Manufacturers have taken the brunt of the economic disruptions over the past several years. High interest rates mean high capital carrying costs, and labor and materials costs have stayed persistently high too. Manufacturing companies need to watch their margins and use their existing capital wisely, and many are taking a fresh look at their working capital planning. Ideally, manufacturers need to be able to see not only how much working capital they have now, but also to project it into the future, and to model possibilities based on the potential steps they could take.
Getting working capital right can be tough. The basic working capital equation of current assets minus current liabilities hides how tricky it is to see the full picture: Current assets are calculated based on cash, which is handled by your treasury and FP&A team; inventory, which your supply chain team manages; and accounts receivable, under your collections or accounting team. Similarly, understanding liabilities requires you to calculate wages (your human resources and financial planning teams), short-term debts (the treasury and financial planning team), and accounts payable (your payments and purchasing team).
Bottom line: There are a lot of factors that go into the number. But fortunately, that means there are lots of levers to pull if you want to improve your working capital situation. Here are a few places to start:
Coordinating sales and operations is one big determinant of your working capital, so start by looking at your S&OP process. Implementing strategies that promote more frequent inventory turns will optimize cash flows while also decreasing liabilities. You should balance production schedules with demand forecasts (hello integrated business planning), utilize just-in-time inventory systems, and streamline the supply chain process where possible. By reducing the time raw materials and finished goods spend in storage, and by only making what you can sell (and vice versa) manufacturers can minimize carrying costs, decrease the risk of obsolescence, and free up capital that would otherwise be tied up in excess inventory.
S&OP can also have other positive impacts beyond supply planning. Businesses can respond more quickly to market changes and customer demands, weather seasonal fluctuations, offer better deals to customers (more on this later), and understand their risks. As a result, your company will be broadly more profitable, further improving your capital position.
Client promotions and incentives can also be powerful tools to improve your working capital position. By offering strategic promotions and incentives to customers, companies can increase inventory turnover and expedite revenue collections, ultimately boosting cash flow. For instance, offering discounts for bulk purchases with favorable payment terms can encourage customers to buy more frequently or more consistently, accelerating the cash conversion cycle. Additionally, implementing loyalty programs or non-discount volume-based incentives can foster stronger relationships with customers, leading to more consistent and predictable sales patterns.
Furthermore, client promotions and incentives can significantly impact Days Sales Outstanding (DSO) by improving cash collections from customers on invoices. By offering better terms for quick payment, such as small discounts for settling within a shorter timeframe, businesses can motivate customers to pay sooner, reducing DSO. This improvement in cash flow can have a substantial positive effect on working capital. Moreover, implementing these promotions and incentives can increase visibility on managing compliance with existing terms. This transparency allows businesses to track customer payment behaviors and tailor their offerings accordingly. For example, companies can use data analytics to identify which incentives are most effective for different customer segments and adjust their strategies to maximize working capital efficiency. By leveraging this increased visibility, manufacturing businesses can optimize their promotional strategies to drive both sales and timely collections, ultimately strengthening their overall working capital position.
Negotiating favorable payment terms isn’t just helpful with clients but can also work with manufacturers’ own commitments. Strategic supplier payment and credit terms can also enhance working capital for manufacturers. Focus on increasing Days Payable Outstanding (DPO), which represents the average number of days a company takes to pay its suppliers. By negotiating extended payment terms, manufacturers can hold onto their cash for longer periods (from 30 to 60 or even 90 days), effectively using their suppliers as a source of short-term, low-interest financing. This also allows manufacturers to improve their cash conversion cycle, reducing the time between paying for raw materials and receiving payment for finished goods.
Effective forecasting of wages and overtime is another area where manufacturers can improve working capital. By accurately predicting production needs and aligning them with available workforce resources, companies can avoid excessive labor expenses while maintaining productivity. This approach allows manufacturers to schedule workers more efficiently, reducing unnecessary overtime and preventing overstaffing during periods of lower demand. Additionally, precise forecasting enables businesses to anticipate peak production times and plan accordingly, ensuring they have adequate staff without incurring excessive costs. By minimizing labor-related expenses and maximizing workforce utilization, manufacturers can free up working capital that would otherwise be tied up in unnecessary payroll costs.
Ultimately, your financial strategy might not sufficiently account for working capital, let alone how it can be optimized, and it might be worth revising. One key capability: scenario planning. The ability to study “what if” scenarios and plan accordingly enables businesses to adapt quickly to changing market conditions. Companies can develop contingency plans that optimize working capital management under various circumstances. This proactive approach to financial strategy not only improves short-term liquidity but also strengthens long-term financial health, allowing businesses to navigate uncertainties with confidence and seize opportunities for sustainable growth.
Manufacturers can leverage this additional cash to make strategic investments in their operations, such as purchasing new equipment, funding research and development, or expanding production capacity. These investments make manufacturers leaner and more agile, driving increased efficiency, productivity, and competitiveness in the market.
It takes work to get to a positive working capital state, but with the right partner and the right technology, it’s a solid investment for your business. Spaulding Ridge has used Anaplan to enhance financial operations for numerous manufacturers across the industry. If your working capital needs a boost, message us, and let’s talk.
