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Cut Costs Using Working Capital

Management
James S. Sagner

W
orking capi- Examples of
tal1 manage- Managing working capital involves organizing your annual benefits
ment involves company’s short-term resources to sustain ongo- achieved by a sample
the organization of a ing activities, mobilize funds, and optimize liquidity. of client companies
company’s short-term The two most critical cost efficiencies are float and in this industry in
resources to sustain processing expenses. recent years are shown
ongoing activities, The author gives some examples of firms using in Exhibit 1 (along
mobilize funds, and with the data for
working capital management to control costs, and
optimize liquid- industry example 2).
he includes a checklist of 20 actions companies The annual savings
ity. The two critical
cost efficiencies are should take to understand their working capital total over $3 million,
float and processing requirements—and produce cost savings. with the companies
expenses. © 2011 Wiley Periodicals, Inc. included in the sample
having annual revenues
• Float involves ranging up to $20 bil-
funds in the process of lion. These results are exclusive
collection or disburse- INDUSTRY EXAMPLE 1: of recommendations that could
ment. These activities have CONSUMER PRODUCTS AND not be quantified (e.g., improved
inherent delays that cost LEISURE control and security).
your company. Although
we cannot eliminate float, Traditional management of Sources of Benefits
we can examine every costs in the consumer products
step of the cash-flow time- and leisure industries focused on The principal cause of this
line to search for savings the processing of consumer remit- situation is the way in which
opportunities. tances and accounts payable dis- responsibility is assigned for
• Processing expenses are bursements. Extending the search events involving working capi-
similarly important, as each for cost management opportuni- tal. The supervision of activities
transaction—whether per- ties throughout a business may prior to and subsequent to the
formed internally or out- yield savings far beyond those activities managed by finance
sourced—has a cost, and that developed using such standard does not usually fall within
cost directly impacts your bank products as lockboxes or the responsibility of manag-
profitability. controlled disbursing. ers with adequate knowledge

© 2011 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).
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 4 The Journal of Corporate Accounting & Finance / March/April 2011

Exhibit 1

Working Capital Cost Management Opportunities

Consumer Products and Leisure Industry Manufacturing Industry
$000/Yr % of Benefits $000/Yr % of Benefits
(cost savings) (cost savings)
COLLECTIONS
Invoice Issuance 300 10 36,000 18
Cash Processing 750 25 18,000 9
Funds Application 400 13 22,000 11

DISBURSEMENTS
Invoice Review 1,000 33 78,000 39
Disbursement Processing 20 1 24,000 12
Clearing and Funding 50 2 14,000 7

BANKING, OTHER 500 16 8,000 4

Note: Italics indicates those segments of the cash-flow timeline that are outside of the responsibility of financial management.

of cash. Their focus often is on • Charlie’s was paid early bidding the disbursement
other objectives or goals in the because his sister-in-law function resulted in operating
conduct of their business-unit worked at the company and cost efficiencies of $20,000,
functions (e.g., scheduling or uti- saw no harm in issuing pay- resulting in annual total benefit
lization of personnel, efficiency ments once the payables of $60,000!
of operations, and concern about cycle was completed.
customer service). • Claire’s was paid before the INDUSTRY EXAMPLE 2:
Here is an example of a con- appropriate date because its MANUFACTURING
sumer products/leisure company. salesperson had once asked
The business of the World of for an early check to make Financial benefits of using
Animals is to stock zoos. Work- her monthly sales goal. The good working capital manage-
ing capital has been a continuing payables clerk imbedded ment are listed for a sample of
problem, and a study of payable the check release date as an 12 manufacturers. Their annual
practices seemed appropriate. ongoing system instruction. savings total over $2 million.
Disbursements were made by The companies included in the
check, with two major payables The company immediately sample range from among the
runs on the 5th and 20th of each researched other vendor largest in the industry to those
month. The results for its largest transactions, and found similar with assets of some $5 billion.
vendors are shown in Exhibit 2, problems. The total cost to The Examples of annual benefits
showing an annual value of float World of Animals from all (cost savings) achieved by a
costing nearly $30,000. Inves- vendors in lost payables float sample of client companies in
tigation into two of the ven- was determined to be about this industry in recent years are
dors paid early determined the $40,000 a year. In addition to shown in Exhibit 1 (along with
following: saving nearly $40,000 of float, the data for industry example 2).

