Inventory optimisation is key for improved cash conversion cycle

22 June 2017 Consultancy.uk

There are large differences in the working capital performance of Dutch manufacturing companies, according to a new benchmark. Inventory management is the explanatory factor for poor performance – the supply chain domain accounts for more than half of the discrepancy between cash conversion cycle leaders and underperformers. 

The benchmark, conducted by M3 Consultancy, a Netherlands based supply chain consultancy, studied the cash conversion cycle (CCC) of nearly 200 manufacturing companies in the Netherlands. The cash conversion cycle is a common metric used to understand how efficient a company’s procure to pay process (P2P) is, and looks at the amount of days between payment of raw materials and collecting the invoices for the finished goods (this could therefore be negative, if suppliers are paid after the invoice from a customer is received). 

The results show that there are large variations in the CCC performance of companies. The average cash conversion cycle for the companies taken under scrutiny was 68 days, yet a large share of those scored either well above or below the median. The worst performers have a CCC of over 100 days, far from the best performers, which enjoy a negative CCC. 

Cash Conversion Cycle in the manufacturing industry

Deeper analysis shows that the performance gap between best and worst performers is mainly driven by inventory levels. More than 60% of the gap – 84 days of the average 135 day discrepancy in CCC terms – is explained for by the Days Inventory Outstanding (DIO), which indicates how many days a company needs to turn its inventory into sales on average.

Days Payable Outstanding (DPO), the period which highlights how long it takes a company to pay its invoices from trade suppliers, accounts for 18% of the gap, while Days Sales Outstanding (DSO), a metric for the average number of days that a company takes to collect revenue after a sale has been made, accounts for the remaining 20%.

Reflecting on the results, Marco Heimensem, a Manager at M3, says: “The results show that most CFOs have mastered the financial side of the equation – credits and debt management. But managing their inventory remains a challenge, they struggle with the complexity.” Based on the analysis, he points out that it is clear that the largest potential for working capital improvement in the industry lies in more effective inventory management.

Cash Conversion Cycle – performance gap (days)

Structurally lowering inventories in the production landscape is however notoriously hard, Heimensem points out. Foremost is that finished goods inventory and service are tightly linked with customer demand estimates and service quality targets. “Lowering inventory arbitrarily can result in unintentional pressure on customer service levels.” On top of this comes that sales teams are primarily driven by selling products, whilst having a tendency to favour speed and service level, often not, or insufficiently, taking into account the impact on inventory and thus working capital. 

Procurement practices also play a role in too high inventories. When negotiating sourcing agreements, procurement can opt for bulk with lower prices, yet at the same time these are provided for with longer material chains, with as a result more material in transit. “The impact on working capital is often overlooked, as it propels cash ‘locked in’ transit mode,” states Heimensem. 

A similar development is visible at manufacturing facilities. In their bid to optimise unit costs, production departments aim to deliver large batches, which, given not all products are dispersed at the same rate throughout the supply chain, results in high inventory levels. Heimensem: “Raw material and WIP levels often result from manufacturing practices, which aim to optimise different KPI’s without taking into account the amount of inventory generated.” 

Inventory management optimisation

Cracking the inventory code requires a complex interplay of methods, KPIs and behaviour, says Heimensem. “Successfully managing inventory requires an aligned approach across the primary value chain, while a rigid governance is needed to orchestrate the entire process towards the desired outcome.” One of the quick-wins commonly found is reducing the hidden unused overflowing stock. Many companies typically keep redundant products in their storage, such as products no longer for sale, and flawed items. “Get rid of these products and inventory cost will decrease immediately”, the M3 consultant says.

Inventory and working capital optimisation

When striving for a structural improvement for inventory management, companies are advised to develop a model in which they not solely take sales, production and purchase into account; inventory management needs to become an essential part of the whole process. “Each department needs to incorporate the working capital (inventory) impact into their decision-making process. For example, the sales department needs to differentiate the delivery time and service level per product/customer. For determining a certain product’s delivery time, one needs to take into account manufacturing lead time, demand, quantities, etc. By passing on inventory cost in the selling price, customers willing to pay for it can be offered a shortened delivery time.” 

Contrary to the dominant thought, the transition does not necessarily imply that performance levels will decrease – “key herein is how the optimal stock model aligns with customer and production strategies and how well the chain of activities is integrated into operations,” concludes Heimensem.

