By Jim Maholic, Oracle
This post is the seventh in a series of ten articles excerpted and adapted from my award-winning and Amazon Top 10 book, Business Cases that Mean Business (details on the book below).
This series is focused on building business cases for transformational cloud initiatives by aligning projected future capabilities to core business drivers. We’re in the middle of unpacking the four components of the business case, which are:
We covered the hypothesis and the gathering of evidence in prior posts. And we explored common, primary benefit areas in the most recent post. Now it’s time to unlock the richest, but often most misunderstood benefit area: working capital.
Working capital is a current asset on the balance sheet; it refers to those assets that are cash or items that can be quickly converted to cash—typically, accounts receivable, accounts payable and inventory. Working capital is most commonly measured and tracked using an equation called the “cash conversion cycle” or “cash-to-cash cycle,” which measures the time between when the company buys raw materials, converts those raw materials into finished goods, and ultimately collects cash from the sale of those goods. Manufacturers, wholesalers and retailers focus on this metric heavily.
In a nutshell, a company buys inventory (typically on credit; we call the time that we take to pay our vendors Days Payable Outstanding, or DPO), it holds the inventory until it can sell it (called Days Sales of Inventory or DSI), and then it sells the inventory to a customer on credit and must wait for payment (the time from invoicing to receipt of payment is called Days Sales Outstanding or DSO). The Cash Conversion Cycle or CCC is computed as follows: CCC= DSI + DSO – DPO.
When developing your proposal, ask yourself: Can you demonstrate that your solution will reduce the time the company has inventory on hand? Will it reduce the time it takes a customer to pay? Will it make it possible to lengthen the time you take to pay your vendors, without injuring the vendor relationship? If it does any of those three things, you have a financial benefit.
To understand this, look at the spreadsheet below. This is the same one we used in the last post. This spreadsheet shows the year-end figures (in millions) from our sample company, Company X, and three of its peers in its industry.
The question to ask regarding working capital is: what is the time value of money? We’re not talking about interest rates; we’re talking about accelerating the cash conversion cycle. We want to convert our purchased inventory into cash from our customer as quickly as possible. To know that answer, we must determine a single day’s value of each working capital item.
Look at Days Sales Outstanding, or DSO. Company X, our company, performs next-to-worst among these companies. In this example, we see that our company takes 49.00 days (on average) from the day we cut an invoice until we receive and record the payment from our customer. If our proposal can help accelerate cash collection by just one day, it could be worth $52.3 million (Annual Sales/365, or $19,115 million/365 = $52.3 million).
Note that Peer 1 and Peer 2 are in the exact, identical business as Company X. Presumably, they sell to the same customers. Why does this customer pay your competitors so much sooner—22 days sooner in the case of Peer 2? If a single day is worth $52.3 million, then two days would be worth $104.6 million. That’s a huge benefit. And it still leaves us 20 days behind Peer 2.
If our company similarly underperformed in Days Sales in Inventory (DSI) we would work the math the same way. In this case, the story is a little different. In this case, Company X outperforms all peers. Good for us. The question to ask in this case is this: Are our executives content and pleased with a 58.45 day performance? What if our proposed solution could make just a small improvement and move inventory out the door one-half day sooner, without compromising safety or quality? If we could show that our solution could produce that improvement, it could be worth $17.3 million. In the case of inventory, we don’t compute one-day’s value of sales, but rather one-day’s value of Cost of Sales, or in this case $12,695 million/ 365. These represent very significant benefits and, if you learn how to talk convincingly about working capital, it will pay dividends for you when you present your business cases.
Keep in mind that working capital benefits are assets, not expense items, so when showing these benefits in your multi-year projections, they only occur once. Consider a simple passbook savings account. If you open a new savings account and deposit $1,000, you have a balance of $1,000. But if you don’t do anything next year, you can’t claim to have deposited an additional $1,000. Your bank balance will still be just $1,000 and that’s it. Working capital benefits can certainly be substantial but they are not cumulative.
In the next article we’ll look at analyzing all of this evidence you’ve collected and making sense of it in ways that convey credible, compelling value.
This post is the seventh in a series of twelve articles excerpted and adapted from my award-winning book, Business Cases that Mean Business.
Developing a business case is simply the identification, calculation and communication of the value of your proposed capital expenditure. Creating a sound business case should not be intimidating. You simply must approach the development of a business case with discipline and ample planning. This series of articles will give you an overview of the creation of a successful business case. If you wish to explore this topic deeper, or just jump ahead right away, check out my book.