Cash & Liquidity ManagementCash ManagementCash ForecastingWorking Capital: Cash Recovery Chain Management

Working Capital: Cash Recovery Chain Management

Working capital was previously regarded, in the past, as being formulae driven and forming part of the balance sheet that, because of timing issues and being historic by nature, has not received much management attention. However, a succession of ‘sea changes’ has occurred that has rendered the area of working capital as being critical to any organisation’s survival.

The first change can be traced back to when many companies were being purchased, their assets stripped, and large amounts of debt being thrust on their balance sheet. However, this debt required servicing and the costs associated have risen rapidly. As cash efficiency stalled, a new debt was sought. The second change was that the credit crunch put paid to new debt being sought and liquidity gaps became the norm. This generated credit warnings – the third change – where any form of credit downgrading caused debt to become even more expensive, and over the past two years a cash crisis has been born where the global economy is reliant upon credit nations such as China and Germany, to finance the countries with a debt mountain to service.

Working capital can be termed as the cash conversion cycle of any organisation. Cash should be received from debtors before it is paid to creditors, in the ideal world, and those companies (Apple, Microsoft and many others) that have a cash model with this scenario are in a very healthy state to make acquisitions, pay for research and development (R&D) and pay high dividends to shareholders, while not worrying about servicing debt as they have little or no debt. However, many companies are not able to follow this course and need to manage their cash flows on a daily basis just to survive.

Figure 1: Working Capital: Cash Recovery

Source: CashPerform


These cash flows can be traced to four specific cash chains, as outlined in the table above:

  • The supply chain or purchase-to-payment (P2P).
  • The inventory chain or inventory-to-cash (I2C).
  • The demand chain or order-to-cash (O2C).
  • The newly termed reverse supply chain or returns, refurbished items that may not involve cash (R2C).

The supply chain is days purchases payable (DPO), which refers to the time it takes you to pay suppliers (normally outlined in the terms and conditions of the purchase contract). The inventory chain is the days inventory outstanding (DIO), meaning the time it takes to convert inventory to cash. The demand chain is the days sales outstanding (DSO), which refers to the time it takes a customer to pay you and finally the reverse supply chain is regarded as nil in days as it should be self- financing.

Please take a minute to complete the timing column in the table and then total it to determine your cash conversion cycle on the basis of: CCC = DSO+DIO-DPO. Ideally it will be a negative number; cash being received faster than paying it out. However, this is often not the case. If your CCC is a positive number do you have some ideas as to why?

The common culprit is usually customers delaying payment but there will be many other root causes. For example, many work-in-progress accounts are left unbilled, inventory is left to gather dust in warehouses and payments to suppliers are actually made quicker in recessionary times just to keep the supplier afloat and the goods and services still flowing. Also many corporates now ‘screen’ their suppliers to ensure they are ‘fit for purpose’ both financially and in commercial viability/sustainability – in other words their credit ratings are also critical to being on the preferred supplier list for the corporate purchasing function, which itself leads to delays in paying suppliers. Hence, if you are a corporate player, you probably have a cash surplus, whereas the suppliers to your organisation are likely to be struggling to make their cash conversion cycle balance to zero.

Evolutionary thinking is therefore required. Debt owed by a robust, reputable customer is good news – i.e. you have sold the goods/services and the invoice has been sent. However, if it remains unpaid after the agreed contractual period and investigations reveal a continuous trend of missed payments or part payments, then the likelihood is that ‘good debt’ will become ‘bad’, and is no longer an asset for an organisation but a liability.

The same can be said of work in progress that is found to have labour, expense and material costs posted to various accounts but with no commercial contract in place for it to be invoiced to customers or clients. This is really a liability. Similarly, stock that has become obsolete or has deteriorated, or has high removal and scrapping costs should be considered as liabilities on the balance sheet. The worry for many businesses is that these ‘liabilities’ can grow to very large values if not dealt with in a timely and prudent fashion.

The good news on evolutionary thinking lies in the areas of suppliers who tackle continuous quality improvement or respond quickly to re-engineer their products and services to meet end customers needs in an efficient manner that means reduced costs and improved margins. Supplier still have to ensure that they are paid on time so they must focus on ensuring their contracts include very tight payment schedules and that the exact amounts are paid. Without this the smaller suppliers’ employees, their own suppliers, the bank and finally investors may go unpaid.