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 The Journal of Corporate Accounting & Finance / March/April 2011 5

Exhibit 2

World of Animals: Billing Activity of Largest Vendors

Days Paid Annual Value of
Vendor (and Usual Pay Early vs. Discounts Purchases Foregone
Accompanying Note) Terms Date Net Terms Offered ($000) Float (at 10%)
Amy’s Alligators (1) 1/10, n/30 5th 25 1/10 discount $3,800 N/A
Ben’s Bobcats (2) net 20 20th 0 $2,200 $0
Charlie’s Cassowaries (3) net 30 20th 10 $2,000 $5,550
Claire’s Cobras (4) net 30 20th 10 $1,500 $4,170
Denali’s Deer (5) 2/10, n/30 5th 2/10 discount $925 N/A
Owen’s Ostriches (6) net 30 20th 10 $830 $2,300
Robert-Paul’s Ravens (7) 2/20, n/90 20th 70 2/20 discount $740 $14,390
Sarah’s Sea Lions (8) net 30 5th 25 $635 $880
Stephen’s Scorpions (9) 1/20, n/30 20th 10 1/20 discount $700 N/A
Tessa’s Tigers (10) net 45 5th *10 $670 $1,860
Annual Cost of Float Foregone (at 10%) $29,150

All invoices are received on the first or second of the month.

Note: A 10% cost of capital is used in these calculations.
*Paid on 5th of 2nd month with the final due date of the 15th of that month.
N/A = not applicable.
Notes:
1. Amy’s cash discount was valued at 18% (30 – 10 ⫽ 20; 360 ⫼ 20 ⫽ 18 times 1%) and worth taking.
2. Ben’s was paid on the due date.
3. Charlie’s was paid 10 days early, valued as ($2,000,000 ⫼ 360 times 10 times 10%).
4. Claire’s was paid 10 days early, valued as ($1,500,000 ⫼ 360 times 10 times 10%).
5. Denali’s cash discount was valued at 36% (30 – 10 ⫽ 20; 360 ⫼ 20 ⫽ 18 times 2%) and worth taking.
6. Owen’s was paid 10 days early, valued as ($830,000 ⫼ 360 times 10 times 10%).
7. Robert-Paul’s was paid 70 days early versus the due date, valued as ($740,000 ⫼ 360 times 70 times 10%). The cash discount was valued as 10.3% (90 – 20 ⫽
70; 360/70 ⫽ 5.15 times 2 ⫽ 10.3%), and not worth taking.
8. Sarah’s was paid 5 days early, valued as ($635,000 ⫼ 360 times 5 times 10%).
9. Stephen’s cash discount was valued at 36% (30 – 20 ⫽ 10; 360 ⫼ 10 ⫽ 36 times 1%) and worth taking.
10. Tessa’s was paid 10 days early, valued as ($670,000 ⫼ 360 times 10 times 10%).

Similar factors drive
these results as was noted for
consumer products and leisure.
As an example, an electronics
company billed $500 million
per year in mailed invoices pre-
pared through two information
systems. Billing terms are “net
30”—that is, payments are con-
sidered late if received more
than 30 days after the invoice is
received by the customer. Con-
sistent with industry practice, no
cash discounts are offered.
Weekly system runs print
invoices an average of 15 days
after the sale date. The due date
for payment is 30 days after the
target date for the customer to
receive the invoice (the “cus-
tomer invoice received date”).
Given typical mail times in the
geographic areas served by the
company, customers receive
these invoices approximately 12
days prior to the due date. The
timeline sequence for a typi-
cal transaction involving these
events is as follows:
• Sale of product: April 1
• Target issuance of invoice:
As soon as possible after
April 1; assume April 6
• Target customer receipt of
invoice: April 9

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 6 The Journal of Corporate Accounting & Finance / March/April 2011

• Actual issuance of invoice:
April 15
• Actual customer receipt of
invoice: April 18
• Target date to receive pay-
ment: May 6
• Actual due date: May 28
The float lost between the
target and actual due dates is
22 days. The value of the lost
days, at an assumed 10 percent
cost of capital, is calculated
as $500 million times 22 lost
days divided by 360 calendar
days times 10 percent cost of
capital = $3.1 million. Research
determined that the delay in
invoicing was caused primarily
by various scheduling issues
within the information techno-
logy function, with invoicing

