Working Capital Mistakes Every Manufacturing SME should avoid !!
“Working Capital is the Lifeline of every Manufacturing business!”
- What does your company’s financial health look like on the Working Capital Barometer?
- Is it adequate, healthy or are you struggling with it?
- Do you have enough funds to manage daily and operating expenses?
Now, let us run a quick reality check.
Have you observed any of the following trends or patterns in your company?
- Plant Managers purchase excess materials to be on the safer side and avoid stock-outs
- A high amount of scrap is generated resulting in significant wastage during Production
- Producing larger quantities than sales forecast ending with excess finished goods
- Facing difficulty in making timely payment of wages, loan EMIs, supplier payments
If you answered YES, to any or all of the questions above, then it is pretty much likely that you will face challenges of :
- Cash flow – Liquid Cash not available to make timely payments.
- Inadequate Working Capital – struggling to have sufficient working capital.
Why does this happen? Working Capital does not get due attention & importance!
As a company involved in providing value & enabling the growth of Manufacturing SMEs for over a decade, we have observed that companies are so focused on the day to day operations, that they do not give the due importance to the Working Capital Management, even though it is an important aspect to ensure smooth functioning of the organization. It is only when problems start creeping up in daily operations that companies examine the Working Capital closely.
Let me share an interesting working capital anecdote with you.
Although the business and revenues were stable, this particular manufacturing company was facing challenges managing their day to day operational expenses.
A detailed analysis of business data revealed that their working capital was reducing month over month. A flaw in the inventory control practices had resulted in an accumulation of 40% excess inventory compared to the requirements. This was eating into their working capital.
Did You Know? If you carry out a detailed Working Capital Analysis; You can UNLOCK valuable funds; locked in the working capital!!
This article aims to make Manufacturing SMEs aware of the common Working Capital Mistakes and to provide them strategies and tips on how to avoid these mistakes.
Working Capital Mistakes Manufacturing SMEs should avoid!
Managing the company’s working capital efficiency is a crucial task, at the same time, it is certainly not an easy task. It involves closely monitoring the primary functions such as procurement, inventory, production, payables, receivables, & more. Let us now look at the common mistakes in working capital management.
1. A flaw in Inventory Control Practices
When a company does not follow standard Material Requirement Planning procedures and Inventory control practices, it is likely to end up with excess purchase of raw materials & consumables, or other inventory items.
One common mistake is Companies tend to add an extra margin of safety at the procurement stage. This results in surplus raw materials & consumables. Sometimes, production is more than the sales forecast resulting in excess finished goods stock. There are instances when finishes goods are ready, but they are not dispatched timely. At times, inventory losses occur due to pilferage, expiry, etc.
All these results in valuable funds locked in inventory and affects working capital adversely.
2. Inaccurate Production Planning / Delays in Production
Production plans are dependent on Sales forecasting & sales orders in hand. Based on Production Planning companies will procure materials for production & carry out production as per plant capacity and draw schedules for timely delivery of finished goods.
Inaccurate or Inadequate production planning impacts the Production process adversely, It increases the Work in progress inventory and causes delays in production.
Wrong sales forecasting or Incorrect MRP may result in excess inventory or stock out situations.
Make sure you review the correctness of your Production planning process periodically to avoid over-production as well as underutilization of capacity. Overproduction can result in funds being locked in finished goods, if not promptly delivered to end customers. Similarly, underutilization of capacity is a loss of crucial resources
There are other reasons which can cause delays in production processes such as:
- Incorrect routing – results in delays in the production process, longer production time, longer time to market. All these will lock in funds in the production process.
- Improper Maintenance – If companies do not pay due importance to proper upkeep of their plant, machinery & equipment, it will impact the production negatively
Thus, we observe that any error in production planning, forecasting, or delays in production or delivery, may result in precious funds getting locked at various stages in the production process.
3. Resources Wastage & Rework
Some amount of waste is unavoidable in the manufacturing process. However, companies that fail to keep a stringent watch on the quality standards and amount of wastage in material, manpower, energy, time will end up overspending & face a shortage in working capital. Let us see some common examples:
- Scrap generated during production – suppose 20% raw materials get wasted, then company ends up spending 20% more for procuring materials
- Defective finished goods – If quality standards are not maintained properly, it may result in defective goods that may be rejected or require rework.