The other aspect of good news is in the area of the reverse supply chain where many customers can return goods to the supplier who then passes them back to the original equipment manufacturer (OEM) where they can be recycled, repaired, replaced or re-engineered. This leads to reduced costs of new manufacture and keeps scrap costs to a minimum, a key feature of delivering on green and corporate social responsibility (CSR) initiatives. The mobile phone and auto industries are good examples of this trend.

Working capital has become a ’battleground’ for many chief executive officers (CEOs) and chief financial officers (CFOs), as it is the source of their cash to service debt, embark on merger and acquisition (M&A) strategies and to develop new markets, new products and new services. Unfortunately the supply, demand, inventory and return chains are not always very efficient or very effective. This has led the banks and software houses spawning many types of funding streams aimed at ‘financing’ working capital. One has to be certain that such funding is to support needed inventory increases or real customers’ debts that can be paid, rather than funding inefficient internal processes.

Cash recovery management is now critical in each of the cash conversion cycle chains. When examining rises in DSO, many root causes emerge: invoices have been raised late (perhaps due to a technical hitch), or have they been raised inaccurately (i.e. wrongly calculated VAT and hence they remain unpaid). When investigating the fall in DPO, root causes can include not taking account of the discounts, rebates or retentions; or perhaps suppliers’ invoices have been paid too quickly or even paid twice. Commercial terms and conditions (T&Cs) are normally the areas that need addressing in these DSO and DPO scenarios. However, any changes have to be very specific, well controlled, monitored and managed otherwise it could lead to loss of suppliers and customers. The loss of a high margin customer or a supplier that has a unique product or service can lead to a loss of business that cannot be replaced. Externally the market may turn against you for ‘failing’ to meet suppliers or customers needs

Cash recovery management also applies to inventory (stock and work in progress) and also to the reverse supply chains, but in both these areas a more informed ‘internal’ approach could be adopted. For example when dealing with stock one might need to establish procedures that look at how the storage, handling, disposal or return of such stock costs could impact the cost scenario for replenishment of the sotcks or even the future use. Cash could be recovered by disposal in a timely fashion, or where returns to an original equipment manufacturer (OEM) could generate cash.

In the case of reverse supply chains, cash recovery can occur by using innovative supply chain finance (SCF) options that allow for goods to be returned in a specified timeframe and a proportionate amount of discount can be applied to invoices raised.

Treasury functions need to appreciate all these aspects that occur within the working capital chain, as many actions impact upon other parts of the chain. This interdependency could significantly cause the cash conversion cycle to deteriorate. As an example, a CFO of a household blue-chip house-builder announced that suppliers were to have all their invoices reduced by 10%. Some suppliers immediately stop supplies or/and, services whereas others decided upon a proactive approach and renegotiated payment terms. The result was to reduce the customers sales, cause costs to escalate (as materials had to be rescheduled or sourced from other companies) and even caused some suppliers to fall into receivership.

The reliance upon historical measures like DIO, DSO and DPO is no longer an option as working capital drivers need to be determined to establish proactive KPIs that really measure the changes within the working capital chains and will be reflected in the cash conversion cycle metrics. Treasury functions are under immense pressure to demonstrate that working capital is actually working in their favour. Investment in working capital to deliver sales growth has been highlighted in many corporate financial reports as being key to them surviving the imminent double-dip recession, but this investment needs to be targeted, measured, monitored and then managed if the organisation is to be successful, particularly in the generation of more cash.


Continuous improvement programmes that embrace the three disciplines of working capital, namely inventory, receivables and creditors will see and cash recovery efficiency improve, costs reduce and optimisation of working capital occur while not being detrimental to the organisations strategic objectives like growth and/or improved profitability. Hopefully you can now complete the table above in light of the comments made, and establish a more positive cash conversion cycle. This can then establish the priorities needed to address working capital optimisation and then deliver the cash for an organisation to demonstrate to investors, credit agencies and to employees that it is ‘fit for purpose’ can service its debt and invest in growth.

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