Working Capital Reduction for Manufacturing Companies

Working capital management has emerged as one of the most important financial priorities for manufacturing companies over recent years. According to Deloitte’s 2015 Global Treasury Survey, nearly 70% of treasurers have been mandated by the CFO to drive working capital improvement initiatives. With the consequences of COVID 19 and lowered estimates for global growth, working capital management and asset efficiency is increasing in importance. 

For most manufacturers, the level of inventory (and total working capital) required to sustain their business is an important determinant of competitiveness. Aggressive competition and an increasingly price-sensitive consumer impose significant downward pressure on operating margins.

Working capital is a measure of the net current asset position of a firm.

Working capital reduction and supply chain efficiency have become synonymous topics of discussion as manufacturing companies attempt to improve margin performance.

The first step in reducing working capital is identifying the drivers of each component.

This article will focus on the first two WC drivers and outlines an approach that can result in tangible inventory reductions.

1. Inventory Classification

Many companies will use a standard inventory strategy across all products. It is important to segment inventory because the strategy for managing inventory is dependent on classification. The most effective strategy for managing ‘A’ items may be quite different than those for applicable for ‘B’ items. Yet, another strategy may be more effective for ‘C’ items or new items.

  • Action: Carryout an accurate classification analysis of finished Goods and apply a category specific stocking strategy.

2. Number of Items

SKU (item/location) proliferation is usually a result of immature product portfolio management processes and a lack of performance measures. Proliferation of SKU’s is detrimental in several regards, not simply adding inventory cost and obsolescence risk but increased complexity and cost of managing the internal supply chain. Inventory inaccuracy also increases as the number of Bill of Materials increases, and higher number of low volume components and raw materials needed to support lumpy or infrequent demand.

  • Action: Implement a formal product lifecycle management process and maintain alignment with your inventory strategy.
  • Action: Review the product portfolio regularly and rationalize SKU’s that no longer meet margin or contribution hurdle rates.
  • Action: Regularly review Make to Stock / Make To Order policies at network node level based on revenue and order frequency. Do not stock an item unless lead time, market competitiveness, or supply constraints dictate the need to hold stock.

3. Number of Locations

For a fixed level of service the amount of safety stock held increases in proportion to the square root of the number of stocking locations, put simply, inventory should be planned and held in the fewest number of stocking locations as possible.

  • Action: Regularly review your distribution network in terms of movement volumes, frequency, and shipment v carrying costs. Variables and business strategy can change over time, so it is important to occasionally step back and sense check the current model is the most efficient or optimized

4. Safety Stock Quantities

The quantity of safety stock for each SKU will vary based on demand patterns, lead time, and targeted service level. Often companies will apply the same service level across all items rather than a specific service level per inventory category. Typically, you should apply a higher service level to your ‘A’ items and accept a lower service target for your ‘B’ and ‘C’ items. Applying a ‘blanket weeks of cover’ safety stock policy whilst very simplistic often results in higher overall inventory costs.

  • Action: Segment your inventory based on ABC analysis and apply differentiate service levels. This can also be done at a product and customer segmentation, but a good starting point is product segmentation.
  • Action: Calculate your safety stocks using a stochastic model. These models can vary in complexity and no single model will drive a ‘perfect’ result. Application of a safety stock formula will typically reduce safety stocks and improve service.
  • Action: Monitor inventory key performance measures e.g. stock outs and adjust the safety stock parameters / settings over time based on learning to further optimize overall inventory.

For more information on Inventory optimization or if you would like to know how we can help, visit our site

Stewart Williams, partner at Optimized Supply Chain Solutions.

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