up and expanding a corresponding know-how base to improve methodological skills, e.g. via training courses. This provides employees with cross-functional knowledge, which is crucial for high performance in WCM.

In addition, motivation is promoted through the introduction of a targeted and performance-oriented incentivization of employees with regard to WCM objectives. If, for example, volume discounts are positively rewarded in purchasing, this results in rising inventories and increased capital commitment. The consideration of various objectives in the strategy must therefore also be reflected in the remuneration and target agreements for the individual employees.