03 August, 2021

Can Reducing Inventory Really Improve Working Capital?

The 1,000 largest American companies would improve their working capital by a combined US$1 trillion if they optimised their inventory and accounts, a recently published report suggests.

The 2016 US Working Capital Survey shows most of these companies are carrying debt instead of improving business processes to maintain cash reserves.

“Once again, low interest rates gave companies a perfect excuse to ignore the hard work of optimizing receivables, payables, and inventory, leaving over a trillion dollars unnecessarily tied up in operations,” said Craig Bailey, director of The Hackett Group. “Instead of focusing on transformation most simply leveraged their future with more loans.”

Top performers in the survey are seven times faster than typical companies at converting working capital to cash. In addition to collecting from customers faster, they hold less than half the inventory than the companies that rely on debt to maintain cash reserves.

For most companies, efficient management is the only way to improve working capital. Large corporations might enjoy the luxury of negotiating cheap loans—an option that will last only as long as the economy cooperates and the central bank doesn’t hike interest rates. The rest of the world needs to cover operating expenses by lowering current liabilities and increasing current assets as much as possible.

Inventory is the linchpin to working capital, especially in general retail and grocery sectors where it can account as much as 70% of current assets. Too much inventory reduces current assets tying cash up in excess raw material purchases or warehousing costs. Too little inventory increases reordering costs, but carrying buffer stock can turn into a liability if a company anticipates more orders than it receives.

“With the globalization of supply chains, inventory optimization has become increasingly tough to achieve,” writes Robert J Bowman. “Companies are liable to find themselves burdened by pockets of inventory and little visibility across multiple locations.”

Generally speaking, getting inventory right includes tying forecasts into sales and operations planning. Bowman writes that corporations should practice “customer segmentation” using statistical modeling and pre-determined service levels to set appropriate inventory levels for each account

This may be an easier proposition for smaller companies than you think. Large corporations with complex supply chains and multiple departments have a serious scale problem. But smaller, nimble companies can take some basic steps to inventory management—using effective purchasing and inventory systems, knowing all stock turnover, applying appropriate controls—that can be coordinated easily across a smaller team.

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