INTRODUCTION:

Working capital management is important part in firm financial management decision.

An optimal working capital management is expected to contribute positively to the
creation of firm value. To reach optimal working capital management firm manager
should control the trade off between profitability and liquidity accurately. The purpose of
this study is to investigate the relationship between working capital management and firm
profitability.
The four major components of working capital are:
1. Cash
2. Marketable Securities
3. Inventory
4. Account Receivables

Cash:
Cash is defined as Demand deposit plus Currency. Cash is probably the least
productive asset you can have. Not only does it not earn any thing, it actually loses
purchasing power as a consequence of inflation. There are three motives for holding
cash balances:

Transactional motives. To conduct day to day business of paying for

purchase, labor etc.

Precautionary motives. To cover unexpected expenditure. If delivery

truck breaks down, it must be repaired or replaced if you want to stay in
business.

Speculative motives. Unusually good opportunities occasionally arise.

If you have the money available, you can take advantage of these
opportunities.

Marketable Securities:
Marketable securities are financial securities that can be sold on short notice. They are
not cash, but they can be easily converted to cash on very short notice. They are a way of
holding cash but with attribute of earning interest. Thus they are Near Cash Assets e.g.
U.S treasury Bills, Anticipation Notes, Commercial Paper, Bankers Acceptances.

Inventory:
Inventories (raw materials, work in process, finished goods) make up a large portion of
most firms current assets, and for many total assets. As such, the extent to which a firm
efficiently manages its inventories can have a large influence on its profitability. Thus,
keeping abreast of inventory policy is critical to the profitability (and value) of the firm.
Inventory can be broken down into three major categories,
A. Ordering cost
a. Fixed Cost- stocking, clerical
b. Shipping Cost- often fixed
c. Missed quantity discounts-an appropriate Cost
B. Carrying Cost
a. Time value of money tied up in inventories
b. Warehousing Cost
c. Insurance
d. Handling
e. Obsolescence, breakage, shrinkage
C. Stock Out Cost
a. Lost sales
b. Loss of Goodwill
c. Special shipping Cost

Account receivable:
Accounts receivable are generated when a firm offers credit to its customers. The first
thing that needs to be addressed when establishing a credit policy is to set the standard by
which a firm is judged in determining whether or not credit will be extended. This is what
known as 5 Cs of credit.
1. Character- the willingness of the borrower to repay the obligation
2. Capacity- the capability of the borrower to earn the money to repay the obligation
3. Capital- sufficient assets available to support operations (as opposed to a firm that
under capitalized)

Working Capital:

Working Capital is the money used to make goods and attract sales.
The less Working Capital used to attract sales, the higher is likely to
be the return on investment. Working Capital management is about
the commercial and financial aspects of Inventory, credit, purchasing,
marketing, and royalty and investment policy. The higher the profit
margin, the lower is likely to be the level of Working Capital tied up in
creating and selling titles. The faster that we create and sell the books
the higher is likely to be the return on investment.
Working capital is an important issue during financial decision making since its being a
part of investment in asset that requires appropriate financing investment. However,
working capital always being disregard in financial decision making since it involve
investment and financing in short term period. Further, also act as a restrain in financial
performance, since it does not contribute to return on equity (Sanger, 2001). Though, it
should be critical for to a firm to sustain their short term investment since it will ensure
the ability of firm in longer period.
The crucial part in managing working capital is required maintaining its liquidity in dayto-day operation to ensure its smooth running and meets its obligation (Eljelly, 2004).
Yet, this is not a simple task since managers must make sure that business operation is
running in efficient and profitable manner. There are the possibilities of mismatch of
current asset and current liability during this process. If this happens and firms manager
cannot manage it properly then it will affect firms growth and profitability. This will
further lead to financial distress and finally firms can go bankrupt.
In traditional view of relationship between cash conversion cycle (as measure of working
capital management) and profitability is ceteris paribus. The shorter firm cash conversion
cycle, the better a firm profitability. This shows that less of time a dollar tied up in current
asset and less external financing. While, the longer cash conversion cycle will hurt firms
probability. The reason is that firm having low liquidity that would affect firms risk.

