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Created on 12.11.2018

Three reasons why working capital management plays a major role in your company’s success

Working capital is a good indicator of operational efficiency and a company’s short-term financial health. Adopting a cautious approach to working capital helps to improve liquidity and, in turn, financing capacity. We provide three reasons to explain why working capital management is also a key instrument in financial management at your company.

First reason: increasing room for manoeuvre

Working capital management enables your company’s cash flows to be carefully managed. A professional approach to working capital – in other words, working capital management (WCM) – creates  greater financial room for manoeuvre for companies. It allows them to optimize their liquidity, strengthen their self-financing capacity, reduce their financing costs and improve their operating margin and profitability.  

The positive impact of WCM on key corporate objectives – such as liquidity, profitability and process efficiency – is also confirmed by the participants in the annual WCM study conducted by the Supply Chain Finance Lab at the University of St. Gallen.

Second reason: making the right decisions based on WCM key figures

All key figures for WCM must be considered in the context of the specific company and the sector it operates in. Company-specific drivers and industry-standard characteristics must always be taken into account when interpreting the figures.

One of the key benchmarks in WCM is the cash-to-cash cycle (C2C cycle). This is a key indicator for evaluating the performance level of individual companies or sectors. The indicator reflects the cash conversion cycle at the company in days between payment to suppliers and inpayment by customers, including all days inventories held.

The C2C cycle is made up of the following three components:

The C2C cycle is a useful indicator for identifying improvement potential in WCM. A high DIH value, for example, usually indicates inefficient inventory management. It may also be justified by the fact that the availability of goods is a company’s top priority.

The WCM study carried out by the Supply Chain Finance Lab at the University of St. Gallen indicates that Swiss companies have had a long C2C cycle for years compared with other European countries: they pay their suppliers too promptly and have the highest DIH values on average.

It also reveals that a non-linear correlation exists between company performance – approximated using the return on capital employed (ROCE) value – and the C2C cycle. This indicates two things:

  • There is an optimal level of working capital which balances out positive and negative effects. This depends on various factors, including the sector of each individual company.
  • A reduction in net working capital only has a positive effect on performance to a certain extent. This concurs with the golden rule of accounting according to which the capital tie-up time and financing period should be aligned with one another. 

Third reason: using WCM as a comprehensive “compass”

Managing net working capital is a permanent issue. It needs to be strategically embedded in the entire company. This allows companies to use working capital management as a compass and to set out the desired approach towards customers and suppliers, for example. As there are always conflicting interests, both within companies and externally, WCM helps with prioritizing tasks and providing strategic direction.

In summary, working capital management is a valuable means of maintaining a healthy balance between current assets and liabilities over the long term from different perspectives and supporting profitability.

The time is ripe to scrutinize the key figures closely. Not only is a turnaround in interest rates more and more likely, which will have a major impact on working capital, but progressing digitization also presents major opportunities for more efficient management of accounts receivable, accounts payable, inventories  and liquidity.

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