- Rework – any rework means companies will end up spending excess amounts on materials, labor, transportation, etc; which can be avoided.
- Idle time – sometimes, stock out or lack of availability of material may result in wastage of time, loss of productivity.
Any waste or rework means spending surplus amount to carry out the same tasks. This will diminish the working capital.
4. Lack of Budget Control & Planned Spending
Companies that do not define specific budgets for each department, or cost center and do not specify spending limits, as well as policies for approvals of expenses, are likely to end up spending on unplanned expenses as well as overspending.
5. Payable & Receivable Management
Companies sometimes offer extended periods of credit to acquire new customers or just to maintain cordial relations. However, this will eventually impact cash flow & result in inadequate working capital.
Companies that are unable to gather their accounts receivables timely, for any reason, are likely to face cash flow issues & this will impact working capital negatively. If this continues to happens consistently, it may even lead to the need for borrowing funds for short terms to ensure daily functioning.
6. Lack of planning for short term liabilities or contingencies
Companies that do not take into account short term liabilities such as Taxes, Statutory Requirements, Loan EMIs will have a shortfall in their cash flow and working capital. Similarly, if companies do not set aside a short term fund for contingencies, they will have a tough time surviving any sort of emergencies.
Why should companies ensure adequate Working Capital?
Adequate working capital is required by manufacturing companies to :
- Procure materials & services at right time & right prices
- Ensure a smooth flow of Production
- Reduce operations cycle timelines
- Disburse wages and salaries timely and regularly
- Pay suppliers, vendors to avail prompt payment discounts
- Build a good reputation for the company.
- Achieve a good credit-score to prepare for future finance requirements
- Create a sense of assurance of being able to handle unforeseen emergencies
How does ERP Software help manufacturing SMEs ensure a healthy Working Capital?
Companies should leverage ERP software to digitize, automate, and speed up business processes, increase productivity & efficiency.
Let us now see specific examples of how ERP software can help avoid working capital mistakes
1. Implementing Budgets & Control
With ERP software you can:
- Clearly define budgets for each function & unit.
- Enforce upper ceilings & restrictions on expenses
- Set up policies for approval or rejection of expenses.
- Set up alerts/notifications via SMS, Email alerts for managing by exception
- Track actual v/s budgeted spend and analysis.
2. Payable & Receivable Management
ERP software offers efficient & effective ways to manage accounts payable and accounts receivable of an organization.
- ERP helps implement “Dunning process” to send automated reminders, emails/ SMS to customers for payments due. Thus, helps faster processing of amounts receivable.
- The accounts payable module sets up notifications and alerts via email/SMS to enable making timely payments to suppliers for improving relations & building a good reputation and also to avoid any penalties, surcharge, etc.
When you can balance the account payables & account receivables properly you will have healthy working capital
3. Credit Controls
ERP software helps establish Credit control policy guidelines for the organization. With the help of ERP you can clearly define how much credit to extend, to whom, and for how many days.
Based on this, ERP sends reminders, notifications, and alerts when credit limits are likely to be reached. This helps to avoid the risk of providing excess credit.
4. Inventory Control
ERP software enables manufacturing companies to manage inventory requirements by using various inventory control & analysis methods. ERP enables real-time tracking of inventory across multiple locations. This enables us to define reorder points & create notifications, alerts whenever inventory falls below certain levels. When companies hold optimum inventory and avoid overstocking, it ensures a healthy working capital.
5. Expenses / Costing Analysis
ERP software provides real-time, detailed reports of costs such as cost of production, cost of overheads, departmental expenses & more. An analysis of all these reports will help carry out a root cause analysis to identify areas of excess spending & take corrective measures
6. Find Cost-Effective / Alternative Methods / Items
Implementing ERP software saves significant time for Employees which was earlier spent on manual & paperwork. Employees can, therefore, focus their energies on more significant & value addition work such as
- Build relationships with suppliers for insights of alternate raw materials, consumables
- Identify alternate cost-effective materials without compromising quality
All these directly contribute to improving the working capital of the company.
Working Capital is essential for the steady functioning of an organization. Maintain a healthy working capital to scale & grow your manufacturing company. Leverage Technology to support and strengthen your processes to ensure a healthy working capital.