Working capital reduction | success factors, possibilities, and benefits
Working capital management is all about reducing cash-to-cash cycles have to be shortened. For this reason Logistics has to release the working capital that is tied up in inventory. However, lower inventories directly affect the delivery performance. This is always a complication!
Inventories are the result of balancing the customer demand on one hand, against the suppliers' supply chains on the other. The foundation for inventory reduction is: smarter planning and better supply chain collaboration. Of course, only after you have got your own business organised. Although this sounds simple, you might not know how to achieve this.
This article provides guidance for smart inventory reduction. This is highly necessary! It is not a coincidence that inventory management is the number one priority for improved supply chain management this year (as was the result of a research by Aberdeen Group).
Working capital management: What are the options?
Pay suppliers later, make customers pay earlier, and reduce inventories. The risk of paying suppliers later probably leads to higher fees. On the flip side, the customer may understand the pressure of paying on time, or rather earlier. However, the customer may then face the same working capital dilemma as you.
Does working capital reduction have to result from lower inventories? Reducing inventories can lead to higher operational, logistical costs (because of more incoming orders, half full trucks or high cross-docking costs. Or worse: a lower service level for customers. The inventory reduction process needs to be well thought out.
Get your business straight
Good inventory management within the organisation is the first success factor:
Checklist for good inventory management and more effective working capital management:
- Do you regularly analyse inventory?
- How many products are in stock for more than 3 months?
- Which articles and suppliers determine 80% of the inventory?
- Do the inventories in the warehouse correspond with your administration?
- Are you analysing your inventories frequently enough? Are you short of time to look at all the articles on a daily basis? Then prioritise!
- Is the data in your system in order? Frequency, delivery times, order quantities, minimum stock levels and service levels.
- Does it take a while before purchase recommendations have been processed into purchase orders?
- Is the phasing in and out of products organised?
- Does the stock manager have current information about backorders, shortages that are to be expected, and the delivery performance of suppliers?
- Do you have insight into the inventory in all your warehouses? Often, there is 'sufficient' stock, however, not in the right place.
Check, act, and (re)planning of items often happens too late, far too late. As a result, the planning cycle is not concluded. You must be able to adjust when a suppliers delivers late, when there is a production problem, when the customer demand exceeds expectations, or when a new products sells faster than expected. Unfortunately many logisticians find the daily 'drivel' annoying. This should not be improved by making quick, ill-informed decisions, but by coming up with smart solutions, by really getting into the details, by delegating and motivating in a right way, and, especially, by measuring and controlling continuously. If you don't do this, inventory becomes off balance and the share of inventory that really adds to the service level will decrease. Ultimately, poor working capital management can often mean business wrongly invest far too much money into the wrong stock.
Inventories are the 'elastic band' between the dynamics of customer demand and the (im)possibilities of the suppliers or your own production process. If you take that elastic away, you connect the shackles in a chain one by one. This requires precise planning, management, and transparency of that chain; where is the stock allocated, what is the current demand, and what will the demand be in the coming days? Inventory management is actually a bad understanding. In essence, it's about precise planning and management of customer demand on one hand, and the suppliers on the other. Inventory is the result.
Every supply chain manager's 5 P's are: Perfect Preparation Prevents Poor Performance. Making plans is useful and necessary, and that happens a lot and often. Yet, these plans rarely work out. The ugly truth is one of big unpredictability. Do we have to stop planning then? Nonsense: you need to know your required materials and capacities in time. But when you take a critical look, a few things will strike you about your approach to working capital management...
Too many details
First of all, planners plan everything in detail.... and make a lot of effort to immediately close their detailed planning for 1 or 2 weeks. Every article, every week, for every production line. With that, they remove all flexibility within the production and distribution process. It is better to make a rough plan first, tactical, on every level in the product family, one or a few weeks ahead, and taking all production- and distribution locations and (im)possibilities of partners in the chain into account. And then, in the very short term, from hour to hour, the detailed planning based on the most current data regarding the real demand. But many manufacturing bosses find this a bit scary...
Second, planners only make one single plan. Foresight is the essence of government. However then you have to decide how you are going to govern upfront. What are the alternative suppliers, at which locations will you produce, and how will you get the products to the customer efficiently? This is why you don't make one single tactical plan, but you make several contingency plans. What if demand is only 50% of what was expected, or what if it is 200%? In short, what is your plan B? Effective working capital management is all about understanding the financial risk around your approach to demand planning.
Get to work with your suppliers and customers
Third is the principal question: why do you keep inventory? Aren't there possibilities at your suppliers, or for a better adjustment with customers, so inventories are not required anymore? Supply chain management offers concepts that support inventory reduction. For example: vendor managed inventories (your suppliers guards your stock), automatic replenishment based on point-of-sales information, direct deliveries by suppliers, and collaborative planning/CPFR (planning together with customers and/or suppliers). Often, here lies an undiscovered area that, next to stock savings, also removes costs from the chain and, in the end, leads to increased customer satisfaction. While Working capital management focuses often focus on money invested in stock, its vital that businesses consider the working costs asociated to theier inventory.
Supported by IT
Supply chain management creates the need for better possibilities for processing ever increasing information flows from the chain and the demand for real-time information. ERP promises a seamless integration of information flows. However, ERP does not offer all functionalities. When planning and management become more complex and time critical, they require separate, and high quality support. Additionally, ERP-systems do not offer management of the supply chain across the borders of their own organisation. ERP-systems are the core of IT for registration purposes, but are complemented by planning and management tools for supply chain management; forecasting, demand management, tracking, replenishment, multi-site planning, and collaborative planning.
The real benefit of working capital reduction is in supply chain management. Create a win-win situation, and make it fun to share results with your partners. Moving terms of payment do not do the trick...collaborative, smarter planning does!
At Slimstock, we analyse more than a 100 supply chains per year. We can benchmark the results using a database with the historical data of more than 600 organisations worldwide. Based on the unique combination of our knowledge, experience, and tools, we can quickly see what is possible, and what can and should be done. Even before the data proves it! We call this supply chain physics. With this unique asset we can help you design a priority roadmap: a map that makes your job worthwhile.