Working Capital Management: 5 Steps For Success
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It may seem as if the greatest single challenge facing professional services firms is winning new clients and new projects, but there is another way to significantly impact your firm’s ongoing profitability and sustainability.
It may be less visible but is equally important, and it revolves around working capital management.
Mastery of this finance function – which is the responsibility of everyone in the firm, not just the finance team – is especially important in project-based businesses where income can be sporadic and infrequent, but outgoings are regular and frequent.
According to PwC’s annual global working capital study for 2019, titled “Navigating Uncertainty.” working capital performance has picked up slightly in the past year, after a five year stretch of deterioration.
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What Is Working Capital?
Often the terms cash flow and working capital are used interchangeably in business, but there is a key difference between them. Cash flow is simply defined as the cash that moves in and out of a business, usually in the form of income and expenditure.
In contrast, working capital is the liquidity that remains after taking into account a firm’s current assets and its outstanding debts.
What Is The Working Capital Cycle?
The working capital cycle (or WCC, also called Net Working Capital Days, or NWCD) is the length of time a firm usually takes to convert net current assets and current liabilities into cash.
In professional services firms, best practice leans towards short working capital cycles, because capital that is tied up in the system is not available to fund growth, or earn returns. In short, clients that take months to pay your invoices – even as your firm incurs regular outgoings in the form of salaries and consultants fees – are effectively borrowing your working capital, with zero interest.
Why Is Working Capital Management Important?
Effective working capital management is important because it ensures your firm is maintaining sufficient liquidity to cover your firm’s outgoings, and secondly, maintaining a sustainable working capital cycle.
In professional services firms, maintenance of a sustainable working capital cycle poses the most significant challenges, because working capital cycles are typically longer than those in stock-and-debtor businesses.
So, the ultimate aim of finance managers is to smooth out elongated peaks and troughs between sporadic earnings and frequent outgoings, because significant problems can arise if these are left unchecked.
In the short term, working capital problems might threaten daily operations or the viability of projects. Over the medium-to-long-term, working capital problems have the potential to curtail a firm’s ability to foster innovation, development and growth.
"working capital problems have the potential to curtail a firm’s ability to foster innovation, development and growth."
How Can You Analyse Your Current Working Capital Process?
There are several key performance indicators that finance managers can use to determine where optimisation in the working capital management process can occur. These include:
Check your current provisions around client invoicing: invoices should be issued as soon as they fall due, not allowed to languish in your project management or finance systems, which has the negative effect of elongating your WCC.
Ensure that all of a project’s time and costs are captured and invoiced: Employees who bill time to clients but don’t submit timesheets on a frequent basis will likely stretch your WCC with detrimental effects. Once time and money costs are entered into your software system, they should be billed to clients at the earliest opportunity.
Get paid for all services on time: Your contracts and Statement of Works should set out payment terms, and your software systems should raise red flags when invoices are not paid on time. Invoices that are not paid by the due date are essentially zero-interest loans to your clients.
Reduce over-servicing, while delivering on time and scope: Again, the contracts and Statement of Works set the parameters for your firm’s role and responsibilities on each project. Remain within your scope – and deliver on the key measures of time and cost – or institute your established and agreed upon procedures for variations and overruns.
How Can Improvements To Your Order-To-Cash Cycle Optimise Working Capital Management?
The order-to-cash process (abbreviated as OTC or O2C) defines all the steps and processes that take place in transactions with your clients. Unpacking and optimising these provides several easy ways to improve your working capital management.
So, what is the order to cash process in professional services firms?
1. Firm provides scope and cost for project;
2. Client signs agreement based on Statement of Works;
3. Project commences (design, documentation, construction, commissioning);
4. Firm monitors time and cost outputs, via timesheets;
5. Service delivery;
6. Firm invoices client at key milestones or project phases (or via the defined payment plan);
7. Client pays invoice.
In an ideal world, the O2C process would be smooth and streamlined, but project-based businesses rarely run entirely smoothly. Instead, various pitfalls can potentially impact one or more of these stages, ranging from commencing work with a poorly defined scope; to over-servicing clients without appropriate variations in place; or being subjected to scope-creep once the job is underway.
