Improve your Company’s Working Capital Management for Growth & Profitability

Credit Management is more than credit risk assessment and collections. In order to provide the maximum value to your company, it requires a view and involvement beyond the walls of the Credit Department. As a Credit Manager by understanding the efficiency of your company's cash conversion cycle, you can impact improvement actions. Proper management of the cash conversion cycle is a critical element of total working capital management. This is what drives your company's liquidity.

Cash Conversion Cycle Defined

To calculate the cash conversion cycle, you need to understand the three building block elements:

• • The length of time from inventory acquisition to sale: Average Days Inventory Outstanding (DIO)
  • The time your company takes to pay suppliers from invoice date: Average Days Payable (ADP)
  • The time it takes from the point of sale to collect what is owed to your company: Average Accounts Receivable collection days, typically measured by Days Sales Outstanding (DSO)

You can calculate the cash conversion cycle using these three drivers with the following formula:

DIO + DSO – ADP = Cash Conversion Cycle

Ten Ways to Lose Working Capital Days

You can have an impact on working capital management performance by understanding how each of these factors is impacting your company's liquidity. You can initiate efforts to work with other stakeholders to improve performance.

Begin by focusing improvement efforts on the following ten ways your company can lose valuable working capital days:

1. 1. Excess Inventory: Holding inventory too long equates to unnecessary carrying costs and collection delays.
   2. Lack of AP Control: Paying too fast can negatively impact cash flow. Paying too slowly can result in losing discounts or lead to credit availability constraints by concerned suppliers.
   3. Slow Credit Review and Approval: There is the potential of lost business or holding inventory and missing the company's sales and cash forecasts.
   4. Order Entry and Invoice Inaccuracy: This Will result in deductions, slow payments, and add to deduction management overhead expense.
   5. Delays in Invoicing: This can lead to delayed receipt of payments.
   6. Hockey Stick Month Ends: By having spikes in shipments on the last few days of a month, quarter, or year-end, can result in payment delays from customers who start the AP clock on receipt of the product and a valid invoice.
   7. Logistics Errors: Shipment of the wrong product, concealed shortages, damaged goods or sent to the wrong location or not in line with the customer's time for acceptance, will result in deductions, slow payments, and add to deduction management overhead expense.
   8. Slow to Identify and Resolve Disputes: This Can lead to potential write-offs due to a customer's unwillingness to research and pay for aged items.
   9. Inadequate Turnaround Targets: A lack of tracking performance and trends prohibits improvement actions and accountability.
   10. Management Lacks Visibility: If the cash-to-cash cycle is not proactively managed it will negatively affect results.

To begin an assessment of how involved your Department is in improvement efforts, ask these questions:

• • What is your role In developing the Sales Forecast? The Cash Forecast?
  • Do you coordinate with: Accounts Payable to coordinate inflow and outflow forecasts?
  • How well does your department communicate with other key stakeholders to understand working capital management delays, and to develop cross-functional improvement initiatives?

Conclusion

Your credit management role is critical to the overall liquidity of your company. To maximize your value, take a broader look at the entire cash conversion cycle. Understand the interplay between your AP policies, delays in inventory turnover, and DSO performance. 

Start by investigating what is causing a loss in working capital days. Work with your counterparts. Identify process or policy breakdowns that are slowing the cash-to-cash cycle. Define and implement the actions needed for needed improvements.

Watch this course on Virtual Banking: Solution to Credit Risk Problems which focuses on how AI in Credit Risk Management could mitigate financial risks to increase a company's profit.