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Annual working capital benchmark: time for a new inventory management model

27 Mar 2018
We just completed our annual working capital benchmark on 160 manufacturing companies in the Netherlands, and the results show that there’s still work to be done. Although several large companies have managed to improve their cash conversion cycle, a lot of cash is still stuck in their inventory. Why is that the case, and what can be done about it?

Why is your inventory high?

When measuring cash-conversion cycle, we combine payables, receivables and inventory. It turns out that like last year, the biggest opportunities lie in the latter. However, managing inventory is deemed to be complex – and understandably so, as there are several reasons why it is difficult to keep your inventory low:

  • Factory processes are often managed based on KPIs that don’t take into account how decisions affect working capital.
  • Service and finished goods inventories are tightly linked: lowering inventory arbitrarily can result in unintentional pressure on customer service levels.
  • Some customers succeed in using your balance sheet to store their products, storing them there until they need them
  • ‘Cost of capital’ is an often misunderstood term. People are convinced that all is good as long they “sell it in the end,” and "money is cheap" failing to realize that having cash on the bank is a valuable asset and WACC is the real measure of capital cost.

Two steps to effective inventory management: how to solve this

The above-described problems can be solved by giving inventory management a proper seat at the decision making table. Instead of taking a back seat to things such as factory utilisation and customer availability, inventory levels should be an integral part of decision making. This model comprises two steps:

1. Clean house: getting rid of redundant stock

Which of the products that you’re currently stocking will you never sell? When answering this question, look at your inventory from different angles:
  • Non-moving inventory: stored products that are selling slowly or not at all
  • Aged inventory: products which are probably too old to be used or sold at full price
  • Inventory on discontinued product lines: articles you no longer include in your catalog
  • Overstocked products: products where you have coverage for many, many years of demand

Once identified, these product should not only be written down but physically removed. Next to an immediate impact of inventory levels, such spring cleaning frees capacity, lowers warehousing cost and often simplifies your operation.

2. Incorporate working capital in your decision making

More departments within a company should incorporate the impact of working capital (or, inventory) into its decision-making process. Teams need to understand that most decisions, big and small, can impact inventory levels months into the future. For example, before agreeing with a customer that a certain product will always be readily available, the sales department should not only consider gross margin, but also the cost of funding and storing the products involved. In this manner, the cost of service, and thus the value to customers, are clear to everyone involved. Based on this insight, gross margin and service can be ensured to be beneficial to both parties. This could mean that some customers are worth a fast delivery and high availability and are willing to pay for it, whereas others might not. 

Curious about your performance?

Does your company have a revenue over 100 mln, and would you like to know your benchmark performance? Please don’t hesitate to contact us (gijs@m3consultancy.nl). We are happy to provide you with the relevant data as well as our presentation.

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