Working Capital Management

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1 Dr. Hendrik Vater, CFO DHL Supply Chain Southern Europe Working Capital Management The ICV s Guideline to Optimize Inventories, Receivables and Payables 2nd International Controller Conference in Croatia (2nd ICCC) Zagreb, Sheraton Zagreb Hotel Zagreb, 5. November 2014 Internationaler Controller Verein e.v. November 5 th 2014 Page 1

2 The ICV s Working Capital Management Task Force Founded in 2009 in Bonn (Germany) the first ever institutional connection between theory and practice via the participation of representatives from academia and practitioners Development of a basic understanding of working capital management and its value drivers What role does the controller play in working capital management? Discussion and exchange of information on examples of best practices in working capital management Topic Leadership provided by the ICV cross-country Internationaler Controller Verein e.v. November 5 th 2014 Page 2

3 Working Capital Management Scope WCM objectives of companies? Best practice in WCM reporting? WCM status quo in practice: organization, methods, tools Role of supply chain management in WCM? Limits of WCM? Positive/ negative measures? Inventories Undiscovered potential in WCM (delivery times, scrapping, etc.)? Sector-specific differences? Possibilities to control the life cycle by company/ sectors/ business cycle? Roll of controlling/ controller in WCM? Best practices In payables, inventories, service levels, receivables Divisional-/ company-wide win-win situations? Different WCM at different strategic positioning? Working Capital Management (WCM) Payables Substantive questions about WCM Receivables Definition of working capital? Key metrics? Organizational foundation of WCM -> successful for the long run? Effects of globalization on WCM? Effects (liquidity/ profitability) on financial performance? Drivers? Which aspects of WCM are impacted by trade-offs between income statement and balance sheet? Framework for successful WCM? Main problems in practice? Is top management aware of the importance of WCM? Leverage effects? Effects of the financial and economic crisis on WCM and the role of the controller? Role of IT in WCM? Internationaler Controller Verein e.v. November 5 th 2014 Page 3

4 Members of the WCM Task Force from If you are interested in participating, please feel free to contact me at Internationaler Controller Verein e.v. November 5 th 2014 Page 4

5 Internationaler Controller Verein e.v. November 5 th 2014 Page 5

6 Fundamentally, working capital management (WCM) focuses on five items in the balance sheet Other receivables 1 Trade receivables Reduction Net Working Capital Otherpayables 2 Prepayments to suppliers Trade payables 4 3 Inventories Increase Customer prepayments 5 Assets Liabilities and Equity Internationaler Controller Verein e.v. November 5 th 2014 Page 6

7 There are several ways to optimize a company s financial performance Focus Measures (examples) Profit Stabilize or increase revenue Lower cost of materials Reduce staff expense Decrease other operating expense Optimizing financial performance Liquidity Working Capital Capital structure Optimize inventories Optimize receivables management Optimize payment terms Lower debt Reduce cost of capital Optimize equity contributions Balance sheet structure Optimize investments (expand capacity, implement technological innovations) Conduct disinvestments Internationaler Controller Verein e.v. November 5 th 2014 Page 7

8 Effects of Working Capital Management Better credit ratings Easier access to capital and better conditions thanks to improved credit rating Higher enterprise value More free cash flow, lower WACC Lower operating working-capital costs Lower non-capital carrying costs (inventory write-downs, insurance, etc.) Lower cost of capital Reduced cost of capital through lower use of capital Lower use of capital Higher capital productivity through use of less capital Released liquidity (internal financing) More cash flow through shorter tie-up of capital, lower financing need Source: Losbichler (2010) Internationaler Controller Verein e.v. November 5 th 2014 Page 8

9 The C2C-cycle shows the tie-up of capital in days Delivery of raw materials and invoice Payment of raw-materials invoice Actual receipt of payment Purchase raw materials DPO days payables outstanding Cash-to-Cash-Cycle length of capital tie-up C2C = DIH + DSO - DPO Customer places order Production starts Production ends Delivery + invoicing Expected receipt of payment Customer pays invoice Storage period raw materials Production throughput Storage period finished goods DIH days inventory held DSO days sales outstanding C2C = DIH+DSO-DPO DIH = Inventories* 365 Cost of sales DSO = Receivables*365 Sales DPO = Payables*365 Cost of sales Source: Losbichler (2011) Internationaler Controller Verein e.v. November 5 th 2014 Page 9

