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Cash on the road: Gauging the opportunities in working capital - EY - Global

Cash on the road

Gauging the opportunities in working capital

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What are the best ways to combine "lean" practices with "agile" responses?

The size of the disparities in performance between companies within each region also points to fundamental differences in management focus on cash and process efficiency.

Variations in working capital performance between companies in each region point to significant potential for improvement. Our analysis suggests that the leading 40 automotive suppliers have between US$17b and US$35b of cash unnecessarily tied up in working capital processes, equivalent to somewhere between 4% and 7% of sales.

We calculated this by comparing the performance of the working capital components of each company with that of the average (low estimate) and the upper quartile (high estimate) of its peer group within its region.

Even at the top end of each range, which might be considered ambitious, experience across many projects, industries and geographies shows that a dedicated focus on working capital management can frequently release results at or above this level. Note that the opportunity is distributed across the whole range of working capital components, with 50% derived from inventories, 30% coming from payables and 20% derived from receivables.

WC cash opportunity

  Cash opportunity
Value (US$b) % WC scope* % Sales
Average Upper quartile Average Upper quartile Average Upper quartile
US 3 7 6% 13% 2% 5%
Europe 9 20 12% 26% 5% 10%
Japan 5 8 12% 19% 4% 7%
All regions 17 35 10% 20% 4% 7%

Source: EY analysis, based on Q410 publicly available fi nancial statements
*WC scope = sum of trade receivables, inventories and accounts payable

Overcoming obstacles for optimizing working capital

The industry faces a wide range of strategic challenges. For example, supply chains are becoming global, creating longer lead times and adding vulnerability to business disruptions. Product complexity is also on the rise, adding both risk and R&D cost. This is to say nothing of the rush to build capacity and distribution in emerging markets.

Visibility challenge

Industry participants are also anxious to improve demand visibility up and down the value chain. But enhanced demand forecasting, production planning and inventory optimization efforts are sideswiped primarily by distrust, often fuelled by a lack of fundamental alignment or even conflicting objectives. Similarly, visibility and cooperation are hampered by the industry's relative lack of standardized processes and systems.

Further complications often include self-billing and vendor management inventory (VMI) practices, poor end-customer forecast accuracy, frequent abuse of consignment stocks and the participation of less sophisticated and less solvent Tier 2 and Tier 3 suppliers.

Overall, the industry is struggling to strike a better balance between operational efficiency with flexibility and responsiveness. The question on all participants' minds: What are the best ways to combine "lean" practices with "agile" responses?

Achieving improvement in increments

Companies need to begin by encouraging a stronger focus on working capital management. Performance evaluation, for example, needs to include a heavier does of working capital measures. Once the organization begins to appreciate working capital costs, it will be more motivated to enact everything from simple to innovative solutions.

A quick fix for many suppliers relates to receivables. The typical supplier has little leverage with an OEM regarding payment terms. But a supplier can pay closer attention to its own invoicing to make the most of such terms. Simple errors, for example, failing to update prices on a master data file, can lead to under-billing or alternatively, to errors resulting in rejected invoices and payment delays.

Similarly, suppliers can also do more to accelerate payment for engineering changeovers, tooling and R&D. These tend to be larger payments. If handled professionally; discussions of terms in these areas tend not to bleed over into the broader commercial relationship.

As for more innovative options, suppliers can continue to push for greater visibility into demand processes. Most have done well in terms of optimizing production and inventory management inside their own four walls. However, more can be done by obtaining buy-in and cooperation across the supply chain.

In addition, suppliers might look downstream to find opportunities for collaborative purchases of steel or other commodities. Larger orders executed with greater procurement expertise, perhaps working with an OEM or an alliance of suppliers, can lead to lower materials costs.

Managing risk in the supply chain

The global downturn of 2008, recent events in Japan and volatility in demand reveal how vulnerable the supply chain is to internal and external business disruptions.

This vulnerability has also been increased by a change in the supply chain risk profile, resulting from lean practices, rising outsourcing and reduced supply base.

There is a need for robust risk management policies to mitigate and manage risk. This process starts with understanding the wider supply chain, improving the supply chain by reducing complexity and increasing process reliability, analyzing and managing risks associated with the critical links and nodes of the organization, improving network visibility and working more closely with suppliers and customers.

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