However, if firm has higher level of account receivable due to the generous trade credit
policy it would result to longer cash conversion cycle. In this case, the longer cash
conversion cycle will increase profitability. Thus, the traditional view cannot be applied
to all circumstances.
Dilemma in working capital management is to achieve desired trade off between liquidity
and profitability (Smith, 1980; Raheman & Nast, 2007). Referring to theory of risk and
return, investment with more risk will result to more return. Thus, firms with high
liquidity of working capital may have low risk then low profitability.
Working Capital Cycle
A useful mechanism for the small-business owner is the working capital cycle. The
working capital cycle can be defined as the period of time which elapses between the
point at which cash begins to be expended on the production or purchase of a product and
the collection of cash from the customer. The working capital cycle analyzes accounts
receivable, inventory, accounts payable, and equity and loans. As shown in the diagram
below, the cash flows in a cycle into, around and out of a business. The faster a small
business grows the more cash it will need for working capital and other investments.
Owners need to understand that the cost of providing credit to customers and holding
inventory can represent a substantial proportion of a businesss total profits.

Source: Planware.org

To help explain the diagram above, some items need to be covered. The two main
elements in the working capital cycle that absorb cash are inventory and receivables. Instock products or work-in-progress items are examples of inventory. Receivables are
established when customers owe the business money. Finally, the main sources of cash
are payables, equity and loans. Payables are established when the business owes a
creditor money.
Each component of the working capital cycle (inventory, payables, and receivables), has
a time dimension and a money dimension. When it comes to managing working capital,
most business owners will say that time is money. If an owner can get money to move
faster around the cycle by collecting money due from customers more quickly or reduce
the amount of money tied up by reducing inventory levels relative to sales, the business
will generate more cash or it will need to borrow less money to fund working capital. As
a consequence, a business owner can reduce the cost of interest or have additional money
available to support additional sales growth or investment.
As a helpful guide to small business owners, below are some if then statements.

If a business owner

Then

collects receivables from customers faster,

they can release cash from the cycle.

collects receivables from customers slower,

the receivables soak up cash.

can get better credit from suppliers,

they can increase their cash resources.

can move inventory faster,

they can free up cash.

can move inventory slower,

they consume more cash.

Factors Influencing Working Capital Performance

For most CFOs, the greatest challenge with respect to working capital management is the
need to understand and influence factors that are out of their direct control, in order to
obtain a complete picture of the company's needs. The CFOs span of control can be
limited in terms of functional silos, though corporate finance may well have some powers
of influence over operating units.
While organizations generally concentrate on the right processes, such as cash, payables
and their supply chain, they are less likely to take into account various internal and
external constraints that can dictate how effectively those processes are executed. For
example, the legal and business environments can have a significant impact on
performance. Similarly, internal considerations as such as organizational structure, shared
systems, autonomous business units, multinational operations and even information
technology can impact working capital, creating barriers that can hinder a CFOs ability to
truly understand, and therefore manage, the company's needs.
The human factor is another important consideration. If management is focused purely on
top-line growth, insufficient attention may be applied to cash flow management and
forecasting. A hard-line focus on year-end or quarter-end results can produce a flattering,
but inaccurate, picture of working capital performance and lead to counter-productive
behaviour. Consider the impact on working capital of a year-end sales push, where
production has been building up inventory (which may not be the appropriate inventory)

to meet this artificial demand and the quality of receivables deteriorates during the early
part of the following year.
While there is no magical solution for effecting robust working capital management,
there are a number of prerequisites for gaining control of the complex process.

Cash Flow Forecasting

Proper cash flow forecasting is essential to successful working capital management. To
do this effectively, organizations must take into account internal and external working
capital drivers and consider the sensitivity of those drivers to changes in the business or
market.
Various questions need to be asked: How will unforeseen events impact working capital
requirements? What if a sudden market downturn or upturn occurs? What if the company
loses a major customer? What happens if a major competitor takes a significant action to
improve its market position? Since each of these could have a sizable impact on the
business, organizations must assume that the only certainty will be uncertainty, and
prepare accordingly.
In addition to assessing the cash flow impact of potential events, companies should
consider the possibility of having to make additional working capital investments. That's
because events could affect non-operational cash requirements such as investments, credit
ratings and the ability to service debt, as well as inventory, payables and receivables.
Companies must implement contingency plans that take a holistic view of the
organization in the context of a variety of different challenging situations. This will help
minimize the adverse effects of unforeseen events and provide financial flexibility in
uncertain times by having working capital as a ready source of cash.

