Need Cash? Look Inside Your Company

Need Cash? Look inside your company

This article was very interesting to read and brought to my attention several issues.
Following the world financial crisis, a common scenario in today’s business world sees organizations always struggling for capital. However, with the ability to better manage their internal policies and processes, organizations may discover that considerable cash flow can be unlocked while making significant difference between failure and survival.

The authors highlight six common mistakes that firms commonly make in managing their working capital. In my opinion some of them can be argued.

The first issue raised is managing to the income statement. Organizations are suggested not to manage to their income statement, as several important cost articles are not reported on it; in this scenario, managers are keen to tie capital up in stock and receivables. The presented example represents this point with the common volume discount. Managers should pay particular attention before buying more supply than they actually need in exchange of a discount, because often this move may result in more costs at the end. This concept can easily apply to all elements of the working capital.
This idea was very well expressed with the example of the metal refining firm which decided to reduce its payment terms from 185 to 45 days. This provoked a decrease in sales, however, it enabled the firm to save 8 Million a year in less capital costs, compensating also for the decrease in transactions.

I think this method should be carefully analyzed, I do not agree with the “one method fits for all” kind of approach. I believe that this approach may be valid according to the situation. I reckon that the most valuable clients should entitle to some flexibility, although in some cases, reducing all of a sudden payment terms may impact on the firm flexibility. On the other hand, this approach may resolve issues with those customers that constantly pay late.

The second mistake reported is rewarding the sale force for growth alone. I totally agree with the fact that sales people should not be rewarded only based on the sales they book in. This way there is no incentive for them to assist in managing customer payment nor to assess the type of client they are acquiring; their only focus would be just on closing the deal at all costs even by offering payment delays or discounts without following up. Very relevant was the example that the author suggested of the aforementioned metals refining firm, which applied more aggressive policies on receivables and resolved the issue of bad receivable generating annual flow of $3 Million.

The third point raised was overemphasizing quality. The author suggests that firms should rethink in applying production rewarding systems based on quality, because this way will badly impact on production speed. I believe this concept is valid to a certain extent. On the provided example this approach made sense: the firm was investing resources for superior quality at extended manufacturing cycles. However, customers did not value the level of quality the company was offering; overall it was a waste of resources. Moreover, the firm was unable to pass associated costs to customers so it was losing. On the contrary, customer valued reduced manufacturing times and costs kept down. I believe that there was a misalignment of considered value between the firm and the customers, as although companies may reconsider the quality level of their products, they mostly need to better understand what customers value the most and align with that.

The forth problem is Tying receivable to payable. The main issue identified reports that firms tend to duplicate the relationship that they have with suppliers with the relationship they have with customers. In this sense if the suppliers give the firm tight terms, the firm tries to recover the cash by contracting its credit policies with clients.

This assumption has been demonstrated to be completely wrong and I completely agree with this point. There should not be a unique process for suppliers as well as customers. The nature of relationships is different and need to be managed according to their conditions. Different factors are relevant to determine the terms that a company formulate for its customers or accept by its suppliers, such as relative bargaining power, industry structure, and competition; in each case those factors differ in the two levels of relationships. That is why firms should have a strategy in place focusing on broaden supplier’s payment time and minimize receivable times from clients; however, in my opinion firms should also aim to be flexible and consider developing terms that are tailored for each supplier and customer segment to address their specific needs and deliver maximum value.

The fifth issue addressed is applying current and quick ration. The article suggests that firms should not manage by current and quick ratio. Because bankers use this approach in managing credit decision, many organizations consequently try to maximize their numbers to show enough liquid assets and manage by following those bankers guideline. The author however, expressed a valuable point highlighting the fact that following this process and by managing to a banker ratio, there is a proven high level of bankruptcy. To demonstrate this he proposed the case of the French customer goods firm, which announced insolvency after six months, after confidently declaring that its ratio rose from 110% to 200% and its quick ratio from 35% to 100%. However, reporting only one case does not make this approach a rule. I wonder what would the statistics be on this.

The article concludes by addressing the last issue of benchmarking competitors. The author discusses that it is very common for managers to compare company performance with industry competitors and suggests that is not a good practice to adopt. I completely agree, examples of successful and innovative organizations like Dell, suggest that it is necessary to come up with creative ideas to look beyond industry boundaries. In fact, when Dell started to compare its products with retailers instead of just comparing them with computer companies, renovated its whole working capital practices. Organizations are suggested to start thinking differently, “outside the box” and take a more innovative approach. To achieve this organizations have to stop relying entirely on the standard industry benchmarks to guide their practices. Looking at what alternative industries are doing implies also to intimately know customers and what they consider as an option to your products outside your category or industry.

This concept is also widely expressed in the Blue Ocean strategy book which is very much open minded. I have been very inspired by this book, which has given me lots to think in regards to my intention of developing my own business.

In conclusion, my attention was driven by the last concept of the articles about creating a participative culture within the firm. I agree with the fact that fostering an environment where all managers engage in an open dialogue with one another as well as other stakeholders certainly enhances value creation.