How to manage working capital effectively

When optimizing working capital, significant funds are released – in large companies we are talking about hundreds of millions and even billions of rubles, which can be invested in new business areas or in financial instruments to generate additional income. To optimize working capital, you need to review the planning processes, primarily inventory management. How to do it?

Step 1. Identify optimization potential

The most common approach for determining optimization potential is benchmarking, that is, comparing financial and operational indicators with similar indicators of other companies or industry averages. This step will determine where to conduct research and form hypotheses.

For example, in retail it is worth comparing the volume of your inventories with the market average and the indicators of the industry leaders in relative terms, as well as comparing the turnover of goods and the timing of sales in the context of each category. In addition, you can compare the structure of inventory, including in terms of the share of active and inactive assortment.

Another useful (and not only for retailers, but for companies from different industries) indicator is dead stock, that is, something that is not being sold. These can be the remains of the New Year’s collection or surplus raw materials after the production of a batch of products. As a rule, they analyze drains that lie motionless for more than three months.

Real case from retail: in one project, we found that the share of stocks that have not been sold for more than six months is 18% of the total. This is 2-3 times more than the market average. Obviously, this is where the huge potential for optimizing working capital lies.

Already at this stage, it is important to check each hypothesis for improving processes for contradictions with Customer Value Proposition (CVP – describes why it is profitable for customers to purchase company products). For example, a hypermarket competes with neighboring department stores and convenience stores. One of its advantages is a wide range where the buyer can find everything: food, household goods, office, clothes, shoes, etc. The potential for optimization needs to be looked around CVP, and in this example, a wide range of hypermarkets will be some limitation.

Step 2. Diagnose the end-to-end planning process

After identifying opportunities for improvement, it is necessary to understand exactly what changes are to be made. To do this, it is worth diagnosing the end-to-end planning process, since each of its participants affects the amount of inventory.

In practice, it looks like this: the more failures in the processes, the greater the risks of lack of goods and lost sales. Companies seek to prevent such situations, increasing the safety stock after each failure.

Thus, in order to find points of operational efficiency and working capital optimization, it is necessary to analyze the following processes:

demand forecasting;
production planning;
procurement planning;
replenishment planning and distribution logistics;
assortment planning;
promo planning.

To carry out effective diagnostics, it is necessary to create a project team of representatives of business functions and outline the goals and objectives of such diagnostics. At this stage, sabotage is possible, the desire to hide the problem and work “as before” or “as historically happened.” That is why it is important to explain to the participants that the main goal of such a project is not to punish employees or deprive them of bonuses, but to improve performance.

Diagnostic tools are:

Interviewing – will show what difficulties employees are experiencing.
Analysis of the operating model, KPIs, planning tools and methods, level of automation – will help identify the “pain points” of current processes that are worth working on.
Comparison with best practices in this industry – will suggest how to solve the problems found.

One of the most common mistakes of the end-to-end planning process is the lack of plan unity. For example, sales, logistics and purchasing can have their own forecast and plan, interacting with other functions only when urgently needed or at regular meetings. All this leads to the fact that buyers buy the wrong thing, logisticians bring it at the wrong time, which in turn forms a dead stock that is not sold for a long time or will never be sold.

From practice: in companies with a lack of unity of plans, dead stock, which is stored and not sold for more than six months, can reach 20%. To assess the scale of the problem, it is necessary to calculate the cost of storage and the cost of “frozen capital,” taking into account the current refinancing rate, for example, for the same six months that this product is no longer on sale.

Step 3. Implement process reengineering

As a result of diagnosing the end-to-end planning process, an action plan is drawn up – a roadmap for re-engineering processes. It is important to prioritize it correctly. That is, to highlight the most significant problems in terms of the degree of impact on such indicators as inventories, forecasting accuracy, availability, and write-offs. And only after that proceed to the formation of changes in processes.

Integrated planning principles help optimize processes – this is a comprehensive planning approach that allows to synchronize the plans of different functions of the company in a single system. Integrated planning includes processes such as demand forecasting, assortment portfolio management, purchasing planning, inventory management, and distribution logistics.

Integrated planning principles:

Unity of plans: planning of all divisions of the company should be based on the same input and data.
Synchronizing all levels of planning: the company’s strategic goals must be decomposed into tactical and then operational ones.
Standardization and simplification: avoid duplication of functions (e.g. demand forecasting should be done by one department), rely on common practices and reference models.
Effective cross-functional interaction: it is necessary to define the rules of the game, fixing mutual expectations between functions on the timing and form of data provision/request processing.
Balance and sufficiency of performance indicators. The amount of inventory is the result of the work of the entire chain of goods movement, that is, at least several departments. Therefore, to monitor the effectiveness of the planning process and the size of the inventory, it is necessary to build a system of end-to-end KPIs, determining their target values. It is important not to overdo it here. KPIs for each level should not be more than 5 for each function, otherwise there is a risk of losing focus. But there may be more indicators: they allow to determine quickly the reason for the deviation of indicators from the target values and perform an auxiliary function.
Creation of the necessary competence centers and employee motivation system. An important task of effective management is the decomposition of strategic goals into tactical ones, and tactical ones into operational ones. The solution to this problem is precisely the formation of competence centers that will perform the function of both decomposing goals and achieving them.
Applying effective approaches and tools in inventory management and planning: segmentation of demand and inventory; tools for forecasting demand and replenishment, optimization modeling, determining the level of insurance stocks; collaborative planning, forecasting and replenishment (CPFR); managing returns and sales of dead inventory.
Regulation and automation of processes.

Step 4. Implement an integrated planning system

The principles of integrated planning are implemented by IT systems for demand forecasting, promo planning, supply chain planning, and production scheduling.

The implementation of integrated business planning (IBP) systems allows to automate target processes, ensure the unity of data and the information environment, synchronize planning levels, ensure transparency of the entire supply chain and monitor performance indicators.

Without automation and the introduction of specialized systems, there is a risk of “rolling back”, since the efficiency of a non-automated process is more influenced by the human factor.

The choice of systems should also be conscious. Particular attention should be paid to the preparation of the terms of reference and the choice of the vendor of the solution, which must be drawn up by an expert on systems of the appropriate class. Otherwise, there is a high risk of introducing the “wrong” system and spending investment and time just on understanding what functionality of the system was needed.

The experience of implementing projects to optimize working capital in large Russian and international companies shows that the proposed approach can reduce inventories by 10-20%. In addition, the introduction of integrated planning principles allows to increase the availability indicator, namely: the availability of goods in the right place and at the right time. Availability affects directly customer satisfaction and sales volume, and is a marker of the effectiveness of the entire supply chain. So, due to the increase in the availability of goods, sales volumes in the network can grow by 1-3%, which is quite significant for retail. Automation, accompanied by the introduction of integrated planning principles, allows to reduce the labor costs of employees, eliminating duplication of functions and freeing them from part of the routine work.