How can you manage uncertainty? The three fundamental approaches are: control it,
predict it, react to it. The most successful approaches are based around one approach, but
contain elements of all three. Market-leading companies, perhaps not surprisingly, are in
the best position to manage uncertainty, often enjoying the ability to control supply,
minimize inventory and apply payment pressure on customers. Companies with less
influence, however, must rely more heavily on a strategy of prediction. To properly
prepare for events and improve or maintain performance during times of uncertainty,
organizations must develop an objective, business-driven view of the role of working
capital. Without real insight into true working capital drivers, a company may be able to
produce a reasonably good consolidated forecast, but find that accuracy drops
considerably when it comes to producing divisional, operating unit or even a product-line
forecast.
Beyond Balance Sheets
The Balance Sheet comprises Long term Assets (real estate, motor
vehicles, machinery) and Net Current Assets. The word Working
Capital is often used for Net Current Assets.
Thus our Balance Sheet appears as follows:
Long Term Assets
Working Capital

6,000
28,000

Cash in Bank

1,000

Total Capital

35,000

We defined Net Current Assets as Total Current Assets less Total

Current Liabilities

We subtract current liabilities items from current assets as follows:

Inventory
Receivables
Prepayments
Payables
Customer Prepayments
Working Capital

15,000
17,000
6,000
(9,000)
(1,000)
28,000

Using this format we can state than any reduction in the Working Capital figure, other
than for provisions for write-offs and write-downs, will generate the same amount of
cash. Thus if a customer pays US$ 500 that he owes to the organization, the Working
Capital figure will fall be US$ 500, and the cash figure will be increased by the same
figure. This revised format is useful when designing spreadsheet financial planning
models for business plans or for internal reporting.
Income Statement
Turnover
Cost of Sales
Royalties
Gross Profit
Distribution costs
Promotion
Write-offs
Administration costs
Operating Profit

Osiris
100,000
(57,000)
(18,000)
25,000
(5,000)
(2,000)
(3,000)
(10,000)
5,000

Balance Sheet

Osiris

Inventory
Receivables
Prepayments: authors

15,000
17,000
3,000

Prepayments : printers

3,000

Payables
Customer Prepayments

(9,000)
(1,000)

Working Capital

28,000

Analysis
Working Capital /
Sales %
Inventory in days
Receivables in days
Prepayments in days:
authors
Prepayments in
days : printers
Payables
Customer
Prepayments
Working Capital

28.00%
96
62
61
19
(36)
(4)
198

Cycle in days
Explanation of the calculations
Working Capital figure Explanation
Inventory in days
(Inventory / Cost of Sales) x 365 = 96 days. More correctly the
purchases figure, if available should be used, in this case excluding
royalties. Thus the publisher holds approximately 2 months of unsold
Accounts receivable in

inventory
(Receivables / Turnover) x 365 = 62 days. Assuming the turnover is

days

phased evenly throughout the year, this means the on average

Prepayments in days

customers take 62 days to pay

(Prepayment: authors / Royalties) x 365 = 61 days. In practice royalties

authors

will be earned that reduce this figure while new advances are also paid

Prepayments in days

to other authors.
(Prepayment: printers / Cost of sales) x 365 = 19 days. In practice part

printers

of the Cost of Sales figure would be new title pre-press costs not
carried out at the printer. This item relates to cases where advance
payments are made to printers as a deposit or for paper. The purchases

Accounts Payable in

figure if available would give a more accurate figure.

(Payables /(All purchases) x 365

days
(9,000 / (57,000 + 18,000 + 5,000 + 2,000 + 10,000) x 365 = 36 days
The purchases (investment) rather than the cost of sales figure should
be used if available. I have assumed that this figure includes money
owed to authors (see prepayment: authors)
Customer Prepayments (Customer Prepayments / Turnover) * 365 = 4 days
Working Capital cycle in 96 + 62 + 61 + 19 - 36 - 4 = 198
days
Working Capital / Sales 28,000 / 100,000 = 28%
%
Explanation of the figures

On average it takes Osiris 198 days to turn an investment into cash and profit.

