Why care about Predictive analytics for working capital?
Predictive analytics for working capital 101
Working capital is a hot topic among corporates, as companies seek to unlock billions of dollars of capital. Early working capital initiative typically include three common practices:
Shortening customer terms, or collecting overdue payments faster.
Lengthening vendor terms to delay payments.
Reductions in inventory to match declining sales.
Initiating these types of changes often takes several years and reaps significant gains. These early gains lead to the perception of ongoing success for the working capital initiative. But these initiatives often stall after the early gains. The next set of opportunities is significantly more complex to identify and change. What can companies do next?
Leading treasury organizations recognize the paramount importance of visibility to their financial supply chain that they aimed for in their physical supply chain. The financial supply chain ensures that you will have the necessary cash flow to remain in business and grow. Visibility to this flow throughout the process provides new fuel to see the available opportunities in order to achieve optimal working capital levels. The gap lies in how to transform from today’s one off process measurement and monitoring to global process analysis across the organization. New applications and processes are necessary to monitor the financial supply chain.
Organizations are in a constant cycle of project and impact analysis. Multiple project ROI cost cases are built for individual one off projects. Despite many companies’ efforts to standardize project templates, project budgets are a highly subjective process. Comparing project ROI’s among multiple projects is like comparing apples and oranges. It is very complex to understand in what order to sequence projects, as it is difficult to conceptualize the intricate inter-dependencies between projects. What if we can have objective ways to compare opportunities, potential for savings, and likelihood to accomplish the savings? If we can obtain these useful information, project review and approval will be even more fact-based and thorough.
The problem with ratio based working capital analysis
Working capital analysis is the subject of many current whitepapers. Results from publicly traded corporate balance sheet are used to provide industry statistic and overall trends. This information provides an excellent picture of what is happening inside particular industries and companies. Turning insights into actions is where these whitepapers fall down. High level, generic actions are recommended for working capital improvements. This often neglects the nuances of geographic region variability, doesn’t assess where in the business process problems are occurring, and assumes all actions have an equal likelihood of being accomplished.
Where does predictive analytics fit in?
Predictive analytics applications bring new opportunities for insights outside of the traditional KPI based metrics. KPI based metrics simply report the current state. Predictive analytics takes the information from the current state and provides predicted outcomes; helping you understand the potential impact of the actions you wish to perform. Conceptually, this is a weighty, ambiguous idea. How about a practical example of how predictive analytics can apply in the financial supply chain and can provide ideas of what to change in your SAP processes?
Let’s say you run your vendor ACH payments in SAP one time per week. No vendors should be paid late, so the payment run is set up to pay all invoices due up until next week’s payment date. This ensures you will receive less complaints from vendors due to any overdue payments. But what is the impact of this business process decision on working capital? Perhaps you should explore automating your payments process so that you can send payments every day and not prepay invoices before they are due. Predictive analytics applications would let you know the effect on your working capital by prepaying invoices.
Armed with this information, extrapolate the ongoing effect of this business process decision. Is your company in a borrowing position? Does this process force you to borrow and repay short term debt each week? What is the ongoing effect of the interest you are paying due to short term borrowing simply because you run your payments once a week instead of every day? These are the questions you need to ask to optimize working capital. Predictive analytics solutions allow for a deeper understanding of daily operational processes, allowing you to analyze their impact on ongoing working capital requirements.
Predictive analytics applications and technologies that provide visibility to the financial supply chain are the next generation, providing ongoing working capital optimization opportunities.