WORKING CAPITAL—an effective barometer of

company’s financial position by (Madiha Naz)

1.Introduction

Working capital is the everyday term for what accountants call net current assets. The working
capital figure is the total of current assets minus the total of current liabilities. The main current
assets are inventory, debtors and cash. The current liabilities are creditors and accrued
expenses. The key factor in the word "Current" is that they are expected to turn into cash, or be
paid from cash, within twelve months.

2.Working Capital Management

What is the number one way to prevent failure in business? Take a minute to really think about
your answer. What comes to mind? Increasing customers served? ? Effective marketing? ?
Location, location, location? ? Improving customer care? ? Being the best in your industry?

Although these are all essential aspects of business, the answer isn’t any of the above. The
number one way to prevent business failure is to properly manage your working capital.

Efficient management of working capital is extremely important to any organization. Holding too
much working capital is inefficient, holding too little is dangerous to the organization’s survival.
Improving working capital performance enhances a company's competitiveness by increasing its
return on invested capital (ROIC) Good management of working capital will generate cash will
help improve profits and reduce risks. However, generating cash through working capital
improvement is often easier said than done.

2a) Working Capital Cycle

Cash flows in a cycle into, around and out of a business. It is the business's lifeblood and every
manager's primary task is to help keep it flowing and to use the cash flow to generate profits. If a
business is operating profitably, then it should, in theory, generate cash surpluses. If it doesn't
generate surpluses, the business will eventually run out of cash and expire.
The cheapest and best sources of cash exist as working capital right within business.
Working capital cycle fig.I(enclosed as attachment)
Each component of working capital (namely inventory, receivables and payables) has two
dimensions ........TIME ......... and MONEY. When it comes to managing working capital - TIME IS
MONEY. If you can get money to move faster around the cycle the business will generate more
cash or it will need to borrow less money to fund working capital.

2b). Myths About Improving Working Capital Performance

The path to working capital improvement is beset with a number of myths. They are not labeled
as such but generally come in the form of proprietary methodologies, strategies, tool kits, and
one-size-fits-all prescriptive solutions. While many of these solutions are offered with the best of
intentions, they commonly lead to an expensive and disappointing conclusion.
The five myths about working capital improvement below are among the most commonly
held. They are particularly pernicious because there is a small element of truth to each
one. Separating truth from fiction can be a difficult task—even for the financially savvy. While
there is no guarantee of success, avoiding these myths will allow a company to increase the odds
of achieving sustainable working capital improvement.

Myth 1: Working Capital Improvement Is Only For Distressed Companies

It is true that distressed companies do have a particular motivation to improve liquidity, it is a
mistake to believe that only distressed companies have an interest in improving working capital.
Companies across the financial health spectrum have an interest in improving working capital
performance. Better working capital performance is particularly relevant for companies that
track overall financial performance with measures such as EVA or economic profit. Lowering
working capital reduces a company's capital charge and increases overall returns on invested
capital. Working capital improvement can also lead to better operational cost performance.

Myth 2: Working capital improvement programs start and end with the treasury function.
Involving the treasury function in a working capital improvement project helps; however, focusing
on the treasury function as the main driver of better working capital performance limits the
effectiveness of the project.
Working capital improvement starts in the heart of a company's operations. It is less about
managing cash flows than it is about addressing the processes and policies that drive those cash
flows.

Myth 3: Improving Working Capital Requires Significant Investments In Systems And IT

Certainly, putting the right information in the right hands at the right time is an essential
component of working capital improvement. In many cases, improvements in cash flow will follow
directly from improvements in information flows. Achieving meaningful working capital
improvements requires probing interviews, simple debtor listings, contract reviews, and basic
process mapping to diagnose improvement opportunities. Less complex systems improvements
such as the installation of a data warehouse and a business intelligence system can substantially
improve access to working capital information, but do not involve the cost or the implementation
burden of many ERP systems.

Myth 4: Working Capital Improvement Needs To Be A Large Corporate Initiative

The key to any working capital improvement program is to focus efforts where they will have the
most impact. One way to focus efforts is to use the 80/20 rule to identify business units or
product lines that represent the lion's share of the working capital. A multinational food company
recently undertook a stock reduction initiative. The company had more than 30 business units
that spanned the globe from North America to New Zealand.
The coordination effort of implementing a corporate stock reduction opportunity across this many
business units around the world would have been challenging to say the least. However, a
simple ranking of what units held stock revealed that over 50 percent of the company stock could
be addressed by focusing on four business units. The company developed detailed stock
reduction plans for these four business units and shared the techniques with the remaining
business units. By focusing resources where it mattered, the company made an impact on overall
stock levels without developing and implementing a slow and complex corporate wide initiative.