New tiles will use more Working Capital than reprints

On average Working Capital equates to 28% of turnover

The percentage of Working Capital to turnover varies according to the type of

publishing

Trade publishing in developed countries may have a figure of between 35- 45 %

of turnover. Academic publishing is higher. Professional publishing uses a lower
Working Capital % figure

Working Capital is also a measure of risk

This figure may include new titles, reprints, foreign language coeditions, licence sales.
The figure would be different for each of these. Within the total Balance Sheet, the
Working Capital figure will vary throughout the year according to the phasing of new
titles and the sales cycle. Publishers should know the typical Working Capital cycle and
the level of Working Capital as a % of turnover for each market or distributor, for each
category of book.
The relevance of Working Capital to publishing in young economies
In the FSU Working Capital levels were controlled at government rather than factory
level. Invoices were settled on standard credit terms. Non or slow payment was not a
major problem for printers and publishers. Risk was a government problem. Authors were
paid standard royalty rates and terms. Inventory levels and print runs were according to a
formula: in textbook publishing, 150% of the textbook requirement would be printed in
year 1, the remaining 50% would be used for replacement copies in subsequent years.
Publishers, printers and distributors would negotiate for annual cash budgets but did not
have to concern themselves about Working Capital questions except where budget
moneys were delayed.
Printing capacity was sufficient to produce local and other agreed requirements. Thus
textbook printing would commence in November for the following September. In a
competitive open economy printers would have to offer discounts and credit to persuade
publishers to take the risk of early ordering. Schools would demand the latest up-to-date

editions. Publishers would have to borrow money from the bank or shareholders to pay
for the inventory.
For young economies, the implications are as follows.
1. In young economies the first industries to develop are those with low or negative
Working Capital % to sales. Negative Working Capital is where the organisation
uses supplier credit or customer Prepayments to fund their day to day needs.
E.G. banks and financial services, retailers, distribution, industries with cash sales
or advance payments on signature of contract (e.g. printers). Organisations with
negative Working Capital use the money from their customers with which to
invest and to pay suppliers.
2. Competition is fiercest among industries with low or negative Working Capital /
sales % figures. Financial entry barriers are lower and these industries are easier
to expand. However profit margins are often lower because of the competition
(but not always!) and the failure rate among such industries among developed
countries is usually higher.
3. Banks are attracted to industries with low or negative Working Capital / sales %
figures as cash and profits are earned more quickly
4. Entrepreneurs are attracted to industries with low or negative Working Capital %
figures
5. Most marketing innovations in book publishing have come about through the
application of the above Working Capital concepts to creating additional sales and
expanding the market. Most of the innovations introduced at the end of the
previous chapter were created by reduced the level of Working Capital and the
time schedule of creating and selling books.
6. The customers, suppliers and authors of book publishers also want to operate to a
low or negative Working Capital / sales %. Thus printers ask for advance
payments e.g. for paper, distributors will try to withhold payment until they have
received money from their customers.
7. Printers are loath to change from their dominant position where they could dictate
prices and schedules according to price scales formulated at state level. These

price scales were geared to maximum production output, not to satisfying

publishers and their customers under national or international competition. 4colour printing would cost 4-times the cost of single colour printing, despite the
introduction of modern 4-colour sheet-fed presses. Printers will change their
attitude to pricing and print-runs only in a crisis. In many young economies
printers have not co-operated with publishers (partly the fault of the publishers)
and faced near collapse as publishers have purchased printing overseas.
8. In developed countries publishers have sometimes allowed retail groups extra
credit (= higher Working Capital for publishers) in order to encourage them to
expand into new outlets or sell more books. It is essential to distinguish between
genuine expansion cases and opportunistic entrepreneurs. The more a publisher is
actively engaged in marketing and distribution, the less likely is the publisher to
have to rely on offering credit as an incentive.
9. The concept applies equally to state enterprises and non-profit making
organisations. If cash and profits are generated more quickly, new titles can be
commissioned sooner, staff and suppliers paid promptly. Bank interest is reduced.
10. Where producers are dominant, their customers will have to accept higher levels
of Working Capital. Where customers are dominant, the producers have to accept
a greater burden. In some young economies, the government may have a policy of
holding key organisations in the state sector or as majority owned state enterprises
rather than encouraging a free-for-all enterprise policy. This may affect printers,
publishers and distributors. This policy will affect the evolution of the Working
Capital cycle and may tilt it more in favour of producers.

