Your Working Capital Management Approach: Is Good Enough Really Good Enough?
The second in a series of posts based on the research report Working Capital Management by the National Center for the Middle Market, this post explores why many middle market companies settle for less than optimal working capital management metrics. Download the full report here.
If your middle market business is like most of the companies the National Center for the Middle Market recently surveyed, cash isn’t a crisis for you. In fact, just 41% of middle market businesses say they experience working capital gaps that require financing. And the majority of those companies need to borrow to meet operating expenses only once or twice per year.
The ability to consistently make ends meet is likely a big reason why the vast majority of firms—75%—tell the Center they are very or extremely satisfied with how working capital management is handled at their organizations. After all, if there is money available to pay the bills and keep the lights on, then cash flow really isn’t a problem, right?
Most companies are tying up millions in cash unnecessarily—money they could put to better use.
When we looked at public company data for middle market firms, we found that in every industry, top-performing companies manage working capital up to four times better than their below-average peers. Extremely large differences exist among peer group companies in all three critical measures of working capital management: days receivables outstanding, current inventory levels, and days payable outstanding.
For example, in the energy industry, the length of time it takes a company to collect from it customers differs by 192 days between companies in the 75th and the 25th percentiles. That means some companies are waiting more than six months longer than their competitors to collect their cash, which can clearly put those slower-collecting companies at a disadvantage.
Or take a look at how quickly companies pay their bills. In IT companies, companies in the 25th percentile parting with their cash five months sooner than their competitors in the 75th percentile.
Differences in the number of days companies hold inventory is vast, too. Across all industries, companies in the 25th percentile hold 407 more days of inventory than those in the 75th percentile.
The financial impact of these differences is staggering. Those companies that manage working capital management metrics well (by collecting sooner, holding less inventory, and taking full advantage of payment terms) have millions of dollars more in available cash than those peers who have their cash tied up in AR or inventory, or who pay their bills sooner than they need to.
Why companies settle for mediocre performance.
Even if middle market companies believe they are doing just fine in terms of managing cash flow, the reality is that some of their direct competitors are likely doing a much better job. And those businesses with more cash will be better able to compete for and capitalize on opportunities for growth.
So why aren’t middle market companies more concerned with working capital management? For one thing, they might not realize an opportunity for improvement exists. Private companies don’t have stock analysts criticizing their actions and might not think to benchmark themselves against their public peers. They may feel be no immediate pressure for them to improve. They fall into the mentality of, “if it’s not broke, don’t fix it.” Or they focus on the issues that are giving them bigger headaches at the time, failing to realize how freeing up more cash may be the very solution to those other issues.
No matter how well you believe your organization is currently doing at managing working capital, it’s worth taking a closer look at what opportunities you have to improve. To get started, check out the Center’s full research report, Working Capital Management: How Much Cash Is Your Business Tying Up?
Next in this series
Post 3: Millions of Dollars in FREE Cash? What’s Your Working Capital Management Financial Opportunity?
Others in this series
Post 1: Cash Is King: How Good Working Capital Management Practices Can Help You Get More of It.