The adverse (long-term) consequences of your efforts to Optimize Working Capital

The major components of working capital are: account receivables, account payables and inventory. Various decisions and actions to obtain cash (i.e. via lengthening or shortening payment cycles, factoring or other tactics), require strategic treasury management. Optimizing working capital without an overall strategic plan, can lead to negative consequences (i.e. dramatically deteriorate relationships with both suppliers and customers), jeopardizing the whole business of your company.

To optimize working capital a business treasurer must: Reduce account receivables, increase account payables and reduce inventory.

A technique frequently adopted by business treasuries to increase account payables is to pay their suppliers late, or even to simply suspend payments until further notice - neither of which are good long-term strategies. Another usual tactic is to make the supplier hold inventory and deliver only what is strictly needed for the production cycle. This ‘unfair’ practice is often called “collaborative” or “on-demand” supply chain management. In reality it simply pushes costs back on to suppliers.

Such strategies steadily produce financial distress to the supplier and enhance the risk of its failure and, perhaps, the breakup of the whole financial supply chain. This ultimately has negative consequences to your business. Furthermore, this strategy doesn’t consider another factor; the importance of ensuring supplier loyalty.

In a globalized marketplace a supplier is serving not only one buyer (i.e. your business), but a network of buyers that are very likely competing against each other. So if you are forcing your supplier to bare all the costs of the supply chain, chances are that the supplier will opt to loosen the relationship with you and prefer to work more for others. A disloyal supplier soon will turn into a supplier that will make very little effort to adapt to changing business requests. If that supplier provides your company with key components (i.e. it’s a ‘strategic’ supplier with a unique product), its lack of agility will make you less flexible and, therefore, vulnerable to market changes. And a company that cannot adjust to market changes will soon be out of business.

The situation on the account receivables side is no different. One common practice adopted to reduce account receivables, is to improve the collection of receivables by tracking aging credits and soliciting late payments from customers. What happens to your company if such collection processes are not executed in a harmonized manner among the various departments? What if a solicitor chases a customer for a presumably unpaid invoice only to discover that the delay had been agreed between the customer and your sales department? Or - after having threatened the customer  with a legal dispute action - the solicitor has to face the fact that the amount of the late payment is minimal versus the potential revenue sitting on a large contract that same customer is about to sign?

Working capital optimization is a best practice that business treasurers must try hard, but other factors must also be considered to mitigate the risk of adverse long-term consequences. Attention must be paid to supply chain risk: Responsiveness, reliability, and flexibility are indispensable performance attributes that participants in the physical and financial supply chain must reciprocally exchange to ensure streamlined operations and profitable results. Suppliers, distributors, freight forwarders, import/export agents, warehouse operators, outsourcing partners, are but a few of the many participants of vast supply networks that are all involved. Before each one embarks on actions to optimize their own working capital ratio, they should look at the bigger picture to avoid likely negative domino effects.

Don’t look at working capital optimization in isolation. Always remember you are part of a vast supply network of inter-connected and inter-dependent constituents and treat them as you would wish to be treated.

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