In recent years, due to supply chain disruptions, many companies have increased their inventories to shore up their ability to deliver. With the economy turned around, priorities have fundamentally changed. In the face of significant declines in orders and sales, as well as expensive financing, the capital tied up in inventories is becoming more important. In addition to the targeted management of inventories, optimized payment terms for receivables and payables can significantly improve a company’s liquidity. In this article, we offer you a practical guide to optimizing working capital.
Net working capital refers to the difference between current assets on the assets side and current liabilities on the liabilities side. Current assets include current assets consisting of trade receivables (debtors), cash and cash equivalents and inventories. Current liabilities include trade payables and short-term borrowings. If current assets exceed current liabilities, the company must raise the necessary capital to provide the operating business with sufficient financial resources. The optimization of (inventory) levels is one of the central adjusting screws for controlling the capital tied up in current assets.
Strategies for optimizing inventories
Does inventory correlate with demand?
In today’s business world, purchasing is often faced with the challenge of balancing surplus goods with empty warehouse shelves. Accurate demand planning can make all the difference here. Ideally, robust sales planning is transferred to production planning and then a resilient procurement plan is derived from it, considering existing inventory levels. This S&OP is associated with many imponderables. By necessity, companies use their historical sales and purchasing data. Combining this with state-of-the-art forecasting tools makes it possible to model future demand quite well. This approach makes it possible to trigger volume contracts and call-off orders in time for the required amount.
The benefits? No more excess inventory tying up valuable capital, and at the same time an end to unexpected supply shortages that could disrupt operations.
How are current overstocks optimized?
Stock items with overhangs have a so-called sediment, which does not move during the period under consideration and exceeds the required safety stock. The safety stock helps to balance fluctuations and risks on the sales and procurement side. The level of safety stock depends on the length of the replenishment cycle; in a shorter procurement cycle (e.g. monthly vs. quarterly), the swing is generally smaller and so is the safety stock required. The replenishment lead times had lengthened considerably in some cases because of the last supply chain shocks, which in principle led to higher safety stocks and increased capital commitment. In close cooperation with suppliers, replenishment times must now be shortened again and optimized.
- Check and update planned delivery times in the ERP systems monthly.
- Differentiate procurement cycles according to the value and mobility of the goods.
Are the right tools and metrics being used?
Appropriate key figures and careful analyses are crucial for success. Here, the key figures must be tailored to the specific needs and goals of each company. For inventories, the most important metrics are: Inventory Turn, Inventory Range, and Coverage Ratio. Current inventory levels are compared monthly with rolling consumption or issue values over the last 12 months.
Modern, customized analysis tools offer the opportunity to bring these key figures into focus. They help precisely calibrate safety stock levels on an ongoing basis and determine the ideal time for delivery. With their help, buyers can methodically evaluate data, identify emerging trends and accurately predict future inventory needs. This leads not only to a reduction in inventory costs, but also to more efficient capital commitment.
- Introduction of meaningful key figures
- Set up regular deadlines to track the derived measures across departments
Are incoming orders and consumption values aligned?
The modern business world faces the challenge of adapting to constantly changing order volumes and consumption levels. The underlying volatility of demand – often shaped by market-driven fluctuations – requires precise and rapid adjustments in ordering practices. This is where digital analytics and forecasting tools play a crucial role. They allow companies to identify potential demand fluctuations in advance and develop adequate strategies.
The answer to this volatile market landscape lies in adaptive production and ordering processes. These range from real-time analysis of relevant metrics to flexible supply chain strategies based on current and future consumption trends. Another critical point in this dynamic is the ongoing communication between purchasing and sales teams. A key focus here should be on the cash-to-cash cycle (days of net working capital employed), which has established itself as an important metric.
Is there sufficient communication along your supply chain?
Small irregularities in customer demand can be potentiated in the supply chain, leading to significant inefficiencies. A well-known phenomenon often referred to as the bullwhip effect. To combat this effect, coordinated communication between all supply chain stakeholders is essential.
Practical example: Explicit production release at the supplier despite existing contracts in order to react flexibly to unforeseen fluctuations in demand.
This includes transparent information channels, coordinated planning procedures and the implementation of common technology platforms. In addition, integrated kanban systems, consignment stocks and the extension of payment terms can serve as effective supporting measures to optimize the flow of information and goods throughout the chain.
Are risk and supply chain management aligned?
For companies looking to increase their working capital efficiency, considering supply chain risk in their strategy is critical. This deep look into supply chains serves to identify and manage potential stumbling blocks early on, whether due to supply chain disruptions or quality issues. At the core of any strategy to optimize working capital should be the goal of maintaining an inventory that efficiently meets demand while minimizing potential risks. In this context, measures such as supplier diversification and the introduction of safety stock can help make a company more agile and robust in the face of market changes.
How do I integrate suppliers?
A typical classification of goods according to value and mobility of demand helps to identify differentiated and effective approaches to supplier integration.
In inventory and capital commitment optimization, a consumption-driven approach such as Kanban solutions is often used, where material supply is triggered by actual consumption. Production-synchronized delivery of higher-value serial material aims to provide materials exactly when they are needed to avoid expensive storage costs.
Special requirements are procured only when there is a proven need, and procurement is often outsourced to specialized service providers. The procurement of project requirements is based on the specific project requirements, and this calls for flexible suppliers who are able to deliver quickly. Early involvement of purchasing enables the timely procurement of long-runners in particular.
Negotiating the return of excess inventory has proven to be an important component in working capital management. An open, data-driven dialog with suppliers can help identify potential win-win scenarios.
Another significant approach to purchasing is the use of consignment inventory. In this model, the inventory remains the property of the supplier until it is actually sold. When implementing such warehousing solutions, it is important to have detailed agreements that precisely define all rights, obligations and responsibilities. Such clarity not only strengthens mutual trust, but also minimizes potential misunderstandings. When handling consignment warehouses, consumption-based billing is the approach to take.
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Part 1: Liquidity squeeze? Working capital management explained simply!
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