Spend Matters welcomes this guest article by Kunal Shah, manager in the operations advisory practice at KPMG.
As we emerge from the recession, companies are holding a record amount of cash. This has resulted in an increase in cash deployment through investments and acquisition made by corporations to improve and expand their business. In the continued effort to increase cash available and provide liquidity to make strategic decisions, a company must properly manage its working capital.
Working capital is an important measure of a company’s liquidity and can be managed through 3 areas of the business: accounts receivables, accounts payable and inventory levels. When tied up in working capital, cash is trapped and cannot be used for investments. This will result in the need for outside financing through asset sales, debt financing or public offerings.
In the current economic environment, it is important to optimize working capital to ensure cash is available to organizations for upcoming opportunities. The procurement function is highly influential in impacting working capital and cash through its involvement in accounts payable and in inventory management. In addition, the procurement function must also work closely with the finance function to set targets for optimizing working capital and for improving cash levels. In order to properly optimize working capital, there are 3 areas procurement can directly impact to deliver results:
- Optimize terms and set working capital targets
- Align procurement cycles with supply and demand
- Partner with finance to drive sustainable change
Optimize Terms and Set Working Capital Targets
A traditional area of focus for procurement is within the procure-to-pay space. While there are traditional leading practices, such as managing buying channels, purchasing against contracts and analyzing spend, the procurement function should also work with finance to manage payment terms.
Procurement can manage and influence payment terms throughout the procurement lifecycle. On the front end, procurement can work with suppliers to increase payment terms during contract negotiations. This requires a sound financial relationship between businesses and their suppliers, otherwise extended payment period will be built into product pricing. Working with suppliers to manage payment terms will help keep cash within the 4 walls of the organization and will allow an organization to make decisions affecting and improving day-to-day operations.
On the back end, procurement can leverage relationships with suppliers to negotiate or manage early pay discounts. By implementing these improvements, procurement will help set working capital targets and manage working capital through payment terms management and they will work with the supply chain to align supply to demand when deploying inventory
Align Procurement Cycles to Supply and Demand
A second area procurement functions can support working capital optimization and cash management is through helping an organization manage inventory. While inventory sits on the asset side of the balance sheet, it can be a liability if cash is tied up in inventory when an organization needs to make strategic investments. As the support function responsible for buying goods, procurement is the gatekeeper for what items come in the door. Working with their stakeholders to understand needs for goods will allow procurement functions to influence inventory levels. Implementing inventory controls and double-checking inventory prior to placing orders will help an organization reduce the proliferation of inventory.
While fundamentally simple, the procurement function needs to work with its business counterparts to create these controls. In order to accomplish this, the procurement function should work with the business to understand requirements that ensure day-to-day operations remain uninterrupted.
After gathering requirements, procurement can manage delivery lot sizing during the P2P process. Instead of procuring goods to sit in inventory, it can issue POs to tell suppliers to batch shipments to align with inventory deployment or usage. Additionally, procurement can take the extra step and align with planning groups. This allows procurement to manage supplier metrics, deploy inventory to the correct location and build a plan for purchasing goods.
Partner With Finance to Drive Sustainable Change
Through its day-to-day activities, procurement provides many useful services to an organization. One additional activity the organization can do is to partner with finance to leverage suppliers and its role as a gatekeeper of cash obligations to improve provide sustainable reductions to working capital and help manage the cash within an organization. Procurement should work with finance to set working capital targets to help manage business operations.
One area procurement and finance can partner in the P2P process is within accounts payable. Earlier, we discussed leveraging supplier relationships to negotiate early pay discounts. To take this one step further, procurement can leverage its knowledge of supplier financial conditions to provide finance additional negotiating points when managing accounts payable. Procurement can engage cash-strapped suppliers to negotiate steeper discounts for early payment, resulting in less overall cash spent and improved relationships through supporting suppliers when they need a cash infusion.