How to Unlock Working Capital and Transform Your Supply Chain’s Financial Performance

Sam Phipps

Last updated: November 27, 2023 | 4 min
Sam Phipps Slimstock Round 230x230 Webp

A 10-step checklist to rocket-power your working capital

Supply chain costs are soaring all over the world. And like many of your competitors, you’ve probably been thinking about how you’re investing your working capital.

Are you:

  • Rethinking your inventory decisions?
  • Moving operations to cheaper destinations?
  • Contemplating a more local supply chain?

Or, are you thinking like Mr Musk and planning on escaping to Mars, just for some headspace?

Well, before you pack your bags with a tear in your eye, here’s an antidote to your angst.

In terms of the rule book for your revenue, there’s a strong chance your balance sheet looks dramatically different to how it looked pre-COVID, be that in overall business performance, departments or products.

When it comes to the supply chain, there are good opportunities to cut costs and unlock working capital. But now, more than ever, there’s risk hidden in every move.

Cut costs in the wrong area and you could be left short in supply. Over-invest in the wrong stock and you could be bleeding the business of working capital by locking it up in products you can’t shift.

Put simply, it’s death by a thousand cuts. It’s a catch-22. But that doesn’t mean you can’t increase your odds of coming out on top.

What does a working capital utopia look like?

Working Capital Cartoon With Money

Whilst it’s not necessarily a good plan for business excellence, colonising Mars gives us a lesson in utilising working capital.

Let’s say you’ve snagged a seat on the first flight out. It’s going to be a long one, so you’ve packed a deck of cards. As you get talking to your fellow passengers, you realise you’re surrounded by some pretty impressive people. And herein lies the first lesson.

Colonising Mars will be tricky. (Talk about an understatement!) Probably even more troublesome than keeping your head above water post-COVID … if you can imagine that.

And so, in difficult scenarios like this, you have to squeeze the value from every opportunity. There’s no space for passengers who add no value.

Every person on the flight to Mars, and those in the eventual colony, must offer something for the greater good. They must pay their way. Or, the whole enterprise could fail.

Working Capital is from Mars

Back on this planet, your working capital must yield the same usefulness if you’re to survive in harsh, alien conditions.

Your inventory, debtors and creditors must be managed incredibly closely and evaluated regularly.

Much like the colony on Mars, if you’re unable to finance the day-to-day running of the business, it’ll simply cease to be operational, cutting off the oxygen supply which keeps it afloat.

Equally, put too many builders on the flight, and there will be some left twiddling their thumbs. In other words, you don’t want working capital sitting around not doing anything when it could be reinvested somewhere where it really counts.

Inventory is from Venus

The reality for most businesses is that they must find the right balance between high availability and optimal investment in stock.

Invest in too much stock, and you’ll find crippling cash flow issues will soon follow. On the other hand, fail to invest enough, and you’ll be limited to offering a poor service, which will turn happy shoppers into angry customers.

Inventory risk should play a big part in your working capital optimisation journey. Any investment that seems to be sound, but which ties up money in products that never sell, is a problem.

And inventory is a different animal to capital.

Most inventory has a shelf life, be it from their perishable nature or the risk of obsolescence due to shifting market demand. And so an over-supply of stock creates a huge risk.

Poor decisions today could follow you for months, or even years, into the future, especially if the products you’re investing in are slow sellers. Therefore, you need to keep an eye on your trajectory.

What is working capital and how does it impact your supply chain?

Working capital, or current assets, are the company’s assets that can be converted into cash in the short term, ie in less than 12 months.

We are often asked is inventory part of working capital. And the simple answer is, yes. But its not the only component to think about.

In this sense, the main assets that make up working capital include:

  • Inventory
  • Cash
  • Short-term receivables
  • Investments

Working Capital Cartoon Checklist

Working capital is essential to run the day-to-day operations of a company. This essential financial resource is the life blood of any organisation. In the context of the supply chain, working capital funds a range of activities including:

Purchase of raw materials and inventory

Working capital enables a company to purchase the materials and components needed for production, and also finished goods in the case of distributors and retailers. Effective working capital management ensures that the company has sufficient financial resources to maintain a steady flow of supply.

