Organisational Challenges in Managing Working Capital in Asia

Introduction

The Operational Cash 2004 survey conducted by gtnews, REL and citigroup, showed that 88 per cent of respondents agreed that treasury has a key role to play in the reporting and management of working capital. The survey also found that only 24 per cent of respondents described their treasuries as simply participating in project teams engaged in working capital initiatives. From an Asian perspective this should be no surprise to anyone as the challenge of working capital management has evolved into different organisational models than those typically experienced in Europe and the USA. This can have serious consequences for the balance sheet equilibrium where in Asia we find a much wider gap in the respective day’s sales outstanding (DSO) and day’s payables outstanding (DPO). At REL, we have noticed that the roles and responsibilities for the management of these indicators is dispersed across the organisation geographically and functionally, leading to decentralised practices and sub-optimal processes and controls.

Growth Does Not Equal Poor Working Capital Performance

‘Cash is king’ needs to take hold within the Asia context as the REL annual working capital benchmarks continue to demonstrate that quantity of excess opportunity has doubled in recent years; firstly let’s remember some well known growth dynamics that have brought about the organisational challenge.

The IMF has forecasted that the US and euro area economies will grow at 3.5 per cent and 2.2 per cent – 4.8 per cent respectively. Asian economies excluding Japan are expected to grow at 4 per cent – 6.9 per cent.

Multi national companies have aggressively pushed these growth patterns and in themselves grown at rates far greater than the macro level for 2005 predictions. This is based on two specific areas impacting the organisations’ working capital – sales and production – the former with sales team dominance in the whole process from sales through to terms negotiation and payment performance; the latter with spiralling inventory and outbound payment performance from operations, and sales, teams satisfying local demand and overseas requirements. Similarly, since 1995, East and Southeast Asia accounted for half of a total foreign direct investment (FDI) flow of $101bn to developing nations (Asian Development Bank). The People’s Republic of China (PRC) received the majority share of this flow, $36bn. The urgency to recoup these investments made into the region has added urgency to selling pressure to meet budgeted sales and market share targets.

Treasury, and to a lesser degree finance, have played a supporting role in cash management, negotiation and risk minimisation to their respective businesses, but only in the past year or so have we seen the emergence of the value adding finance teams asserting some of the controls and management on working capital that we expect in Europe and USA.

Challenges to the Role of Finance Teams Exist

REL has been operating across Asia for 10 years and we have put together a commentary on our experience with clients in respect to the management of working capital, in particular those responsible for DSO and DPO parameters. Adrian Ow, Senior Consultant based in our regional office in Singapore, specializing in the implementation of cash management processes has realized that the models implemented for best practice show a more distinct non-finance orientation than we see in other regions.

• It is a common issue among finance and treasury professionals in Asia that their departments lack the control and influence over credit receipt and payment performance, as well as risk management decisions. These activities form part of the integrated customer service process owned by the sales and commercial teams. Gaps in this process may be hidden when the market is booming and sales targets are being met, but when the going gets tough, balance sheets come under scrutiny and higher levels of bad debt have cost many businesses dearly.
• This lack of influence is not limited to the area of credit and risk management. Our experience in assisting clients to manage their working capital in Singapore, Malaysia, Thailand and China shows that inventory forecasting is often derived from annual budgeted sales plans rather than forecasted demand and recognized data modelling. This is driven from the ground level where sales executives are cushioning their customers from potential lapses in service levels by keeping high levels of inventory just in case the customers need them. With a mounting pressure to gain market share and drive sales growth, companies are maintaining sub-optimal inventory levels and this is costing Asia’s top 1000 companies $50bn-worth of inventory every year.
• The systemic effect of this is that when sales budgets are not met, distribution chains are stuffed with excess inventory in comparison to real demand. This attempt to meet budgeted sales numbers is typically translated into high levels of returned goods or non-collectable receivables.
• It is clear that working capital is not just sales, operations or solely a finance issue, it is about a holistic approach to working with customers and suppliers to ensure that the extended enterprise processes are operating at an optimal level to maximise working capital efficiency.
• Even when the product is sold, there is the issue of collecting monies as well. Whose responsibility is it? There are two schools of thought here; one that believes the sales function owes the relationship and a sale is not a sale till it is in the bank. The other school of thought is that in order to achieve good performing DSO results, dedicated finance professionals should be pro-actively contacting customers about payment and disputes.
• In Asia, we rarely see the full implementation of either of these two schools of thought. Typically there are ambiguities between sales and operations teams and finance functions over their roles and responsibilities within extended enterprise processes. This results in confusion over relationship ownership and re-active contact strategies.

Developing the Working Capital Organisation for Asia

Best practice models of working capital management have been implemented in many world class MNCs. Maximising the benefits of these in an Asian business environment has required a fine balance between growing the business, optimising cash flow and managing risk simultaneously. The conflicting demands of sales growth and effective optimisation of the balance sheet is achievable. Finance and treasury have a significant part to play and we believe are emerging as champions of enabling controls and significant performance improvement. The REL Asia Working Capital Model highlights key aspects of organisational composition and structure to bring global best practices in working capital management to the Asian business environment.

