Active working capital management secures liquidity through the effective use of available funds and offers great opportunities to increase existing values. A three-part blog series shows how a company's capital commitment and cash conversion cycle can be determined and which measures can be taken to affect these positively.
Part 3/3: Active inventory management to control capital lockup
In first part of the series the net working capital and the cash conversion cycle have been examined in more details.
The second part of the series focused on the management of receivables and payables.
The key facts of part 1 and 2 summarized:
- The net working capital provides information about the short-term capital commitment of a company.
- "Cash Conversion Cycle" (CCC) represents the average number of days it takes the company to convert capital outflows for purchasing stock items into capital inflows from trade accounts receivable.
- Liquidity can be positively influenced by active management of receivables and payables.
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The Days Inventory Held (DIH) key figure can be used to analyze the capital tied up in inventories
DIH indicates the average number of days that pass between the receipt and issue of inventories. The smaller the DIH, the less capital is tied up in a company's inventories. Low DIH can be an indicator that inventory is managed more efficiently and that there is a correspondingly low storage duration. However, in periods of high demand, a too low inventory level may risk that customers cannot be served, which is why inventory management must also take into account a sufficient buffer for possible additional orders. Inventory levels cannot be considered in isolation, but in the context of the business model or industry, as different business models require different inventory levels. Reasons for a high inventory level can be a consequence of an usually advantageous bulk purchasing as well as ensuring the availability of raw materials.
Inventory reduction helps to decrease the amount of capital tied up
Measures that can reduce inventories and positively influence liquidity are:
- Analyzing and reducing inventories: Analyzing inventories, taking into account internal production and logistics processes as well as industry and seasonal peculiarities, provides clarity on the level of inventory required.
- Setting up direct inventory planning: Inventory planning can be set up on the basis of an analysis of warehouse lead times, inventory turnover rates and order lead times. Based on planned orders, times and quantities for required stock orders can be determined.
- Optimization of purchasing processes and production processes: Adjusting ordering processes to production can lead to more efficient inventory management in the long term. In addition, optimizing production and logistics processes can reduce lead times and thus reduce excess inventory.
By shortening the capital commitment period, liquidity can be released in the company. Active inventory planning close to actual needs can help to keep the proportion of tied-up capital low in the long term. At the same time, smooth purchasing and production processes support an improvement in storage times.
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