Working Capital Optimisation Needs Management Mandate

This article investigates the status of working capital management among Danish companies and considers the challenges they face in this area and how they can optimise this part of the business.

Ernst & Young, in co-operation with Danske Bank, carried out a working capital management survey in June 2008. The target group was those responsible for finance and treasury in Denmark's 500 largest companies. This article presents the results of the survey around benchmarking and where responsibility for working capital management is allocated within organisations.

No country can escape the effects of the credit crunch and Denmark is no exception. In recent months, the liquidity of Danish companies has been under increased pressure due to lower credit limits as well as rising interest rates. These conditions have led to an increased focus on the non-interest bearing assets and liabilities on companies' balance sheets and working capital in particular.

Against the backdrop of the current financial climate, the management of a company's working capital has moved directly into the spotlight, as working capital management has a significant influence on a company's profitability. For instance, too much working capital lowers the level of return on investments and has a negative influence on the value of the company. In contrast, a reduction of working capital can significantly improve cash flows and free up capital from the company's balance sheet. The capital freed can then be used to reduce the level of debt, pay dividends to investors or re-invest in company growth - all of which are valuable cash management techniques in today's difficult credit environment.

Focus on Working Capital Management

The survey results underline the fact that the optimisation of working capital is an important focus for all participating companies. Seventy-nine per cent of the respondents answered that this area is included to some or a large extent in the company's formulated targets and financial strategies, while only 4% said that this was not the case.

The focus on working capital management is also reflected in the fact that 46% of the corporate respondents said that they work in accordance with a structured method for optimising working capital. Most of the corporate respondents (71%) indicated that communicating key data and figures for working capital is included in a structured way in management reporting and follow-up to some or to a great extent, while only 6% said that there is no mention of working capital in regular reporting.

With regard to the companies' performance in relation to working capital management, the majority of corporate respondents believe their performance to be average in terms of utilisation of their optimisation potential. The large number of companies that rate themselves as average could indicate that many companies have no clear idea of how effective they are with respect to working capital management and do not regularly perform benchmarking in this area. This is clearly an area for improvement because it is only by comparison with peers that corporates will really see whether their policies and procedures are truly best practice.

If we look at developments in working capital over the past two years, the survey results show that the majority of the companies have experienced either neutral or negative development. There is, however, a connection between improvement in working capital and a structured approach to optimisation. Companies with a structured approach have been more successful in reducing their working capital over the past two years.

When asked where they think the greatest potential lies with respect to working capital management, 43% of the participants responded that it was in the re-designing and optimisation of internal processes. A large number of the companies expect to automate a number of their processes in the future. They can do this by increasing the use of e-invoicing (both for their own invoices and for those received from suppliers), electronic approval of supplier invoices and electronic checking of supplier invoices in relation to orders and the receipt of goods. The use of automatic netting in treasury systems is also expected to increase. Finally, a general response from the majority of the participants was that many important processes in debtor, creditor and stock management could be improved.

The survey revealed that a large number of companies have plans to improve their internal processes within the next three years. In many cases, it will be easier for a company to optimise its internal processes than to improve external payment conditions that are determined by both the negotiating position with the counterparties and local customs. (These issues will be explored in more detail in an upcoming article on gtnews by Danske Bank.)

While awareness of the benefits that can be derived from the optimisation of working capital management is evident from the survey, one condition for working capital optimisation is that senior management continues to focus on and prioritise it.

Working Capital Needs Management Mandate

The survey revealed that the responsibility for working capital management lies mainly with the finance functions. Approximately 60% of the survey respondents said the finance function had overall responsibility, while only 20% said management did. The remaining 20% was spread across other departments including treasury. When questioned whether this allocation of responsibility gave rise to challenges with regard to support and focus, more than half (56%) responded that this is the case to some or to a great extent.

Ultimately, the responsibility for working capital management should be placed at a senior level allowing those in charge to influence processes throughout the organisation, e.g. purchasing and sales. Despite this fact, the survey revealed that only a third of corporate respondents use pay and individual targets for top management as a tool for successful optimisation and maintenance of focus on working capital management, while 56% said that this never happens. Our experience shows that successful optimisation and sustained improvements require continuous attention from managers and employees.

Senior management must take a lead in establishing the company's action plan to achieve working capital optimisation and ensure that all departments understand their role and impact when it comes to overall working capital. Measurement and remuneration can be effective tools to achieve this.

Conclusion

The survey clearly reflects the fact that working capital is of great importance to companies and will continue to be as they face the ongoing impact of the credit crunch. This attention will lead to change and development in a number of internal processes in the years to come. It is also true to say that many companies find it difficult to convert their aspirations about working capital optimisation into action and strategic targets for the organisation. This is where senior management must implement performance targets, benchmarking with peers and an internal optimisation policy.

Effective working capital management can free significant instant liquidity - a valuable tool at a time when liquidity is a scarce commodity. This is an area that requires constant attention to avoid relapsing into old routines, so it is crucial that new work processes are firmly implemented across the company and that management continues to monitor progress.

Article by Simon Lajlev Larsen is head of working capital management services at Ernst & Young Denmark. He is responsible for sales and delivery of working capital management projects in Denmark. Larsen has over 10 years of experience within financial and operational process optimisation. He has a MSc in Economics & Business Administration from Copenhagen Business School.