Exhibit 3

Possible Working Capital Cost Savings

General and Banking Ideas
1. Calculate the cost of capital to value the savings that may be available in reducing working capital.
2. Determine the amount of working capital float and consider alternative processes to improve float management.
3. Examine bank products for possible application to the management of float and fraud prevention.
4. Determine the appropriateness of your company’s bank account structure. What is the cost and purpose of each
account; who are the authorized signers?
5. Drain any excess funds from bank accounts where only a minimal earnings credit rate is received.
6. Invest temporary excess cash through an appropriate short-term instrument.
Receivables Ideas
7. Develop appropriate policies and focus your company on the management of receivables.
8. Review and take appropriate action on your receivables aging schedule.
9. Analyze the entire process of generating invoices, including design and timing.
Inventory Ideas
10. Develop appropriate policies and focus your company on the management of inventory.
11. Examine the purchasing cycle and determine if it is in compliance with appropriate procedures.
12. Determine if there are specific purchasing problem areas such as high prices paid, or lack of compliance with
purchase order and receiving report requirements.
13. Calculate your economic order quantity for each significant purchase and determine optimal procedures.
14. Consider whether just-in-time is appropriate and any possible risks.
Payables Ideas
15. Develop appropriate policies and focus your company on the management of payables.
16. Actively manage accounts payable and determine when to release payments.
17. Review the terms of sale offered by vendors, possibly taking any cash or other discounts offered.
18. Consider alternatives to check disbursements for vendors, such as procurement cards, freight and logistics
services, and comprehensive payables.
International Ideas
19. Begin moving international transactions to any of several electronic mechanisms in order to eliminate paper checks.

20. Consider the potential advantages of tax-advantaged or reinvoicing centers to manage regional activity in global
markets.

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 The Journal of Corporate Accounting & Finance / March/April 2011 7

cycles run at certain weekly
intervals at the convenience of
that department.
Once senior management
became aware of the potential
value of the lost float, it was a
relatively simple matter to man-
date the rescheduling of process-
ing runs. While some customers
did notice the change in the
timing of their monthly invoices
and held checks until the usual
release date, many paid once the
bill was approved. In addition
to these changes, the processing
cost of invoices was carefully
examined, and various efficien-
cies were developed.
SUGGESTED BUSINESS
ACTIONS
Exhibit 3 lists 20 actions that
companies should be taking to
understand their working capital
requirements.2
ORGANIZING THE WORKING
CAPITAL REVIEW
Any attempt at a comprehen-
sive working capital effort will
seem daunting when manage-
ment is faced with the variety
and quantity of issues present
in a business enterprise. A use-
ful approach may be to assign
specific sets of tasks to ad hoc
committees composed of rep-
resentatives of each functional
area likely to be affected. The list
could be organized by working
capital account.
The next step is to determine
current practice—the “base”
case. Documentation of that sta-
tus assists in deciding whether
change is necessary and feasible,
and eventually how much the
change will cost. Each committee
should issue a report showing: a
brief description of the working
capital change, how the system
currently works, which functions
are responsible, whether informa-
tion technology or vendor inter-
faces will be affected, the cost
and benefits from the change, any
additional data that is required,
and the time required for imple-
mentation. Senior management
can then prioritize company
working capital change efforts.
NOTES
1. Working capital is defined as current
assets less current liabilities, stated in
currency units.
2. The 20 actions are excerpted from the
50 listed in the author’s Essentials of
Working Capital Management (Wiley,
2011), Chapter 10.

James S. Sagner is with the School of Business of the University of Bridgeport (Connecticut), teaching
MBA-level courses in finance and international business, and is senior principal of Sagner/Marks and of
Bank Credit Training Partners. He has managed over 250 large-scale studies for global organizations and
is recognized as an expert in financial management and economic analysis. His clients have included
financial service and manufacturing companies. Previously, he was with the First National Bank of Chicago
(now JPMorgan Chase); A.T. Kearney, financial and economic consultants; and the Maryland Department
of Transportation, where he served as chief economist.
He is the author of seven books and some 50 papers and articles that have appeared in various pub-
lications. In addition, he teaches in the executive education program at the University of North Carolina.
Dr. Sagner received his BS from Washington and Lee University, his MBA from the Wharton School of the
University of Pennsylvania, and his PhD in business and economics from The American University. Sagner,
who was honored as a Rockefeller Fellow, is a CCM, a CMC, and a member of Beta Gamma Sigma.
Concepts in this article are expanded and explained in the author’s book, Essentials of Working Capital
Management (Wiley, 2011). See especially Chapters 2, 5, and 7.

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