Myth 5: Working Capital Improvement Is About Generating Short-Term Results

Sustainable working capital improvement requires constant vigilance. Companies that are
successful in making improvements last do so because they make substantive changes to their
underlying business processes, performance measurement programs, and incentive
schemes. Working capital becomes an important measure of business performance alongside
revenue growth and margin enhancement. Institutionalizing better working capital performance is
a good way to ensure lasting improvement and to inculcate the "cash culture" that many
companies aspire to but few achieve.
Avoiding some of the myths about working capital is a good first step to starting a successful
working capital improvement initiative.

2c) 9 Ways Companies May Improve Their Working Capital Position

The companies can improve their working capital position by at least 20 percent over time if they
pay attention to the following list of cash management do's and don'ts:
i) Institute dispute management protocols. Consider that review of the past-due A/R illustrates
a high level of customer disputes, which are taking on average of 30 days to resolve and
consuming significant amounts of personnel time.
Tack the root cause of the disputes—in this case, poor adherence to pricing policies—the
company can eliminate the disputes, thereby improving customer service. Established dispute-
management protocols free up time for personnel to be more effective at their designated roles,
and they also will increase productivity, reduce operating costs and potentially boost sales. And
finally, days payable outstanding (DPO) and working capital will improve, as customers won't
have reason to hold payment.
This example illustrates how working capital is one of the best indicators of underlying inefficiency
within an organization
ii) Facilitate collaborative customer management. Collaborate with customers to help them
plan their inventory requirements more efficiently and replicate this collaboration with your
suppliers.
By aligning ordering, production and distribution processes, companies can increase inherent
efficiency and achieve direct cost savings almost instantly. At this point, payment terms can be
most effectively negotiated.
iii) Agree to formal terms with suppliers and customers and document carefully. This step
cannot be stressed enough. Terms must be kept up to date and communicated to employees
throughout the organization, especially to those involved in the customer-to-cash and purchase-
to-pay processes; this includes your sales organization.
Avoid prolific new product introductions. Poor product-range management creates inefficiency in
the supply chain. This increases operating costs and exposes the company to obsolete
inventory.
iv) Don't forget to collect your cash. This may sound obvious, but many businesses fail to
implement effective ongoing collection procedures. Customers should be asked if invoices have
been received and are clear to pay and, if not, to identify the problems preventing timely payment
v) Steer clear of arbitrary top-down targets. Too many companies, for example, impose a 10
percent reduction in working capital for each division This can result in goals that de-motivate
employees by establishing impossible targets, creating severe unintended
consequences. Instead, try to balance top-down with bottom-up intelligence when setting
objectives.
vi) Establish targets that foster desired behaviors. Many companies will incent collections
staff to minimize A/R over 60 days outstanding when, in fact, they should reward those who
collect A/R within the agreed-upon time period.
vii) Do not assume all answers can be found externally. Before approaching existing
customers and suppliers to discuss cash management goals, fully understand your own process
gaps so you can credibly discuss poor payment processes.
viii) Treat suppliers, as you would like customers to treat you. Far greater cash flow benefits
can be realized by strategically leveraging your relationship with suppliers and customers. A
supplier is more likely to support you in the case of emergency if you have treated them fairly,
and, likewise, a customer will be willing to forgive a mistake if you have a strong working
relationship.
Utilize segmentation tactics to split your customers and suppliers into similar groups. Finally,
allocate your resources according to the segmentation, with the aim of maximizing value.
ix) Celebrate success in hitting targets. Emphasize the actions that helped you get there. Ask
your people to remember what it felt like when they hit the target so they can motivate themselves
to hit it again.
Following these do's and don'ts will allow companies to optimize cash and highlight internal
inefficiencies that must be remedied to better serve customers.
3. Conclusions
Working capital is a highly effective barometer of a company's operational and financial efficiency
and effectiveness. The better its condition, the better positioned a company is to focus on
developing its core business. By addressing the drivers of working capital, in fact, a company is
sure to reap significant operating cost and customer service improvement. Leadership,
perseverance, a practical focus, and luck make a winning strategy for mining the balance sheet
for cash and making lasting improvements to working capital performance.

References:
 www.planware.org “managing working capital”
 Ms. Anindya Kar"Create the Business Breakthrough You Want: Secrets and Strategies from
the World?s Greatest Mentors" ? 2004 Mission Publishing, a division of The Mission
Marketing Mentors, Inc., www.missionpublishing.net
 Don Featherstone” 5 Myths About Improving Working Capital Performance”
http://www.bankofamerica.com/October 2005

 Andrew Ashby,”11 Ways Companies May Improve Their Working Capital Position “April 2006