Working Capital Management.

 

What is Working Capital Management?

Working capital management refers to the management of a company's short-term assets and liabilities in order to ensure that the company has adequate cash flow to meet its obligations and maintain ongoing business operations.

This includes managing items such as accounts receivable, accounts payable, inventory, and short-term borrowing. The goal of working capital management is to ensure that a company has enough cash on hand to meet its short-term obligations and to take advantage of business opportunities as they arise.

Working capital, also known as capital de giro in Portuguese, is the financial resource available to fund a company's day-to-day operations. It represents the difference between current assets (assets that the company expects to convert into cash in the short term, typically within a year) and current liabilities (debts that the company must pay in the short term, also typically within a year).

This financial metric is a critical indicator of a company's financial health as it signifies the company's ability to cover its daily expenses, purchase inventory, and pay its employees. In cases where working capital is insufficient, a company may struggle to meet its debts, acquire necessary supplies, or compensate its workforce, leading to cash flow issues and jeopardizing the continuity of its operations.

Conversely, a company with a healthy working capital enjoys greater financial flexibility to navigate challenges and capitalize on growth opportunities. It is imperative for companies to closely monitor their working capital and implement measures to ensure it consistently remains at healthy levels. This may involve adopting strategies to enhance operational efficiency, cost reduction initiatives, meticulous management of accounts receivable, and optimization of inventory management, among other actions.

Working Capital Management - Part II

 Working Capital is the capital required for the company to operate or operate on a day-to-day basis. Working Capital is the amount of resources to finance the financial needs of the company while it is producing, storing and selling. Inflows of Resources increase working capital and, in companies, the main and often only source of inflow of resources is Sales Receipts. Other Resource entries would be: - Loans; - Receipt of advances paid by customers; - Any other transaction that involves the entry of money On the other hand, there are several outflows of resources such as payments to Suppliers, Tax Payments, Salary Payments, etc. .  

Working Capital is directly related to the survival and viability of companies. Companies that are unable to maintain themselves with their own capital end up having to borrow capital from third parties at a high financial cost, which in Brazil is one of the highest in the world. At this time of deep crisis, the focus is on working capital management. The application of the best techniques with the development of action plans to optimize Working Capital is vital for companies.

But what has the most impact on the Working Capital of Companies? Cash inflows and outflows determine a present Cash Flow (based on effective and already assumed commitments) and future (based on already assumed commitments and planned cash inflows and outflows). Companies must make a detailed planned cash flow for at least the next 90 days . This will require a fair amount of estimation. One US group worked by requesting detailed cash flows from their branches for the 13-week period. The branches were requested to send the flows every 15 days.

Flows were compared and when large variations were found between information from a previous flow and the current flow, the branches had to justify it. This system forced the financial area of ​​the Branch to be careful with Cash Flow Planning. In many companies there is no Cash Planning and when it exists, it is often poorly prepared. What ensures a favorable Cash Flow? Several factors contribute to a Favorable Flow , that is, the one obtained by cash-generating companies: - Maintain a good relationship between the deadlines practiced in Sales and Purchases. If possible, always buy in terms longer than the terms practiced in Sales. 

Unfortunately, many companies do the opposite and end up accepting payment conditions for purchases in extremely short terms. Not to mention the case of imported products with advance payment. If a company makes purchases for payment in 30 days, for example, and sells for an average receipt in 60 days, it will have to finance 30 days with equity, or seek to capitalize in some other way. When there is production and not just marketing, it is necessary to add the lead time that involves the entire production cycle. Under normal conditions, the biggest cash generator is Profit . Therefore, companies need to obtain good profitability in their final margins and a good contribution margin after deducting all variable costs from the net revenues involved.

Another major element with a high impact on Working Capital is the company's inventory. Good Inventory Management is essential for the health of the company's Working Capital . But unfortunately few are the companies that have a good inventory management. Many companies accumulate materials with low turnover and sometimes adopt an unfavorable purchasing policy, generating important values ​​in stocks with movement and sometimes even without movement at all. Is it possible for companies to have a good management of Working Capital and still be in difficulty due to lack of Cash? Yes, it is possible and this occurs when: - the company defines that Caixa will support Expansion Projects that are incompatible with cash generation; 

- when there are large purchases of Fixed Assets;

- when there is a mix between the company's finances and the owners' personal finances;

- and other varied factors that impact cash.

