Business And Leadership, Ireland's Business News Service

It is crucial for us all that businesses get a better handle on the whole working capital cycle, and the drivers behind it, believes working capital expert John Mardle. He tells Ann O’Dea it should never simply be left to the financial director.

Working capital management is a key issue for any business’s survival and sustainability, says John Mardle, an expert in working capital optimisation and managing director at Develin & Partners in the UK. Yet most businesses don’t properly understand what’s involved. He believes that much more focus needs to be put on educating companies on the importance of strong management of working capital, and that the focus in the good times has been far too much on profit and debt.

“Companies have been failed by the educational establishment. The business schools and the universities have tended to focus on leveraging the debt rather than on the internal working capital of the organisation,” says Mardle.

“To some extent, that has been good. But we’ve had it good for 10 years and we’re now looking at managers and directors who have known nothing but good times. I’ve been through two recessions and I know that at the end of the day if you cannot generate cash from within, and you are beholden to creditors, then you are dead in the water.

“Unfortunately, the educational establishments have not really grabbed that and have tended to concentrate on private equity, the banks and venture capital to generate cash for companies that in many cases are not viable going concerns.

“I don’t blame directors and managers. In many cases they just have not been made aware of the importance of their own

working capital management,” he says. Indeed, Mardle is critical too of the media in this regard, and their narrow focus on the availability of credit from banks.

“The media campaign makes me cringe at times – even some of the statements Mr Brown is coming out with over here these days like, ‘We’re doing everything we possibly can’. The businesses are certainly doing the best they can, but in many cases they have such limited tools, and such limited understanding of how much headroom they have to be able to manage their money supply.”

So, does he believe the majority of companies properly understand how to manage working capital? “Rarely. The reason being, many don’t even understand the terms and conditions of their own sales and those of their suppliers.”

Mardle gives regular seminars on the subject to managers and directors and he says the same stories occur. “We find that they can be paying suppliers in 35 days and getting cash in from a customer in 47. Now, there’s a discrepancy there of 12 days, and that’s just a good average.

“So what we often find is that they are paying suppliers too promptly, which seems a bit odd. Don’t get me wrong, I’m not saying ‘keep the cheque in the drawer’. In these tough times you’ve got to keep your suppliers afloat to satisfy your own customers. But we find businesses paying their suppliers, not looking at their own terms and conditions, and realising the customer isn’t going to pay them until long after the event.”

According to Mardle, the problem is companies send out their invoices with standard terms and conditions of payment across the company. “What we advise is that you look at your terms and conditions on a customer/supplier basis. In some cases, the large company down the road is likely to be able to pay you within 14 days, whereas the small supplier, the one-man band who is a critical part of your set up, in some cases may need payment earlier. It has to be almost looked at on a case-by-case basis.”

Not that Mardle claims this is easy. “It is difficult because you may have a large number of suppliers and customers, and you could be generating a large amount of work there. But, to be frank, the owner manager today has got to be looking at that sort of level of detail in order to survive.”

In practice, Mardle finds that many of the businesses he sees are not establishing a robust, rigorous and regular (he calls it the three ‘R’s’) reporting of cash flow. “They don’t do the daily bank balances, they don’t do the weekly forecasts, and in most cases the financial supply chain is not properly understood. We call it the ‘cradle to covenant’. Basically, when an order is won, you’ve then got to understand when your loans and covenants are due.”

He’s a believer in the old maxim, ‘Profit is vanity, cash is sanity’, he says. “Indeed, you see classic cases where people are still supplying, still making profits, but they just don’t understand the cash. Businesses don’t fold because they don’t have profits. They fold because they don’t have cash. You’d be amazed how many businesses we meet think profit and cash are the same thing.”

Though an accountant by trade, the accountancy professions does not escape Mardle’s ire. “Often there are too many accounting loopholes put in place to ensure revenue, with no real idea where the cash is coming from.”

It is a mistake, says Mardle, to believe that working capital management is an issue for the finance department. He says it must be a company-wide concern, and, indeed, one for everyone in the chain. “We need to understand how we all impact on each other and interact with each other. In any working capital policy, people from sales through to purchasing, through to distribution, all have to be in the loop. They need to really understand how they all work together to make it work. And in many cases there are customers out there, suppliers, that you have to bring together in the same room and actually talk through the issues.”

Mardle sometimes finds himself involved in mediation between customers and suppliers, in cases of, for example, bad debt. “You get a supplier and customer in the same room, and all of a sudden they see each other’s approaches and they say, ‘Oh, if we’d understood that, we’d have done this’. What we end up doing is keeping them out of the courts and actually working together.”

He says a good understanding of days sales outstanding (DSOs), days payable outstanding (DPOs) and inventory turns is very important. “This is the basic stuff. But the critical piece is understanding the working capital drivers, or what makes DPOs and DSOs go up or down. Again, in many cases, businesses just don’t understand the drivers. What drives a DSO up to 75 when it should be 45? What’s the driver behind DPO going down when it should be going up?