Other potential issues include delays beyond the firm’s control; or clients that don’t remit in accordance with your specified terms.
All of these issues can quickly turn into major headaches if left unchecked, so we recommend that finance managers implement the 5 steps below into practice, to prevent issues from arising in the first place, or limit the damage if and when they do.
How To Manage Working Capital Effectively In 5 Steps
It’s worth repeating here that working capital management is not the sole purview of finance managers: this issue is central to the profitability and sustainability of the entire firm, meaning it is the responsibility of all employees across every department to adopt a rigorous approach to cost improvement on a company-wide basis.
One of the best ways of optimising working capital management in professional services firms is to instill the importance of doing so throughout the entire firm, and to enhance knowledge within project teams of the cash implications of project-based decisions.
It’s everyone’s responsibility to nurture the capabilities needed to optimise working capital, including standardising processes for service delivery that will help to reduce inefficiency and uncertainty.
Our 5 steps to best practice for managing working capital are:
1. Enact contracts and/or Statement of Work templates and agreements
Establish the parameters for each new project – including scope, cost and time – and your firm’s role and responsibilities to deliver, before commencing new projects. Use templates for contracts and Statements of Work agreements, to maximise efficiency and reduce your firm’s exposure to risk.
2. Use technology to prepare regular revenue recognition tasks
Correctly defined costings should form part of the client agreement on all new projects, to avoid problems once the job is underway. Software solutions (such as ERP) can then automatically calculate the value of services rendered and generate client invoices, which can be triggered as defined milestones are completed, or in accordance with the agreed payment plan.
3. Make sure your employees complete timesheets every week
The data contained in your employees’ timesheets is the raw material for your revenue recognition and invoicing, so it’s essential to collect this information on a regular basis. In addition, careful monitoring of timesheets enables Project Managers to track project progress accurately, and make any cost and schedule adjustments – which will ultimately impact working capital – as necessary.
4. Streamline the invoicing process and payment deadlines
Technological solutions also make it possible for project-based firms to take the guesswork out of invoicing and payments, be it transferring fix-priced payment plans from contracts or Statements of Works to your software system. The system then provides prompts and alerts when invoices fall due; are executed; and paid; or when they fall overdue.
5. Focus on the project baseline
The easiest way to streamline your firm’s entire project and financial management processes is to set realistic terms at the outset – within the contract, Statement of Works and project baseline – and then monitor resource distribution and finances regularly.
"It’s everyone’s responsibility to nurture the capabilities needed to optimise working capital, including standardising processes for service delivery."
Tracking Your Progress
Once you have implemented the 5 steps, there are several ways that you can track your firm’s performance against working capital benchmarking:
- Use software systems (such as ERP) to monitor project and overall finances on a weekly basis, keeping a careful eye on incoming and outgoing finances. KPIs to monitor include the Working Capital Cycle/Net Working Capital Days; Days Payables Outstanding (DPO); and O2C performance. Keeping an eye on these measures can help to resolve working capital issues before they arise.
- Create a system of checkpoints based on the 5 steps. By improving your O2C and working capital management, it’s possible to build up revenue to create a state of financial stability that will help to protect your firm from unexpected challenges and market volatility. Achieving best practice working capital management will also provide a buffer to support senior managers to react appropriately, or if future profitability is placed at risk.
Bear in mind that keeping a watchful eye on project and company finances will also help to identify and minimise non-essential expenses, leaving your firm in a better position to invest instead in employee skills training. Doing so promotes the development of the firm’s pool of talent – and ability to innovate – and both of these can underscore your competitive advantage and position the firm for growth.
In conclusion, it pays to remember that, as a service-centric organisation, your clients’ needs should be at the centre of everything you do.
Shifting clients to regular payment plans – triggered either by the milestone completion or a defined schedule – helps to create a steady income stream for your firm’s outgoings. It also smooths out the client’s outgoings and is more manageable than a large lump sum payment at the conclusion of a project. Also, staged payment plans have the added benefit of reducing your firm’s financial risk against project delays and cancellations.
As you embark upon this process to optimise your firm’s working capital management, bear in mind that your focus on deploying new tools; rethinking business processes; and internal change management efforts should not adversely affect your ability to continuously deliver a rewarding client experience.
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