For many companies, working capital is a combination of earned organic operating cash and cash from financing activities, i.e., borrowed money. Global commerce is dependent on the availability of credit to trading partners. As credit markets tighten up, working capital tightens up, creating a rather tight feeling for many companies.
Working Capital is an ongoing concern for manufacturers, importers, distributors, and retailers. Tight credit requirements continue to worry business owners. The still-jobless recovery from The Great Recession continues to pressure top-line revenue growth.
Many companies look to the Income Statement for relief, but balance sheets prove to be the undoing of many a company. As credit markets tightened in 2008 and 2009, many companies shrank their inventory to free up cash. Some weathered the storm, while others fell into liquidation because of deep and long bets on inventory. Companies held off replacing inventory and waited for the market to recover as sales dropped. While in a broad sense that strategy appears to be sound, in a much narrower sense it is difficult to succeed with.
CASH FLOW: The other challenge through The Great Recession is what happened to the cash-to-cash cycle. As sales dropped, retailers ignored payment terms and paid invoices late. While some suppliers could exercise limited power of supply, they did so at their peril because retailers could swiftly switch suppliers. Late pay traveled up the supply chain, placing more strain on the limited cash reserves of all the upstream trading partners.
Cash turnover, or cash-to-cash cycle, is a key concept that surprisingly few people in the supply chain, general merchandising, and business community are able to grasp. In its simplest terms, the cash-to-cash cycle is the number of days between when you pay for inventory and when you collect payment by selling it. In a simple retail or distribution environment, where little value is added while the inventory is in possession, increasing the velocity of the physical supply chain is a tactic to improve the cash cycle. The situation is different in manufacturing, where multiple cost inputs create the finished product: purchase of the raw materials, components, labor and processing costs, each at different times.
Guess What? Not all inventory is the same. Most of those who are involved in supply chains understand fast movers, slow movers, and dogs. When management pulls back on the reins and tightens up the open to buy, new challenges are created for inventory managers. If you have a high enough overall volume with the supplier that you can always meet order minimum, you don't have any problems. On the other hand, if your order volume across a vendor’s product line is thin, but you have a few items that are high movers—or worse, they are companion items to your high movers—you may have a problem making order minimum.
So what can an inventory manager do when they have to replenish but what they need is not enough for order minimum? They order more stuff. Sometimes they order the fast-moving product and just take a deeper position of it, and other times they order some of the other, slower-moving product so they don't end up having that dating problem because they bought deep. But they order more than what they need to make that minimum, sometimes with no knowledge of what the extra inventory is doing to the cash flow. This is an Inventory Replenishment Squeeze Play created by purchase terms.
Excess inventory places incredible pressure on Working Capital. The best way to relieve that pressure is to lower inventory and improve the cash-to-cash cycle.