Working Capital levels in book publishing in developed countries

Working Capital is a major problem in book publishing. Most publishers solve the
question on a temporary basis by negotiating credit with printers and other suppliers.
Their own customers solve the problem by negotiating credit with publishers or
demanding sale or return terms. Sale or return terms make planning and cash
forecasting much more difficult. Most publishers rightly prefer to offer a slightly higher

discount for a firm sale. Retailers will argue that they would not purchase many new titles
without their risk being mitigated by a sale-or-return policy
The central issues, which must be solved, are:

Investment decisions rely too heavily on economies of scale e.g. in printing

prices, by amortizing first edition costs against larger print runs

Publishers produce too many titles, which receive too little promotional effort and
thus sell slowly or not at all.

These can be solved only through long term changes in publishing strategy and greater
attention to the value chain where suppliers, publishers, wholesalers and retailers cooperate to mutual benefit and shared risk. On demand publishing may reduce inventory
levels but does not solve the marketing aspects.
Many publishers have studied the publishing of music CDs and cassettes, and of greeting
cards with a view to finding solutions. While lessons can be learned, there are major
differences:
CDs, cassettes and greeting cards

Are all high margin projects

Carry much heavier promotion budgets and commitment to marketing

Are standardized in format

Enjoy few economies of scale so short run and on-demand manufacture are the
norm

Sell to a more wide variety of retailers

Sell on a less seasonal basis

Paperback publishers have adopted some of these aspects and have fought successfully to
overcome the low price perception of paperbacks. Paperbacks can now sell in many cases
at the same price as a hardback edition. The creation of hit-parades or Top 10 listings
has been adopted for books of different categories and has attracted significant media

attention thus making books more fashionable. As a result books may sell faster, perhaps
at higher prices and thus reduce Working Capital levels.

Book Packagers
Book packagers create books under contract to publishers, book clubs or foreign
distributors. They evolve as part of the specialization process especially when publishers
become larger and more bureaucratic. Publishers buy the rights for a territory for a period
of years or number of printings (provided that the title stays in print). The financial
attraction to publishers is that they can buy smaller print runs at economic cost. Most
publishers will make advance payments to the packagers but may be able to approve the
content and design. Most packagers prefer to sell finished books rather than license titles
on a film and royalty basis.
Packagers buy at low prices from printers because they create only a small number of
titles but each title will have a large print run. Packagers often stay loyal to printers who
reward them with long credit and, in many cases, lower printing prices than those paid by
their publisher customers.
In the TV world many program companies will create programs for several networks
while TV companies concentrate on distributing the programs. The production companies
will retain the rights and earn fees for repeat-shown programs. A similar situation exists
in the multimedia field.
Thus packagers are specialists who are not involved in marketing and distribution.
Subsequently a small number of them have decided to become publishers and done so
very successfully after re-financing. Most stay as packagers. Compared with publishers,
these packagers have little market value in acquisition terms.
Thus packagers are very similar to many private publishers in young economies but with
important differences as the table below shows:

Book Packagers

Private

publishers

in

young

economies
- Founders are creatively rather - Founders are creatively rather than
than

market

driven;

enjoy market driven; enjoy freedom

freedom
- International printers offer - Printers tend to give better prices to
them low prices and credit; established

publishers

printers have often offered credit to allow packagers to start up, Some publishers may be closely linked
sometimes with dire results for with a printer. The printer may demand
the printer
- Packagers

usually

advance payment
allow - Publishers will not involve customers

publishers to approve content

in the book content except in special

cases e.g. textbooks and Ministry of
Education,

University

Publishing

Houses
- Receive advance payments - Are paid after delivery
from publishers
- Hold no Inventory but reprints - Will often sell the total print run to a
make high profits
single or small number of distributors
- Purchase rights from authors - Sell books with no transfer of rights
and designers, and sell territorial
or other rights to a number of
customers
The Working Capital cycle in both cases is similar in both cases. The reason is perhaps
the same. Neither the book packager nor the young private publisher is adequately
financed; both enjoy the creative aspects but do not want to expand if it means losing
control. There are few potential buyers for book packagers.

The cost of starting such organizations is much lower. Working Capital is lower because
they are involved only in creating the books. They influence distributors, retailers and
consumers only so long as they generate saleable new ideas. While book packagers can of
course sell foreign rights, their potential to sell reprints is lower.
Making more efficient use of Working Capital
The table below lists items, which influence Working Capital levels favorably and
adversely

Items that reduce Working Capital levels for Items

publishers
- Increased profit margins
Customers
who

pay

that

increase

Working

Capital levels for publishers

- Lower profit margins
promptly - Long print runs except where all

- Advance payments by customers

the

books

publication

are

required

on

e.g.