Payments to suppliers

A strong supply chain is built on solid relationships with supply chain partners. Paying suppliers on time is a pre-requisite for effective collaboration. Working capital is therefore essential to ensure that the company can pay its suppliers without delay.

Inventory handling and distribution

Working capital also covers all inventory costs. This includes the handling and transport of goods, warehouse rents, and salaries of workers involved in the supply chain.

How can you unlock cash throughout your supply chain?

Too much stock will tie up working capital that could be used for much more productive purposes, not to mention the risk of obsolescence.

Similarly, having insufficient inventory to meet product demand will result in a loss of sales. Therefore, you need to attain the perfect balance to meet customer demand, without falling into the trap of overstocking.

Here are some practical steps to help you achieve the optimal stock point as you free up working capital.

Take advantage of EOQ

The Economic Order Quantity (EOQ) formula helps us to determine how much product we should order from our supplier, and when we should place the order, to minimise the overall cost. To calculate it, variables such as annual demand, the administrative cost of each order and the cost of storage are considered.

Fine tune your service levels

Having the maximum amount of product available to meet customer demand may seem like a good option. However, having exceptionally high availability will also mean exceptionally high costs, and you will have to tie up a lot of working capital. In this sense, it is advisable to review your assortment strategy to prioritise which products will require a high service level (and therefore high working capital investment) and which products are ones where you can relax the service level requirements.

Enhance your demand forecasting capabilities

This is a basic step towards optimising your stock, because if you don’t know your demand, it is impossible to correctly calculate how much product you need. Use demand forecasting tools and technologies to more accurately forecast future sales patterns.

Build stronger relations with suppliers and customers

The way you interact with your partners throughout your supply chain – ie your suppliers and your customers – and the agreements you make with them will also impact on your working capital.

Extending supplier payment terms allows you to delay cash outflows and improve working capital for a certain period of time. However, it is important to bear in mind that delaying payment of an invoice can also be detrimental depending on the supplier as you may no longer have access to early payment discounts. But the key point here is that negotiating favourable agreements with your suppliers can help you improve your working capital.

Equally, the same measures that can work to improve your cash flow with suppliers will also work for your customers, but in reverse. The sooner you get your invoices paid, the sooner the cash will come in, and the sooner you will have more working capital. Similarly, you will also have to weigh up whether it is in your interests to offer your larger customers payment plans that better suit their needs to ensure their satisfaction and to try to maximise their loyalty.

Collaboration with suppliers and customers

Beyond reaching agreements that benefit your company, it is true to say that your customers, your suppliers and your organisation will all benefit from greater collaboration. By communicating with both your customers and your suppliers, you will be able to anticipate potential fluctuations in demand (in the case of your customers) and variations in supply (in the case of your suppliers). In other words, if information flows in both directions, you will all benefit.

Create cost savings in the supply chain

Finally, another way to free up working capital in your supply chain is to reduce supply chain costs. You can take some of the following actions to reduce the money you spend in your supply chain.

For example, accepting an order and shipping with a half-empty truck is a waste of your resources. Group several orders into fewer shipments to reduce transport costs, optimise routes and reduce transport rates. All these and similar actions will improve the availability of working capital.

Likewise, analyse the current structure of your distribution network and consider whether adjustments can be made to reduce costs. This may include consolidating warehouses or strategically relocating distribution centres to minimise distances and transport costs.

Furthermore, automating manual and repetitive tasks can increase worker productivity and even reduce labour costs. This is applicable both in supply chain execution, such as through warehouse automation, and in supply chain management, through supply chain management software that works by exceptions and alerts.

