Working capital is a challenge to manage. It has several parts and is a byproduct of operational and financial efficiency that seldom has a single, clear owner. To manage it well requires resolve to work across several areas of the business to give your cash flow better footing.
Emmanuel Caprais describes himself as a corporate athlete—a discipline to achieve your maximum potential through professional capabilities, physical and mental wellness. Exercising the discipline “muscle” may also carry over to how he runs his FP&A department at ITT Inc. as Vice President—Strategic and Financial Planning, including his interest in managing working capital (WC).
A quick primer on WC: it is trapped money in your operations that could be used to generate returns, if invested properly. Technically, WC is (accounts receivables) plus (inventory) minus (accounts payable). Notice that these are all balance sheet accounts; WC does not register on your income statement but has a tremendous impact on your cash flow. Too much inventory means your money is tied up; too many receivables means cash is not coming in (although it may be recognized as income), too low payables means you are paying suppliers quickly and are a net of supplier credits. “It has very concrete consequences on a company’s performance,” Caprais said.
AFP interviewed Caprais on working capital management.
AFP: What are the benefits of unlocking working capital?
Caprais: By reducing the amount of your working capital, you can both increase your cash generation and reduce your structural costs. For instance, a high level of inventory will require warehousing space in the form of rent/depreciation which will require supervision and materials handling (people), utilities, security (overheads) and materials obsolescence; without mentioning the missed opportunity cost of using the space or funds more productively. Additionally, in the event of a downturn, you would have fewer liquid assets available to weather the storm.
AFP: Can you lay out a process of examining working capital?
Caprais: ITT is an industrial company and the journey we embarked on to improve working capital has forced us to look granularly at our accounts receivable past dues, for instance, and identify the serial late-payers and tailor proactive strategies to motivate these customers to pay us on-time (e.g. having your sales person bombard with phone calls a customer). We have analyzed our production planning patterns, our safety stock and consignment stock policies and created order blacklists and stop orders to reduce the amount and improve the quality of our inventory. So it is an in-depth process applied to a typically overlooked topic, but this is the only way we found to get results.
AFP: This opens up a new line of thought…what other balance sheet effects can you think of for income-producing products and services?
Caprais: You’re absolutely correct, working capital performance impacts your overall Return on Invested Capital (ROIC) and you can apply the same logic to other assets such as your machinery and equipment for instance. By focusing on improving machine efficiency and uptime, you will limit your future capital expenditures to support sales growth. Your asset turn will increase, and you will realize benefits from fixed costs absorption allowing you to expand margins.
AFP: What is more important today in your business, cash flow or GAAP income?
Caprais: It’s like asking if I prefer steak or lobster! I want them both, I like my surf and turf!
AFP: Okay, that question does not count. WC is spread over AR, AP, supply chain…who “owns” working capital?
Caprais: Everybody owns working capital. All stakeholders should be accountable and incentivized to improve working capital (cash). Sales doesn’t just close orders, they must collect too, Operations doesn’t just manufacture products, they need to use the lowest amount of resources to do so, Purchasing doesn’t just buy supplies, but it must negotiate the best terms with suppliers. Finance doesn’t just close the books, it needs to analyze, identify actions and partner with the business to make it happen.
AFP: How are technology and data impacting the effort to improve WC management?
Caprais: At ITT we have used real time business analytics dashboards to convert raw data into user friendly charts to be used by all stakeholders to drive improvement. Real time communication is key to maintain focus on the issue and it helps aligning diverging goals. But be careful with automation at all costs, we have experienced negative consequences by wanting to automate too much. There is nothing better than a simple solution.
In the current environment, cash flow is what matters, for businesses and customers. For more insights on how companies are navigating this difficult time, visit AFP's Coronavirus Resource Center.