While the role of the finance department becomes more responsible and accountable for working capital management, there is also a need to strengthen the accountability of the function. Finance should be reporting directly to the CEO or Managing Director so that key business decisions are made with a balanced perspective from the commercial and financial viewpoints. At the same time, we need to be realistic that consistent and reliable credit and supplier information in countries like China, Thailand, Vietnam, Cambodia and Laos is more difficult to obtain so sales and operations input has to be taken more often than say in Europe or USA. This more balanced view between robust risk management policies policed by a strong finance team with input relationship stakeholders will ensure growth with a more stable balance sheet appearance and risk minimisation.

This joint approach should be used in pricing, stock forecasting and inventory management as well. Sales budgets should be aggressive but they need to be checked with realistic demand growth in the economy and sector. Real time demand information from distributors in an extended enterprise model will drive more accurate production planning and a reduction in excess inventory. Asia businesses needs to be mindful that although order fulfilment and service levels are important aspects of customer service but what is the cost to the business in providing this level of service to a particular customer segment. What is your customer profitability for this segment? Research has shown that today, share prices are twice more likely to be influenced by growth in margins than by market share. An optimal service level needs to be determined for each customer segment for every category of finished goods to maximise profitability and returns on capital employed.

Figure 1: Extended Enterprise Process

Optimising the Organisation for DSO and DPO Improvements

The increasing profile of the finance function in Asia should be mirrored for the control and improvement of DSO and DPO performance. For instance in the case of DSO, the processes surrounding receivables management across Europe and the US are teams of professional finance staff contacting customers to resolve complaints and ensure on-time payments. In Asia however the task remains sales-centric. At REL, we believe that finance has a key role to play in dealing with payables functions of key customers, specifically in targeting their main customer groupings based on size and profitability. For the less strategic accounts, which typically represent the majority of accounts in most businesses, practical approaches need to be developed using finance and sales teams. The growth in popularity of financial process outsourcing and resource consolidation has forced senior finance executives to do more with less. To maintain the same DSO performance with smaller finance teams, senior finance executives need to seek a creative solution to manage the volume game. This approach utilises the customer relationship skills of the sales team with the specialist finance support to manage risk. Pro-active contact when done correctly from a customer servicing perspective to identify complaints, service lapses and to ensure that the customer is fully satisfied with the goods and service provided will help to remove barriers to prompt and full payment. This customer service mindset change needs to be inherent in both the sales and finance staff for this approach to succeed.

Similarly for the maintenance of DPO performance, finance challenges need to change the perception that payment processing is a non-value added task. At best, if done efficiently on a centralised basis, it will assist in reducing the costs per transaction and lower the operating budget of the finance team. Contrary to this misconception, payments processing is a treasury function that should demand the full attention of senior finance executives. Too often we observe poorly set up payables process and ineffective banking relationships have caused payment delays, dissatisfaction among suppliers, duplicate payments and erosion of business reputation in the marketplace. This translates to higher prices made by suppliers to compensate for potential payments delays, shorter payment terms extended, causing longer term inefficiencies to the bottom line, cash flow and supply chain flows.

Optimising the payables process does not only mean negotiating longer payment terms with suppliers, which can prove a win-lose strategy with its benefits negated by higher prices and lowered service levels from suppliers. The value-added payables process, senior finance executives involve the payables processes in pricing negotiations. Through a review of supplier spend, payment history weighted with cash flow and price discounts trade-offs, a win-win pricing and payment agreement can be established with suppliers. This results in better pricing and cash flow and moving towards building rewarding supplier relationships. It does not stop here as an integrated and cost efficient payment channel is essential to ensure that payments are made in full and on time taking advantage of discounts established earlier in the negotiations process.

Integrating the Treasury Function

Treasury functions must form an integral part of the finance role, specifically in championing the benefits of better controls, streamlined processes, and managing the cash flow. There are three areas where REL have seen a more imposed contribution:

1. Banking relationships and the growing applications for cash management in the business. This is exemplified in selecting a banking payment and receipt channels, which can be complicated by the broad spectrum of payment requirements and business practices in Asia. While Japan and Korea use a high level of electronic payments like RTGS and Giro, cheque payments are still significant in Singapore, Malaysia, Thailand and India. For companies with Asia-wide operations, a regional bank with local infrastructure and payment products customised to the country’s trading practices, coupled with standardised regional integrated, reporting and reconciliation process can be a better banking solution.
2. Maintaining the optimum equilibrium of cash in- and out-flows as signified by the DSO and DPO levels, essential for effective cash management and forecasting.
3. Increasingly acting as models for streamlining of processes and resources across local offices into centralised teams within the region.

Moving Forward

Finance and treasury are emerging with increasingly important roles within businesses in Asia. Implementing best practices is crucial in getting the desired results and balancing the DSO and DPO equilibrium. Failure to understand the commercial implications and blindly implementing global models will impact on strategic goals for market share and margins. REL believes that working capital does not have to suffer conflicting demands of growth against cash, cost and service. With unique insights, consistent implementation momentum and the will to succeed in one of the world’s fastest growing regions, these goals can be met; and finance and treasury do have a significant part to play.