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Wed June 19 2024

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Why working capital provides the foundation for future growth

20 Sep 11 The construction sector in the UK has experienced a sharp contraction since reaching the heights of 2008.

In a climate of economic uncertainty, public sector cuts continue to bite, private sector projects are being postponed and banks remain reluctant to lend to businesses. For construction firms, this means finding new ways to raise capital. Looking internally and adopting a sustainable approach to working capital has become the optimal way to lay down the foundations for future growth.

Many firms recognise that improving working capital can promote company growth and profitability. Yet current strategies often overlook the significant role accounts receivables can play in reducing the cost of working capital whilst having a positive impact on customer relationships. A shortage in cash flow can shake the foundations of even the sturdiest companies and, with orders forecast to continue falling well into 2012, financing is being squeezed from all sides.

Firms operating in the construction sector therefore need to take a new approach to working capital if they are to weather the storm and be ready for growth once the economic climate improves. Specifically, they need to focus hard on managing their cash flow efficiently as the recession grinds on, given that the industry can be crippled by the requirement to make a significant investment in materials and labour well in advance of payment.

The danger of short-term fixes

Conventional approaches to managing cash flow have traditionally focussed on short-term strategies such as prolonging accounts payable and stripping out costs. Although withholding payments can, in the short-term improve liquidity, this does not help long-term sustainability as the monies owed will eventually be collected. Indeed, recent research has found that billions of pounds are unnecessarily tied up in the working capital of both big and small companies due to the withholding of payments.

Firms cannot ignore the detrimental impact that withholding payment can have across the supply chain and throughout the wider economy. Consider the situation: a major contractor withholds payment to its cement supplier, who in turn has to delay payment to its machinery supplier, who is then left struggling to pay its parts supplier, and so on. At the end of the day, if smaller suppliers at the bottom of the chain go out of business, construction can grind to a halt as the supply of raw materials and labour dries up.

These are only short-term solutions to renewing cash flow, and it’s accounts receivables where the greatest untapped opportunity for innovation in sustainably optimising working capital lies.

Accounts receivable is often the largest entry on a balance sheet but has traditionally been approached as more of an administrative concern. Unlocking the value of this entry can directly improve a construction firm’s profitability by reducing the financial risks posed by write-offs and late payment, and at the same time enhancing the relationship with the customer; at the heart of which are the credit, collections and complaints functions.

A wholesale rethink across these processes is required if firms are to handle working capital with a much more strategic and customer-centric approach to credit, collections and complaints. When done successfully, firms not only keep cash flowing through the business, but can free-up funds to build for future growth.

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A transparent and customer-centric strategy

So what does a customer-centric and strategic approach to credit, collections and complaints management entail exactly? First, it is about recognising how accounts receivable management operates at the very heart of the supplier-customer interface. By understanding and analysing customer behavioral information using qualitative analysis,detailed reporting and KPIs, it is possible to segment the customer base and apply appropriate action profiles to minimise payment times. This reduces DSO (days sales outstanding) and allows firms to identify and target the weakest customers to enable informed decisions on the terms and conditions to be applied to future transactions.

Second, the ability to segment customers also allows firms to define a tailored collections strategy per group to reduce risk and improve customer relationships. Collection terms should be discussed and agreed from the very outset of a relationship and then applied consistently throughout. A disciplined and structured approach to collections again reduces DSO and improves cash flow, whilst nurturing a much closer customer relationship. Naturally, this also provides more scope for flexibility in the collections process if required.

Lastly, by combining multiple sources of external and internal credit information, it is possible to predict the bad debtor of tomorrow. Every customer should be evaluated regularly for risk and analysis of their payment history and behavior provides the key risk indicators. For example, if every complaint raised by a customer is spurious, this is a sure sign that something is wrong. Using historical data to analyse root causes for complaints allows a firm to both identify and counter illegitimate complaints at an earlier stage. More importantly, it allows a firm to modify internal processes and procedures. Long-term structured complaint analysis leads to improvements in logistics, services, and administrative processes. The result is fewer complaints, improved payment times and reduced write-offs.

A transparent and customer-centric strategy

For many businesses, credit, complaints and collections management are still functions considered to be outside the focus of senior management. But at a time whenthere is much greater scrutiny of a firm’s accounts receivable and its true value in respect of how much is actually tied up in high-risk customers,a good credit, collections and complaints policy is no longer a luxury and is certainly not a burden for companies looking to reduce the cost of their working capital. It is a valuable aspect of doing business that provides tangible financial and operational benefits.

It means that supplying the customer no longer ends when the product or service has been delivered. A customer-intimate credit, collections and complaints manager not only clears the path to payment and improves accounts receivables, but can form the strongest of bonds by understanding and analysing customer behavioral information to ensure the relationship is sustained.This ensures that all business functions can apply a consistent approach to managing the customer relationship with the ability to identify early on exactly why payments are being delayed, and allow an informed and timely response in accordance with the customer’s profile.

Maintaining a 360-degree view of customer relationships and elevating accounts receivable to a strategic level ensures transparency throughout the company – from the collections department, all the way to the CFO and MD. If construction firms can optimise working capital in this way, they give themselves the best possible chance to achieve sustainable growth and build towards long-term success.

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