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UK manufacturing sees orders slow amid Brexit anxiety

11 April 2019 Consultancy.uk

Manufacturing in the UK saw negative growth for the end of 2018, reflecting a wider slowdown in the UK economy to 0.2% for the quarter, followed by three months at the start of 2019 which saw continued softening in orders. With uncertainty still hitting the sector ahead of Brexit’s deferred deadline, the industry faces a difficult 2019.

Despite a perpetually changing economic landscape, manufacturing remains a keystone industry in the UK. Optimism in the industry has been riding high in recent years, reflecting the perceived potential of automotive technologies, but last year saw a slight dip in business performance, ahead of what seems set to be a turbulent period for British manufacturing. Ordinarily, the sector might have expected to recover its footing relatively quickly, but with the looming spectre of Brexit making the economy’s future completely uncertain, this has not been the case.

The uncertainties of Brexit have continued to create headaches for companies on both sides of the channel. As contingency planning continues, new analysis from BDO and the Make UK explores how manufacturing – a segment likely to be hard hit by Brexit – has fared in the final quarter of 2018.

Output balance stable

Manufacturing remains a key industry in the UK, generating around 10% of total economic output and supporting around 2.7 million jobs. Yet while the industry has seen a number of years of strong optimism as well as demand, Brexit is set to throw a spanner in the works, with a range of manufacturing companies leaving the UK, or considering it. Indeed, UK manufacturing’s output currently sits at a 15-month low as the industry anticipates a cliff edge Brexit.

In terms of growth for various parts of the UK economy, a slowdown was noted in the final quarter of 2018 compared to Q4 2017. Manufacturing, in particular, saw growth declines coming in at almost -1%, with a similar trend in production. Construction saw a sharp contraction, falling 2 percentage points to below 0% growth in December 2018. Only services managed to have positive % growth in the final quarter. The final quarter as a whole saw growth of 0.2% in the UK economy – the lowest level in six years.

Output across most sectors in the industry remains positive, with the percentage balance of change in output at 22%. The result is the tension quarter of positive percentage balance of change, with stagnation on the final quarter of 2018. The firm is projecting a slight softening of output going into Q2 2019. The firm notes that there is some stockpiling taking place, with orders and outputs unaligned going into 2019.

Order balance remains positive but dips further

While there is a broadly positive picture for output, the firm does note considerable differences between subsectors. Basic metals for instance, saw a net 24% fall to -18% over the past three months. Metal production is also seeing relatively poor performance as demand from the automotive industry enters a period of acute uncertainty. However, most industries are to see improved output on balance, with rubber & plastic increasing from a net 11% to net 56%.

Export trade

Having been buoyed by the lowered value of the pound, UK export orders are up slightly on the previous quarter, but remain well below the most recent peak in Q3 2018. Domestic orders were relatively strong, with a year between the most recent peaks for the segment. However, Q2 2019 looks to see domestic orders fall sharply, to half Q1’s result, while export orders too are set to see declines.

The decline reflects a decrease in basic metals, possibly a reflection of changes affecting the auto industry. Meanwhile, export orders are down due to Brexit cross-border uncertainty – the effect of the sterling devaluation unable to continue to buoy the market. Basic metals and metal products are both in negative territory for the coming three months.

Investment and employment intentions

UK employment figures reached new milestones, with total unemployment down to 3.9% while participation rates hit record highs. Employment planning continues to be in net positive territory, with a net positive balance of 22% in Q1 2019. The coming months are projected to see a slight dip, again, largely resultant from uncertainties around Brexit. Basic metals is the sector most likely to see a negative trend, reflecting the expected decline in orders.

Investment intentions meanwhile continue to be in positive territory. However, again, the now acute uncertainty about Brexit – the UK government has boxed itself into a corner – mean that confidence around investment could wane rapidly.

Commenting on the wider economy, Peter Hemington, a Partner at BDO, said, “Manufacturing firms have been ramping up their preparations for a disorderly Brexit, in large part through the stockpiling of imported goods. This has had the effect of inflating activity levels… It’s too late to do anything about this now.  But a disorderly Brexit would be far worse than the current relatively mild slowdown, possibly disastrously so… We are concerned it looks more likely than ever that we will exit the EU without a deal.”