Working Capital Management (WCM ) The evolution over the months and the total amount of Working Capital are the main indicators for gauging the financial health of the business. Organizations should seek to minimize the WC in order to immobilize a minimum of their own resources for the operation of their businesses, without compromising the level of customer service. Taking the value of Working Capital as a percentage of Sales, or as a percentage of Total Assets are also ways of controlling Working Capital as a performance indicator. 

Obtaining a single-digit percentage, ie below 10% of WC on Sales, is a positive and above-average indicator of what happens in companies. Working Capital Management should be the result of joint work between all those directly involved with it, but under the coordination of the company's financial area. But the essential management of Working Capital needs to be Financial Management  < < < Click to access additional post What makes up Working Capital? Three main groups of accounts determine Working Capital, and each one must be managed in order to obtain the best key performance indicators (KPI – Key Performance Indicator ). 

There are other elements that can impact the WC, but in operational terms, the main ones are presented here.

Companies must have goals for the KPI's that affect Working Capital and manage their activities with a focus on continuous improvement in these KPI's. MAIN COMPONENTS OF THE WC There are three main components of Working Capital:

• inventories
• Bills to receive
• Bills to pay

A book could be written about each of these items. There are many opportunities for improvement or deterioration of these indicators. The Quality of Management will be the differential.

INVENTORIES  – Inventories are necessary to support the business. 

       The more inefficient the organizations

 can have huge inventory. 

Inefficient organizations also tend to accumulate:

- large amounts of inventory with little or no use;  

- spoiled products;

- new products launched and stalled that did not result in expected sales, etc.

Inventories are normally measured in days and healthy organizations should not keep inventories with a turnover of more than 30 days for products purchased or produced locally, 60 to 120 days for imported products.

Inventory levels are determined by the processes and quality of management in the Supply Chain area and by the quality of management that companies have.

Some techniques such as JIT (just in time), Kanban, S&OP (Sales and Operation Plan), contribute to the optimization of inventory levels.

In virtually all companies we find large sources of waste in inventories and, consequently, excellent opportunities for improvement.

Contribute to the improvement of inventory levels:

1- calculate inventories in days per item;

2- preparation of ABC analysis of stocks;

3- programs to reduce complexity by reducing the number of SKUs;

4- efficiency analysis of sales forecasts (forecast);

5- review of safety stocks; 

6- complete evaluation of processes involving MRP; 

7- negotiate consigned stocks.

8- competent management in case of project changes. Badly handled changes often leave many discontinued items in stock.

9- Obtain high accuracy in inventories. I usually say that they should be managed like the cash in a bank. A bank teller is never counted with any differences found adjusted. Well, then why assume adjustments in companies' inventories.

INDICATORS : Inventory turnover in days (the smaller the better), inventories as a percentage of sales, provisions for slow movement of inventories, inventories written off due to absolescence. 

ACCOUNTS RECEIVABLE  – Accounts Receivable volumes depend on the payment conditions applied to customers and the level of default that the company has. Payment terms granted to customers must be as short as possible, and must be in line with payment terms to suppliers. Companies should always try to buy and pay in terms longer than the payment terms granted to customers. Customer payment conditions should not be the subject of sales negotiations , otherwise there is a risk of losing control over this important indicator. Contributing to the improvement of Accounts Receivable levels: 1- not using payment conditions as an element of commercial negotiation;

2- observe a strict credit policy;

3- agile legal collection for bad payers;

4- Agile contact with customers to resolve issues;

5- Joint work between the financial and commercial areas;

6- practice few and commercial conditions with short deadlines;

7- Do not give in to pressure from customers; not accept extensions.

INDICATORS:  Accounts Receivable Turnover in days (the smaller the better), accounts receivable as a percentage of sales, percentage of overdue receivables ( overdues ); amount of the allowance for doubtful debts. BILLS TO PAY

– Payment terms for accounts payable should be as long as possible. When developing a new supplier you should get the longest payment terms. The lowest financial cost should be obtained, negotiating short payment terms so as not to pay financial costs to suppliers is not acceptable, unavoidable financial costs should be accepted and passed on to the sale prices of products

Contribute to the improvement of Accounts Payable levels:

1- do not use short payment terms to reduce purchase prices;

2- check the time that occurred between the date of issue of the invoice and the date of receipt of the product and assess whether the period elapsed is within the normal range, the days of delays in deliveries must result in extensions of the bills payable;

3- Obtain the longest possible payment deadlines for suppliers.