10 Definition of WCM based on the ICV Working capital comprises in detail: The current assets tied up in operating activities Whose positions do not earn interest and which Therefore must be financed with interest-bearing capital This narrow, operating definition of working capital management can be expanded for each individual company But when doing so, care must be taken to ensure that the additional positions to be included: Are material and related to operations Are controllable by management Are not interest-bearing Release liquidity and Are short-term in nature (up to 12 months) Internationaler Controller Verein e.v. November 5 th 2014 Page 10

11 Ranges within the definition of working capital Most comprehensive definition WC = current assets - current liabilities Most narrow definition WC = inventories + trade receivables - trade payables Assets Liabilities and equity Assets Liabilities and equity Non-current assets Equity Non-current assets Equity Current assets Non-current liabilities Current assets Non-current liabilities Inventories Current liabilities Inventories Current liabilities Trade receivables Trade payables Trade receivables Trade payables Other receivables and assets Tax and other provisions Other receivables and assets Tax and other provisions Securities and equity interests Current liabilities to banks Securities and equity interests Current liabilities to banks Cash and cash equivalents Other liabilities Cash and cash equivalents Other liabilities Deferred items Deferred items Deferred items Deferred items Source: Losbichler (2012) Internationaler Controller Verein e.v. November 5 th 2014 Page 11

12 Components of WCM the definition of working capital can individually be extended Item Inventories, operating supplies Raw materials and operating supplies X Work in progress, incomplete services X Finished goods X Prepayments made X + Receivables and other assets Trade receivables X Component of working capital Yes No Potentially Receivables from affiliated companies If operational, non-interest-bearing and controllable Receivables from companies in which a participating interest is held If operational, non-interest-bearing and controllable Other assets If operational, non-interest-bearing and controllable Investments in affiliated companies X Other securities X Cash on hand, bank balances and checks X Deferred items X Unbilled, but rendered services X - Current liabilities Provisions If operational, non-interest-bearing and controllable Tax provisions X Other provisions X Liabilities X Current portion of bonds payable X Current liabilities to banks X Prepayments received for orders X Trade payables X Liabilities from honoring bills of exchange & preparing own bills of exchange For purchases of goods Liabilities to affiliated companies If operational, non-interest-bearing and controllable Liabilities to companies in which a participating interest is held If operational, non-interest-bearing and controllable Other liabilities, including tax payables X Deferred items X Liabilities for received but not-yet-invoiced services X Internationaler Controller Verein e.v. November 5 th 2014 Page 12

13 From Cash-Cycle KPI to Management Processes Value Target Purchase to Pay (payables) - DPO + Forecast to Fulfill (inventories/raw materials) - DIH Order to Cash (receivables) - DSO Delivery / Invoice Goods Receipt Maturity Date Payment Delivery / Invoice Maturity Date Payment Time Source: h & z Unternehmensberatung AG / Peter Rueffer(2008) Internationaler Controller Verein e.v. November 5 th 2014 Page 13

14 Potentials for Working Capital optimization can be identified throughout the entire process flow Accounts Receivable Sales, credit & order processing Contract management & invoicing Terms of trade Dispute management & collection Payment application Master data Contract administration & archiving Target conditions Proactive customer contacts (before due date) Payment forms Risk assessment Profitability Credit terms Dunning procedures & timelines Cash application Credit approval & credit limits Billing triggers and invoice issuance Term extensions & approval Escalation & repayment agreements Offset, reciprocal agreements Credit risk monitoring & portfolio management Service level parameters Hidden credit days Legal steps Unjustified discounts Quote process Invoice accuracy & approval Financing, Securities & INCO terms Dispute resolution Order entry Processing specific invoices, e.g. compensation deposits Premiums & rebates Dispute root cause eradication Strategic positioning & sales channels Unbilled goods & services Customer segmentation & service levels Credit note process & management Workflow design & technology Guidelines & process documentation Goal setting & reporting Internal & external communication Cash culture Source: EY (2013) Internationaler Controller Verein e.v. November 5 th 2014 Page 14