School

and

university textbooks
- Inventory which is sold and paid for quickly by - Slow authors who deliver late and
customers

after

publication whose

manuscripts

- Lower Inventory levels by reducing print substantial

require
editing

quantities and working with printers who will - Holding paper stock unless market
deliver quickly and produce low print runs conditions demand and the savings
economically

are
-

large
Slow

schedules

for

the

development of new titles

- Successful promotion that speeds up the rate of - Making advance payments to
sale

printers
- Seasonal sales except where the
publishers prints only for the season

- Licensing (but problematic in young economies)

- Paying suppliers on completion with credit

- Authors who deliver manuscripts on disk ready for
computer

make-up

- Incentives to staff , authors , suppliers, customers ,

sales staff and agents to speed up the rate of sale
and

of

developing

new

books,

delivering

manuscripts on schedule

The attention of readers is again drawn to the examples at the end of the previous chapter,
which illustrate ways in which publishers have produced affordable books through a
marketing initiative. The concepts of this chapter apply in each example.

The danger of averaging Working Capital levels

Osiris has a Working Capital to Sales figure of 28%. However the figure will be the
average of the organizations different activities. Let us assume that there are three
divisions that produce different types of books for different markets and use different
methods of distribution. The table below shows how each division generates much Net
Contribution and also how much Working Capital is used in each division. The cost of
sales, royalty, distribution, promotion costs and write-off figures differ in each case as a
percentage of sales although not all the costs are necessarily variable. The term Net
Contribution is the amount of money that each division generates towards the central
administration cost of the company and hence to profit. Items below Net Contribution is
not relevant to our analysis unless administration cost vary according to each market.
Interest on bank loans could however be usefully charged against each division to give an
even more meaningful figure. Although a Balance Sheet item, Working Capital is shown
under Net Contribution to highlight the relevance of comparing Net Contribution and
Working Capital levels by division.

Income Statement
Turnover
Cost of Sales
Royalties
Gross Profit
Distribution costs
Promotion
Write-offs
Net Contribution**
Working Capital

Division A
60,000
(33,000)
(10,800)
16,200
(3,900)
(1,100)
(1,700)
9,500
19,200

Division B
30,000
(18,000)
(6,200)
5,800
(1,000)
(900)
(1,100)
2,800
7,800

Division C
10,000
(6,000)
(1,000)
3,000
(100)
0
(200)
2,700
1,000

Total
100,000
(57,000)
(18,000)
25,000
(5,000)
(2,000)
(3,000)
15,000
28,000

** Gross Profit less distribution, promotion and write-offs. The contribution to

administration costs and profit from publishing activities
The analysis of the above sheds useful light on profitability and use of Working Capital
by division. This is discussed in detail below.
Analysis of the net contribution
The table below shows each cost item included in the Net Contribution calculation
expressed as a percentage of turnover.

Division A
Cost of Sales % to Turnover
55.0%
Royalty % to turnover
18.0%
Gross profit margin %
27.0%
Distribution % to turnover
6.5%
Promotion % to turnover
1.8%
Write-off % to turnover
2.8%
Net Contribution % to turnover 15.8%
Working Capital / Turnover % 32.0%

Division B
60.0%
20.7%
19.3%
3.3%
3.0%
3.7%
9.3%
26.0%

Division C
60.0%
10.0%
30.0%
1.0%
0.0%
2.0%
27.0%
10.0%

Average
57.0%
18.0%
25.0%
5.0%
2.0%
3.0%
15.0%
28.0%

The most effective programs for both improving working capital performance and
forecasting are those that look beyond the local organization and consider the broader
corporate environment. Corporate investment and financing arrangements, for example,
may provide for cash to be delivered by one location, but utilized at others. Restrictions
on the repatriation of cash, internal inefficiencies in moving cash, delays driven by banks
and sometimes-inadequate access to information can make the process problematic.
Cash generated in one country, for example, many not have the same value to the
organization as cash generated in another. As a result, companies must plan global
working capital improvement initiatives in the context of the ultimate use for the cash,
rather than simply managing local balance sheets.
Improving Working Capital Management
Successfully improving working capital management requires a multi-pronged approach.
Companies must seek granular detail to identify the underlying drivers of working
capital. This requires separating perception from reality and pinpointing impediments to
efficient cash flow, such as poor links between production and billing or clumsy treasury
operations.
Companies must also adopt an entrepreneurial mindset. They must act quickly to drive
change by combining operational and financial skills, and expand their thinking beyond
the finance organization to gain a more complete view of overall operations. Rather than
wait for the perfect solution, they must identify and implement strategies that result in
quick wins, generating short-term cash to fund longer-term projects.