INDICATORS:  Accounts Payable turnover in days (the higher the better), accounts payable as a percentage of sales. Accounts Payable by supplier. WC - Working Capital in absolute values​​WC or net working capital is the value resulting from the sum of Accounts Receivable and Inventories, from which Accounts Payable are deducted. The objective is to obtain the lowest possible value, which will be essential for the financial health of the company. A low NWC is also essential for good cash flow. INDICATORS: WC is measured in absolute value and as a percentage of sales. As a percentage of sales, a 1-digit WC, or below 10%, can be a good indicator, depending on the nature of the business.

Working Capital Monitoring, Analysis and Management System Simple information with monthly calculation of Working Capital indicators demonstrated comparatively with previous periods and demonstrated with planned values ​​and still demonstrated with Strategic Goals Incorporate qualification system by Traffic Lights (red - poor, Yellow - Reasonable , Green - Excellent Proposed Working Capital Control and Management System Model

Working Capital – (Working Capital)

Monitoring “ Working Capital ” indicators, qualifying and assigning “ Traficc Lights ” can greatly assist in the management of companies' working capital.

There are three main components of Working Capital: Inventories, Accounts Receivable and Accounts Payable.

Monitoring, control and adoption of good practices can minimize the Working Capital required for the operation of companies. On the other hand, the lack of control over these indicators may even make the company's operation financially unfeasible.

Working Capital performance indicator management model

In the model below, a table was prepared to communicate the management of indicators of the various components to be controlled through performance indicators.

Unfavorable indicators in a good management system by indicators will bother the organization, which will act to obtain strategic improvements.

The model alone is sufficient to give an idea of ​​the quality of management for each component of Working Capital. There is no need for large systems to have adequate control of indicators. The chart shown below can be easily assembled in excel. But if they want to develop a system in another tool, it can be done.

Proposed model for controlling Working Capital performance indicators:

ü   Values ​​in Reais for the three components of Working Capital.

ü   Values ​​in days for three components of Working Capital. For each indicator a specific calculation will be required.

ü   Values ​​in days for the total Woking Capital. The calculation formula will take into account the total value of Working Capital as a Proportion of Annual Sales. Suppose you get 25% of annual sales, which would be ninety days or three months. The ideal would be the lowest possible value of Working Capital in days.

ü   Traffic lights with colors qualifying the calculated indicators ( Traffic Lights ).

In this case, the results obtained would be compared with the objectives and historical records of previous periods. Obtaining the expected result, the color of the traffic light would be green. If the goal was a little lower than expected, the traffic light would be yellow, and if the result was well below expectations, the traffic light would be red.

ü   Trend arrows.

Trend arrows would be placed, which would be based on action plans and expectations of the unfolding of indicators in future periods. An upward arrow would indicate that the indicator's tendency would be for improvement, however, in order to place an upward target, it would be necessary to have evidence that there are actions in progress in order to obtain future improvement in the indicator. In other cases, downward arrows would indicate worsening trends in the indicators. An example would be a deterioration in accounts receivable indicators due to the increase in bad debt due to problems in the economy. In this case, it would be up to the company to come up with an action plan to avoid or minimize the expected losses.

Data with Past Periods and Strategic Goals can also be incorporated. Just add the columns

Working Capital Framework with Performance Indicators

Some may say: accounting already reports a series of indicators. Really, in a cold and unstructured way. Our proposal, as in the figure above, is to demonstrate indicators with small evaluation traffic lights, Green=Good or Great, Yellow= Regular and Red= Bad or Terrible. 

Arrows are also placed on the table showing the trends, that is: maintain, improve or worsen, and in the case of improvement, planned actions must be taken that will sustain the planned strategic improvement.

ü   Measure the indicators, evaluate, score assigning colors to the traffic lights ( traffic lights ).

ü   Keep the indicators on the walls and in places that will be under your eyes.

ü   Set ambitious goals.

ü   Prepare and monitor action plans aimed at seeking short, medium and long-term improvements in performance indicators.

ü   Encourage and reward good results. Take corrective measures for lower-than-expected results.

ü   Address in meetings and seminars.

See also: Click below How to prepare a Projected Cash Flow