CASH is KING: Preserve cash and reduce working capital by improving supply chain

Though the case of Greece and now Hungary debt is different, but it underlines the fact that CASH is, and will remain as, KING for at least the foreseeable future. This makes all the more important for the organizations to preserve cash and increase cash flow and the primary metrics that every organization needs to focus on, are average cash conversion cycle (derivative of cash to cash cycle that I wrote some time back), return on working capital and perfect order fulfillment. If we can keep a tab on above 3 metrics and try to improve then, we will have much better availability of cash in the system. Small measures like establishing and early payments discount structure with all the suppliers and setting up an online visibility capability into financial chain events can help increase the flow of cash as per the planned benefits of the organization. For example, if you have the option of exercising the discount for an early payment of a supplier, then you can use it you’re your benefit based on the your evaluation of the situation if paying early is more beneficial at this point of time or preserving cash is more important. This gives you additional flexibility in managing your cash to cash cycle and hence improves return on working capital. I understand that this strategy is completely opposite of the more popular “days payable outstanding extension” strategy which is a part of larger strategy that have five pillars of reducing working capital in system, but since it does not rob you of exercising the option of extending DPO or pay early to get a discount, this makes more sense in current scenario.

I mentioned above about the five pillar actions for reducing working capital, so let me pen them down here for everyone’s benefit:
  • Reduce Inventory – Infact, it should be optimize inventory as reduction of inventory impacts perfect order fulfillment too which is a key metric in preserving cash
  • Reduce days sales outstanding
  • Extend days payables outstanding
  • Utilize short term financing often
  • Short term cash investment
Similar to the strategy discussed above on DPO extension or availing discounts from suppliers, we also need to look at reducing the DSO by offering early payment discounts to the customers, which ofcourse is a popular action these days.

I talked about DSO and DPO and there is another very important that needs a mention here in little detail, which is optimization of inventory as stated above. The drivers to optimize the inventory are your forecast accuracy, optimization of routes of inventory whether it is coming from supplier or shipping to a customer, level of collaboration between you, supplier and customers (this in turn, will again impact the forecast accuracy) and status of implementation of lean and just in time principles. Also, there is a need to implement an inventory optimization tool that talks to your ERP and your business intelligence system provides real time suggestions to deflate inflated inventory, reduce obsolescence, reduce stock outs and increase perfect order fulfillment, all of which will improve the cash flow within the organization and will keep the health of the organization much better.

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