Working capital has the power to create, or destroy, value for shareholders. Three key components of working capital are inventory, accounts payable and accounts receivable. Each of these elements is examined by analysts for indications of a company’s financial soundness and operational efficiency.

Reduce the Cash Conversion Cycle

By reducing the cash conversion cycle, a key metric monitoring the length of time between when a firm buys a product from a supplier and the collection of payments from customers for that product, companies can significantly increase profitability. The longer it takes a company to turn raw materials into sales revenues, the longer the company’s working capital is tied up and cannot be utilized for growing its business and increasing profits.

Smart working capital management is a necessary part of company growth and profitability. Efficient management of working capital can potentially free up cash for other uses that can build shareholder value. The extra cash can be used to reduce the reliance on debt or other forms of external financing. Increasing cash availability can also help strengthen the balance sheet and enhance operational performance. The extra cash can also be used to build shareholder value through mergers and acquisitions. In the investor community, working capital is often considered a proxy for the strength of how well a company is run.

Working capital is a simply concept because it’s all about freeing up the company’s cash. Unfortunately, many companies face internal challenges. There is a gap between recognizing the need for working capital improvement and understanding what steps to take to improve cash flow.

Challenges to Improving Working Capital

There are many challenges to improving working capital, including:

• Limited access to needed information. Many companies lack the real-time data and metrics needed to evaluate the effectiveness of working capital and improvements.
• Lack of formal structure for working capital improvement efforts. It can be difficult to sustain the effort without a formal structure. Few companies have a formal improvement program with clear ownership across the organization or the organizational tools and the capabilities to implement a program.
• The number of working capital stakeholders and their differing perspectives. The distributed nature of working capital can make it difficult to implement a working capital improvement program. Each stakeholder is likely to have a different perspective on how to enhance working capital and the relevant priorities.
• Time constraints. Organizations often struggle to focus on improving working capital because of other priorities competing for attention.