Why working capital management is important

Working capital affects many aspects of a business, from the liquidity available for the day-to-day operations to efficient production processes, and the short-term financial stability of the company. Especially in times of uncertainty, managing working capital efficiently is critical to the success of a company. It ensures that capital is not unnecessarily tied-up in operational activities and that enough liquidity is available when needed, for example, to actively respond to changes in demand or market uncertainty. Regardless of its positive impact, working capital management is often regarded as a necessary evil. As a result of the lack of focus, today around 1.2 tr EUR excess working capital are tied up on balance sheets worldwide. To continuously optimize working capital management, specific key metrics are available to companies. These are used to continuously monitor working capital and serve as a basis for the definition of measures.

Metrics to evaluate working capital performance

Working capital describes how much capital is tied up in financing ongoing business operations. It consists of short-term assets, such as accounts receivables and inventory, and short-term liabilities, such as accounts payables. A common metric to measure how efficiently a company is managing its working capital is the cash conversion cycle (CCC). It measures the time it takes a company to convert the funds tied up in working capital into cash generated through the sale of the finished product.

The Cash Conversion Cycle is calculated using three metrics (CCC = DIO – DPO + DSO):

1. DIO (days inventory outstanding) measures the average number of days it takes a company to convert its inventory into sales.
2. DPO (days payables outstanding) measures the average number of days a company takes to pay its trade payables.
3. DSO (days sales outstanding) measures the average number of days a company needs to collect cash after the sale of the product.

Benchmarking working capital performance

With the calculation of the CCC, companies can easily use their financial data for an initial assessment of their working capital. However, in order to gain a true understanding of the working capital needs, an assessment of the competitive environment is also necessary as working capital practices can differ significantly in different industries and regions. Benchmarking working capital management is therefore important to determine whether capital is being used efficiently in order to finance more investments and innovations. For example, a benchmark analysis can show which possible drivers / measures exist compared to the competition in order to achieve a more efficient working capital management. One reason for this can be a DPO that is lower and therefore worse than the industry standard. This means that suppliers grant longer payment terms to the company’s competitors than to their own company. A company can use this information to renegotiate its payment terms and thus improve its cash flow.

The CRX Markets Working Capital Analyzer

The CRX Markets Working Capital Analyzer is a web-based tool based on current data from several thousand companies. The Analyzer helps companies to understand how efficiently they use their working capital. Instead of manually collecting a lot of information for your competitors, the CRX Markets Working Capital Analyzer is available free of charge and delivers valuable key figures after only a few entries. The tool compares the working capital efficiency of companies with that of their competitors within the same region and industry. It provides detailed insights and hints for improving working capital efficiency and helps to assess how much cash flow could be generated through the right measures.

Try the CRX Markets Working Capital Analyzer and contact us for more information. We are happy to support you in interpreting the key figures.