Working capital optimization: measuring success

Working capital metrics

The basic metrics used in any working capital optimization program are as follows:

• Days payable outstanding (DPO) — the number of days taken to pay supplier invoices.
• Days sales outstanding (DSO) — the number of days taken to collect payment from customers.
• Days inventory outstanding (DIO) — the number of days taken to sell inventory.
• Cash conversion cycle (CCC) — the number of days that cash is tied up in inventory and receivables before being converted back into cash, calculated as DSO + DIO — DPO = CCC. The lower the CCC, the more efficient the cycle. Some companies may have a negative CCC — meaning that they receive cash from customers before their suppliers have to be paid.

While these standard metrics are useful in a game-changing cash optimization strategy, they only tell part of the story. That’s because they focus solely on the organization’s working capital strategy and do not take into account its other strategic goals — or, indeed, the impact of a working capital optimization program on the supplier base.

Seeing the bigger picture

Other metrics may provide a more informative picture. For example, an organization may be interested in generating better returns on its cash by offering early payment in return for price discounts. The value of those discounts — perhaps measured as EBITDA — can be compared with the cash committed, providing a calculation that is effectively a risk-free return on cash (because suppliers have to be paid anyway).

Multiplying that EBITDA by an appropriate valuation multiple for the organization gives a figure equivalent to the market capitalization added to the business by the better purchase prices.

Impact on the supplier base

Metrics can also be used to gauge the impact of working capital optimization on your suppliers. For example, businesses often aim to harmonize payment terms across their supplier base. This means that wherever in the world the organization deals with a particular supplier, the payment terms will be the same. The proportion or number of suppliers that have agreed to standard terms is therefore another appropriate metric.

Some companies use early payment programs to improve supplier relationships, with the goal of becoming a preferred customer and increasing the chances of getting exclusive access to supplier innovation. Supplier satisfaction surveys can give an insight into this — although measuring the value of innovations that have arisen from close supplier collaboration can be difficult.

Also challenging is calculating to what extent you have helped take cost out of the supply chain and improve supplier health. Data analytics may give an insight into a supplier’s cost of capital. It may also be useful to look at the value of invoices that have been offered up for early payment compared with the value that could have been paid early. Comparing those figures to the supplier’s total revenue can provide some interesting insights.

Measuring program success

While the strategic goals of the program should be regarded as the first measure of success, you can also use a number of other measures to assess whether a program has been effectively deployed and communicated to suppliers, and whether the offering has proved attractive for them. These could include measuring the time taken to implement and activate the technology platform.

Then, as the program is rolled out, you can monitor how many suppliers have been informed about it — and how many have enrolled. The difference between those numbers may shed light onto how attractive the opportunity is for suppliers and/or how effective your communication has been. You can also measure how many suppliers are taking advantage of the early payment opportunity.

Finally, measures related to AP costs can give you a clear indication of the program’s success. These can include headcount, processing error rates, numbers of phone calls or email enquiries from suppliers and the proportion of invoices handled on the platform. Particularly important is the speed with which invoices can be approved for payment: the longer it takes to do the necessary three-way matching and sign-off, the longer suppliers will have to wait before they can avail themselves of any early payment opportunities.

To know more visit www.drgrep.com and call us. We help buyers of all sizes maintain a better relationship with their supplier base at the same time optimize their cost centres. Working with us both suppliers and buyers resolved many of their supply chain finance related issues in past financial year. We also help businesses with their financial strategy, pricing strategy and other structural issues as far as business operation is concerned. Drop us a note and we will be more than happy to hear your story as well.