“We’ll often dig around; we might go back through invoices, CRM systems, customer complaints, and in many cases we find it was a sales manager in Manchester who gave a freebie away or gave an extra 10 days’ credit. It’s totally out of the norm and it has skewed the DSOs.

“The other critical thing is that you normally only get terms such as DSO and DPO on the back of a balance sheet. That is rubbish. It doesn’t work in today’s climate, where it is all about understanding what the drivers behind these terms are about,” continues Mardle “They can be anything from a supply truck being turned around at the port because of bad weather. All of a sudden you can’t supply, and if you can’t supply, then you have a problem raising invoices to get the goods paid for.

“And, more importantly, your important customer doesn’t get the goods, and that customer then has a problem with their customer. It has a huge knock-on effect on the whole financial chain.”

He says there are countless other drivers that go unnoticed by management. “You’d be amazed what we find – invoices dated 2009 going out in 2008, and getting returned because of the wrong date on them. What happened? They did the VAT change and for some reason some of the programmes automatically changed dates as well and didn’t pick up on it.”

He says the VAT-rate change didn’t help businesses in the UK. “So many invoices got returned because they were miscalculated, and the timing was terrible because it was end of year. Ironically, the government gets crucified too in this case, because it doesn’t get the right VAT amount in.”

He is astonished that the Irish Government would have put businesses through all that pain of changeover for a rise of 0.5pc when I tell him. “Surely not? For half a per cent? Oh my goodness. Well, it’s a programmers dream, because they are the ones who will make a fortune out of this.”

As we have moved from a manufacturing economy to a service economy in countries like Ireland and the UK, there’s another factor that businesses need to focus on, says Mardle, and that is work in progress. This, he says, needs to be separated out as a separate statistic.

“Focusing on one statistic is a recipe for disaster. One needs to have all four areas fully understood. Yes, DSO, DPO and inventory turns – but also work in progress. One of the big things that happens in service companies is that so many things get put into work in progress – cost, timesheet, labour, material. And guess what? You can’t invoice it, because the customer hasn’t agreed it. Well, you had better get out there and get them to agree it. That was fine in the old days, but in today’s climate you risk ending up with a massive amount of work done that is unbillable.”

As regards what owner managers need to concentrate on now that we are in the midst of a recession, Mardle reiterates the importance of understanding your own drivers and not leaving it in the lap of the financial director.

“Don’t simply leave it to the accountants to manage the process. They are there to generate the numbers. You and your managers are best placed to understand the actual working capital drivers, and the relationships with suppliers and customers. The managers are the ones who can give you the answers and make things happen. After all, they are at the grass roots.

“When we do our seminars we often speak to managers in charge of millions in costs, and they don’t have a clue of how the cash flow works. You need to get down to that level of detail. These are the people who are face to face with the customers, with the suppliers.

“Get a method in place for communicating with your managers so that they are telling you this supplier is in difficulty, or that customer has a problem. Because if you have that traceability, that record, then the managers can say they have done their job. They have forewarned management that there’s an issue coming down the pipeline.

“Ninety per cent of working capital problems can be identified months before any statistics are generated, because it’s all about the relationships. It is blindingly simple, but you have to keep re-enforcing that message.”

Relationships are also vital when dealing with banks and key creditors, says Mardle. “Key creditors have got to be honest with you. Are they suffering as well? Are they unable to invest in machinery you need them to have? Are they cutting back on facilities? Are they cutting back on health and safety?

“There’s the whole area of social responsibility here too. You need only look at Primark here in the UK (the retailer was reported as having suppliers that used cheap child labour last year). If you have suppliers it doesn’t matter if they’re in Timbuktu or Manchester or Dublin, if they’re not doing it properly, there are people who won’t want to do business with you.”

Whether dealing with the bank manager or an investor in your business, Mardle recommends an up-front relationship and early disclosure of any problems coming down the line. “Honesty is critical, but timing is really critical. It’s no use going to a bank manager on 30 March and saying this month’s figures are going to be terrible. You should be saying that in January.”

However, he cautions that a sensible approach needs to be taken with this. “Think about what you say to them. You don’t want to frighten them either. It’s all about wording and timing. You’ve got to have a bit of nous about you, so you’re giving the true picture but not colouring it in any way.”

It is in a business’s own interest to have this kind of honest rapport, he says. “Whether it’s the bank, the market, or the small guy down the road that’s just invested in you, if you’ve got that rapport with the person, whereby you’ve given them honest, up-front early disclosure, then they can make a decision. 

“The good thing is you can then actually factor that into your plans, and have two or three months to play around with. If you do it on 30 March and you want an answer the next day, you’re dead in the water.”

John Mardle is the speaker at an ICAI seminar in Dublin on 8 June on Driving Cash Flow and Ensuring Efficiency through Working Capital Optimisation.