Working capital is defined as the amount of cash an organization has on hand at any given time. Some people also refer to working capital as net liquid assets or current assets minus current liabilities (where ‘current’ means due within a year). The amount of working capital held by a company is a primary measure of operational health because it communicates a steady top line and the ability to manage costs.
The management of costs is a clear reason procurement needs to be concerned with working capital, but we shouldn’t be confined to thinking about working capital in the limited sense of indirect or overhead cost management. An increasing number of companies are moving towards expense-based models where they pay other companies to hold inventory and manage assets (read outsourcing) rather than running parts of the operation themselves.
In the past, direct spend included the materials, energy, and labor costs a company incurred in the process of making the products sold to customers. In the case of facilities and equipment, these costs were reflected on the balance sheet as fixed or capital assets rather than short-term expenses. As operations are handed off to suppliers rather than being managed in house, procurement often takes responsibility for the resulting contracts and supply relationships.
When you add this to the fact that procurement often reports to the CFO, it is critical for us to understand how we can support the organization’s strategy for working capital:
1-Establish Payment Terms: If working capital is, as we have said, equal to current assets minus current liabilities, a company can maximize cash on hand by collecting short and paying long. By establishing payment terms that allow a company to collect on their accounts receivable as quickly as possible, but take as long as possible to pay their suppliers, they get to hold their cash longer, increasing working capital.
2-Implement Technology to Manage Initiatives: Since companies today are faced with managing an abundance of contracts in both sales / the supply chain, there is no easy way for terms and timing to be optimized without the support of automation. Procurement already owns eProcurement and accounts payable solutions in many organizations. Building on that by coordinating through accounts receivable creates a single team to establish, administer, and monitor the flow of cash in and out of the organization.
3-Manage Interface With Suppliers: Under a model where more operating costs are managed as expenses, suppliers hold an increasingly important position to the organization. When a process is outsourced, related risks are not eliminated; they are simply relocated behind the wall of the supplier. Suppliers then bear the burden of material, labor, and energy costs as well as the bulk of the delay between delivery and receipt of payment. As the primary interface with suppliers, procurement can identify issues or needed changes in terms.
In order to accomplish any of these strategies, procurement needs to be aware of the organization’s working capital strategy. Ask questions such as the ones below to kick off your work capital and CFO alignment strategy:
- Do current conditions provide incentives to hoard and hold it, or invest it for growth?
- What are the costs of capital to organizations that make the decision to borrow more?
Pursue this information from the CFO as the first step and then begin the work to outline plans for procurement to have a positive impact.
Do you know your organization’s current strategy for working capital? What is procurement doing to contribute to the company’s operational and financial health? Share your thoughts by commenting below or tweeting @BuyersMeetPoint.