How can you measure the effectiveness of your working capital investment? Here’s your pre-flight assessment:

Working Capital Cartoon Arrow

Becoming au fait with continuous assessment can make your venture a success, just like a lack thereof can let the oxygen slip.
Here are a couple of metrics you should keep a close eye on:

Inventory turnover days

This simple financial ratio highlights how many times a company has sold and replaced inventory during a given period – something you should have fairly robust data for.

Obviously, the higher this metric, the longer your working capital is tied up for, and to work this out, you should base your calculations on the cost of goods sold, rather than the revenue.

Inventory turnover days are used as an efficiency ratio. To calculate days in inventory, divide the cost of average inventory by the cost of goods sold, and multiply that by the period length, which in most cases will be 1 calendar year?

The cash conversion cycle

The cash conversion cycle is the timeframe from a purchase order being paid, until the associated payments are received.

Simply put, money out versus money in, by product.

Your business must naturally use its own resources to fund stock in the interim period.

But one important calculation here is ‘Earn x Turn’: a product’s margin multiplied by the annual number of stock turns.

A rocket-powered checklist for working capital optimisation

Like so many lessons in the supply chain, there’s only so much you can ascertain using analogies about Mars until the real analysis must take place.

And so, we’ve written a checklist to help you apply the theory in practice: 10 questions to ask yourself that can ease your working capital worries, 10 puzzlers to posit to your supply chain department, which might calm your cash constraints.

Answer the 10 questions below to discover how well your supply chain department manages working capital:

  • Do you have visibility over your current investment of working capital in stock?
  • Do you have the ability to project how the investment of working capital in stock will evolve over the next year?
  • Do you regularly compare your current investment of working capital to past performance?
  • Are inventory values represented in your systems in terms of cost of goods sold, sale price and units as standard?
  • Is the inventory risk relating to perished/obsolete stock quantified regularly?
  • Are important purchasing/inventory decisions made based on the return on capital employed?
  • Does the supply chain department receive a monthly overview of the cash flow position?
  • Is cash flow taken into account when making significant inventory decisions?
  • Do you have a robust service level strategy in place to prioritise investment in key products? Are these parameters reviewed regularly?
  • Do you have the tools in place to collect and report all of the relevant data? More importantly, do you have a forum to discuss and escalate working capital challenges?

Final Thoughts on working capital optimisation … good answers to difficult questions

These questions aren’t designed to be easy.

But if you can find good answers to each one, you’ll find that your chances of success will rise like a rocket ship.

And whether you’re embarking on a project as precarious as colonising a new planet, or simply trying to keep your cash flowing, only the right analyses and strategies will yield success.

Don’t shy away from making these calculations on an ongoing basis either.

It’s a short-sighted business that doesn’t re-evaluate continuously to see where capital could be better utilised.

After all, there’s no room for passengers on your rocket ship. And every pound invested must earn its place.

Download our Working Capital Optimisation Checklist

Is your approach to working capital management up to scratch? Find out with our 10-step checklist.

Working capital FAQs

What is working capital?

Working capital comprises a company’s assets that can be converted into cash within a short period of time, usually less than 12 months. As a general rule, this money is used to cover a company’s recurring expenses and receivables falling due in the short term.

How does working capital affect the supply chain?

Working capital is critical to ensure the smooth and efficient functioning of a company’s supply chain. It affects procurement capacity, supplier relationships, inventory management, agility and operational continuity. Therefore, it is important for companies to closely manage and control their working capital to maintain an efficient and profitable supply chain.

How can working capital be released throughout the supply chain?

One way is through stock optimisation. By improving demand forecasting, refining the assortment offered to customers by prioritising the most profitable products and leveraging EOQ, it is possible to free up working capital throughout the supply chain.

How can a company create cost savings in its supply chain?

Seeking suppliers with better prices and more favourable payment terms or renegotiating existing agreements, optimising inventory – avoiding overstocking and minimising the risk of obsolescence – and implementing technology and supply chain management systems can all improve efficiency and reduce costs associated with the supply chain.

Please select your location to see content specific to your country

x