Having the right people in place can also make or break the effort. Companies need to
identify individuals who can be responsible for setting targets and performance levels and
be held accountable for delivering. These professionals should be encouraged to
challenge the status quo and drive change, using cross-functional teams.
Measured Approach
Finally and this is where many projects fail, companies must remove emotion from the
analysis process. All initiatives must be business-case driven, and projects without
measurable results or those not contributing to overall goals should be abandoned.
Companies must agree on success criteria, prioritize based on contributions to these
criteria and continuously measure performance.
While working capital forecasting is critical to a company's ability to make informed
strategic business decisions, many CFOs struggle with the process because of a lack of
control and real insight into the underlying drivers of their working capital needs. By
empowering the entire organization to understand the company's true working capital
needs, companies can successfully reduce their financial risk, prepare for uncertainty and
create a ready cash reserve that will provide flexibility and security during difficult times.
11 Ways Companies May Improve Their Working Capital Position
With interest rates continuing to rise, oil and commodity costs mounting and everincreasing pressures from Wall Street to increase shareholder value, it's surprising that
some companies are not taking more measured steps to drive effective cash management
and increase free cash flow.
Working capital is a highly effective barometer of a company's operational and financial
efficiency and effectiveness. The better its condition, the better positioned a company is
to focus on developing its core business. By addressing the drivers of working capital, in
fact, a company is sure to reap significant operating cost and customer service
improvement.

According to an analysis of financial results from the 2,000 largest companies in the U.S.
and Europe performed in 2005 by Hackett-REL, U.S. and European companies have
reduced working capital by 12 percent and 17 percent, respectively, over the past three
years. This strongly indicates that awareness of the benefits of working capital and cash
management improvement has been elevated beyond the treasury to the office of the
CEO.
Excess Cash
But while corporate profits may be soaring, corporations are still overlooking billions in
cash a staggering $460 billion in the U.S. and some $570 million (469 million) in
Europe. This enormous sum is literally stuck in transit, a result of inefficient receivables,
payables and inventory practices that could be reclaimed with relatively little investment.
Hackett-REL, which is part of The Hackett Group, a strategic advisory firm, calculates
that in the U.S. alone, getting this excess under control would reduce total net debt by 29
percent, increase net profit up to 11 percent and improve return on capital employed
(ROCE) from 13.9 percent to 15.1 percent.
Liberating the billions in cash trapped on the balance sheet is easier than one may think.
Dell Inc., for instance a lauded for overall strong corporate management and working
capital performance builds a computer only when it has received payment for an order,
and doesn't pay its own suppliers for an agreed-upon period of time thereafter. As a result,
Dell enjoys negative working capital and, the more it grows, the more its suppliers
finance its growth.
Not all companies can operate like Dell, but most can improve their working capital
position by at least 20 percent over time if they pay attention to the following list of cash
management do's and don'ts:

1) Get educated. There is more to working capital management than simply forcing
debtors to pay as quickly as possible, delay paying suppliers as long as possible and keep
stock levels as lean as possible. A properly conceived and executed improvement
program will certainly focus on optimizing each of these components, but also, it will
deliver additional benefits that extend far beyond operational rewards. All this
underscores the need for ambitious executives to integrate working capital management
into their strategic and tactical thinking, rather than view it as an extraneous added bonus.
2) Institute dispute management protocols. Consider a case where a company's
working capital is deteriorating due to an increase in past-due accounts receivable (A/R).
A review of the past-due A/R illustrates a high level of customer disputes, which are
taking on average of 30 days to resolve and consuming significant amounts of sales,
order-entry and cash collectors' time.
By tackling the root cause of the disputes in this case, poor adherence to pricing policies
the company can eliminate the disputes, thereby improving customer service. Established
dispute-management protocols free up time for sales, order-entry and cash collections'
personnel to be more effective at their designated roles, and they also will increase
productivity, reduce operating costs and potentially boost sales. And finally, days payable
outstanding (DPO) and working capital will improve, as customers won't have reason to
hold payment.
This example illustrates how working capital is one of the best indicators of underlying
inefficiency within an organization and why it is critical that senior executives remain
focused on addressing the primary causes of working capital excesses to control
operating costs and remain competitive.
3) Facilitate collaborative customer management. One of the most important cash
management and working capital strategies that executives CFOs and treasurers, as well
as CEOs can employ is to avoid thinking linearly and concerning themselves solely with
their own company's needs. If it is feasible to collaborate with customers to help them