15 Potentials for Working Capital optimization can be identified throughout the entire process flow Accounts Payable Purchase order & fulfilment Invoice receipt & processing Terms of trade Payment timeliness Cash paid Sourcing, procurement strategy & channels Billing triggers & events Payment terms Dispute management Payment timeliness Spend forecasting & budget setting Invoice processing Payment key date Early payments Payment frequency & method Supplier selection & spend consolidation Invoice receipt Payment discounts Partial payments Offset, reciprocal agreements Contract management Invoice matching and discrepancy management CapEx milestones Credit notes & discounts Authorization & cash management Requisition & approval process Accruals Management of supplier groups or segments Duplicate payment recovery Cash flow forecasting Arrival of orders & service System vs. contract terms Standard contracts & tenders Master data Workflow design & technology Guidelines & process documentation Goal setting & reporting Internal & external communication Cash culture Source: EY (2013) Internationaler Controller Verein e.v. November 5 th 2014 Page 15

16 Potentials for Working Capital optimization can be identified throughout the entire process flow Inventory Product range management Forecasting & Demand Planning Sales order processing & Customer service Materials planning, Purchasing & Replenishment Manufacturing Scheduling, Execution Inventory Management Logistics, Returns & Finished goods warehousing Product data maintenance Access to customer demand forecast Delivery conditions, Frequency & Order quantities Replenishment method Capacity planning & management Inventory record accuracy Warehouse structure & location Inventory classification Forecasting process & tools Customer service level definition & achievement Supplier contract terms & Order parameters Production planning & scheduling Inventory mix management & Safety/Target stock Warehouse management Product & inventory categorization Forecast accuracy Lead-time Management Supplier performance monitoring Manufacturing process efficiency Inventory vs. Service trade-off management, MTS vs. MTO Dispatch mode & Delivery routing Product & inventory category maintenance Scheduled orders Order processing Purchasing timing, JIT & Postponement Batch size SLOB & Clearance process Logistics Product life cycle management Supplier access to forecast & True demand info Order fulfillment MRP standing data quality Capacity & bottleneck management Management of spares & repairs Returns management Supplier assessment & rating Workflow design & technology Guidelines & process documentation Goal setting & reporting Internal & external communication Cash culture Source: EY (2013) Internationaler Controller Verein e.v. November 5 th 2014 Page 16

17 Typical responsibilities of the WCM components, with highly diverse interests along the value chain How are the responsibilities currently organized in your company? N = 99 Payables Raw materials Responsible for Work in progress Finished goods Receivables No responsibility Purchasing Production Functions Logistics Sales Other Size of the circle = number of times mentioned Source: Horvath & Partners (2013) Internationaler Controller Verein e.v. November 5 th 2014 Page 17

18 Focus of WCM: harmonizing the divergent interests and priorities of the functions and business units... Department Traditional departmental objective Departmental desire Negative consequences on working capital Sales Maximize revenue Wide variety Readily deliverable Attractive payment terms for customers Large inventory of finished goods Long collection periods for receivables Production Minimize production costs High machine utilization Large lots Limited variety Supply security Large inventory of work in progress and finished goods Purchasing Reduce purchase prices Large order quantities High supply security Rapid payments to suppliers High raw materials inventories Low supplier payables Source: based on Losbichler / Mahmoodi (2012) Internationaler Controller Verein e.v. November 5 th 2014 Page 18

19 Approaches to optimizing Working Capital areas for optimization extend across the entire value chain Order processing Demand planning Returns Procurement planning Inventory planning Credit note process Debtor management Production planning Returns consolidation Operational Input logistics Receivables management Supply chain master planning Automatized processes Areas for Action Inventories Production Work in progress Payables Storage Finished goods Working capital cycle Returns Strategic Product development Product portfolio management Customer strategy/management Sales strategy/management Supply chain strategy Purchasing strategy Internationaler Controller Verein e.v. November 5 th 2014 Page 19

20 Working Capital Management Summary Determine clearly defined responsibilities for project as well as long term implementation! Integrate KPIs for working capital management into your existing financial reports KPIs on working capital management should be integrated into the incentive-management target agreements "You never walk alone : The optimal structure of working capital does not stop at the boundaries of the own company; it requires a view beyond the company In the long run, working capital management can only be successful if the actions are taken not only rigorously but lived for the long term Understanding the potential for conflict and the associated processes facilitates finding a solution that will help achieve objectives. Improve liquidity, add to returns and strengthen the balance sheet in order to boost the overall competitive profile of the company! Internationaler Controller Verein e.v. November 5 th 2014 Page 20

21 Outlook Thank You for Your Attention! Internationaler Controller Verein e.v. November 5 th 2014 Page 21

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