Dutch manufacturers improve cash conversion cycle and inventory management

New analysis from Dutch supply chain firm M3 Consultancy finds that, on average, manufacturing firms in the Netherlands have improved their cash conversion cycle in the past year. Yet the gap between the best and worst performing companies has increased as organisations continue to explore alternative methods to reduce working capital.

Supply chain optimisation is at the core of organisational strategies to reduce working capital. Lowering inventories is a critical part of this puzzle and one which manufacturing companies are continually striving to improve. Another vital component is effective oversight of the finance and procurement departments, overseeing processes such as purchase to pay and metrics including days payable outstanding (DPO), among others.

The analysis finds that firms in the Netherlands have successfully improved their inventory management in the past 12 months. This appears, however, to have come at the expense of a smooth financial operation. The consulting firm – which offers services across the full spectrum of supply chains and operations – assessed the working capital performance of over 150 Netherlands-based manufacturing firms in producing its latest report.

The key takeaway from their findings is that the average manufacturer has reduced its all-important cash conversion cycle (CCC) from 68 days recorded in last year’s report, to 57 days this year. A substantial minority had a negative CCC – considered optimal to maintain a healthy bank balance while acquiring new inventory. Yet some of the worst offenders had a CCC approaching or even exceeding 200 days.

The variation is so great that, despite the average CCC falling, the gap between the most and least effective companies has increased. The first quartile of firms manage a CCC that is on average 139 days faster than the fourth quartile. In last year’s analysis published by M3 Consultancy the gap was slightly smaller at 135 additional days of working capital.

Digging deeper into M3’s analysis reveals that, of the 139 days separating Q1 from Q4, 32 days were stuck in payables (DPO), 73 in inventories (DIO), and 34 in receivables (DSO). In last year’s report DPO and DSO accounted for 24 and 27 days respectively, while inventory took up 84 days. Firms have therefore reduced the time their CCC spends wrapped up in inventories but their time management of payables and receivables has gotten worse. In other words, while supply chain has managed to improve its grip on excess inefficiencies, finance and procurement are struggling to realise improvement potential.

The trouble with inventories

Despite the improvement in inventory management, it is clear that this area remains the main area where value can be identified and unlocked. Practice shows however that this essential part of the supply chain remains a major obstacle for manufacturers as they struggle to systematically reduce their CCC to a negative value, or even to within the timeframe of one or two months. This isn’t a mystery but is instead a common organisational challenge, concludes the M3 Consultancy analysis, which explains why lowering inventories in production industries is hard – and keeping them low even harder.

Chief among them is the fact that raw material and WIP levels are typically born of manufacturing processes which seek to optimise KPIs without considering the amount of inventory created. Similarly, capital targets are not always understood throughout the business, with some departments taking a narrower view of what constitutes success than is needed at management level.

Further along the value chain, because service and finished goods inventory are interconnected, any artificial lowering can pile pressure on customer service levels. It is also true that some customers and suppliers succeed in using the balance sheet of companies to 'store' their products.

Then there is the issue of global sourcing, which trades lower prices for longer material chains with more material in transit and generally fails to take into account the impact on working capital.

Finally, management of inventory levels is often impeded by a short term focus, in which case lowering can do more harm than good – “selling inventory today could lead to service problems and manufacturing complexity that end up driving levels even higher”, M3 Consultancy concludes.