plan their inventory requirements more efficiently, it may be possible to match your
production to their consumption, efficiently and cost-effectively, and replicate this
collaboration with your suppliers.
The resulting implications for inventory levels can be massive. By aligning ordering,
production and distribution processes, companies can increase inherent efficiency and
achieve direct cost savings almost instantly. At this point, payment terms can be most
effectively negotiated.
4) Educate personnel, customers and suppliers. A business imperative should be to
educate staff to consider the trade-offs between various working capital assets when
negotiating with customers and suppliers. Depending on the usage pattern of a raw
material, there may be more to gain from negotiating consignment stock with a supplier
instead of pushing for extended terms - particularly in cases of long lead-time items or
those that require high minimum-order quantities.
The same can hold true for customers. Would vendor-managed inventory at a customer
site provide you the insight into true usage to better plan your own production? It is
important to remember, however, that this is not the solution for all products, and it
should be evaluated on a case-by-case basis.
5) Agree to formal terms with suppliers and customers and document carefully. This
step cannot be stressed enough. Terms must be kept up to date and communicated to
employees throughout the organization, especially to those involved in the customer-tocash and purchase-to-pay processes; this includes your sales organization.
Avoid prolific new product introductions without first establishing a clear product-range
management strategy. Whether in the consumer products or aluminium extrusions
business, many companies rely heavily on new products to maintain and grow market
share. However, poor product-range management creates inefficiency in the supply chain,
as companies must support old products with inventory and manufacturing capability.
This increases operating costs and exposes the company to obsolete inventory.

6) Don't forget to collect your cash. This may sound obvious, but many businesses fail
to implement effective ongoing collection procedures to prevent excess overdue funds or
build-up of old debts. Customers should be asked if invoices have been received and are
clear to pay and, if not, to identify the problems preventing timely payment. Confirm and
reconfirm the credit terms. Often, credit terms get lost in the translation of general
payment terms and what's on the payables ledger in front of the payables clerk.
7) Steer clear of arbitrary top-down targets. Too many companies, for example,
impose a 10 percent reduction in working capital for each division that fails to take into
account the realistic reduction opportunities within each division. This can result in goals
that de-motivate employees by establishing impossible targets, creating severe
unintended consequences. Instead, try to balance top-down with bottom-up intelligence
when setting objectives.
8) Establish targets that foster desired behaviours. Many companies will incentives
collections staff to minimize A/R over 60 days outstanding when, in fact, they should
reward those who collect A/R within the agreed-upon time period. After all, what would
stop someone from delaying collections activities until after 60 days when they can
expect to be rewarded? Likewise, a purchasing manager may be driven by the purchase
price and rewarded for buying when prices are low, but this provides no incentive to
manage lot sizes and order frequency to minimize inventory.
9) Do not assume all answers can be found externally. Before approaching existing
customers and suppliers to discuss cash management goals, fully understand your own
process gaps so you can credibly discuss poor payment processes. Approximately 75
percent of the issues that impact cash flow are internally generated.
10) Treat suppliers as you would like customers to treat you. Far greater cash flow
benefits can be realized by strategically leveraging your relationship with suppliers and
customers. A supplier is more likely to support you in the case of emergency if you have

treated them fairly, and, likewise, a customer will be willing to forgive a mistake if you
have a strong working relationship.
That said; also realize that each customer is unique. Utilize segmentation tactics to split
your customers and suppliers into similar groups. For customers, segmentation may be
based on criteria including, profitability, sales, A/R size, past-due debt, average order size
and frequency. Once segmentation is complete, it is important to define strategies for
each segment based around the segmentation criteria and your strategic goals.
For example, you should minimize the management cost for low-margin customers by
changing service levels, automating interaction, etc. Finally, allocate your resources
according to the segmentation, with the aim of maximizing value.
11) Celebrate success in hitting targets. Emphasize the actions that helped you get
there. Ask your people to remember what it felt like when they hit the target so they can
motivate themselves to hit it again.