Working capital management: an urgent need to

refocus

Maynard E. Rafuse Managing Director, Bennecon Limited, Process Analysis and

Stock Management Consultants, London, UK

Argues that attempts to

improve working capital by
delaying payment to creditors
is counter-productive to
individuals and to the
economy as a whole. Claims
that altering debtor and
creditor levels for individual
tiers within a value system
will rarely produce any net
benefit. Proposes that stock
reduction generates systemwide financial improvements
and other important benefits.
Urges those organizations
seeking concentrated working
capital reduction strategies
to focus on stock management strategies based on
lean supply-chain techniques.

Creditor management is essentially a

Darwinian situation, the survival of the
fittest. Large companies enforce their terms
with smaller companies, who in turn enforce
their terms with those smaller yet.
The apparent intention of many UK
companies is to defer payment as long as
possible, often well beyond the agreed
arrangements. Most purchase agreements
will incorporate a single monthly payment,
normally end-month following, but often
into the second month following or later yet.
Actual payment frequently goes well beyond
the agreed terms.
This article proposes that improvement of
working capital by delaying payment to creditors is an inefficient and ultimately damaging practice, both to its practitioners and to
the economy as a whole. Stock reduction
strategies, drawing on some of the techniques
of lean production are far more effective,
and the article proposes that those seeking
concentrated working capital reduction
strategies should focus on stock reduction.
A report issued in 1994 by the Forum for
Private Business (FPB), a UK small-business
trade association, states that on average its
respondents debtor accounts were paid more
than 50 days beyond the agreed due date[1,2].
The absolute data are shown in Table I.
The report indicates that SMEs had average
gross debtors of at least 40 billion outstanding. This total was reduced by 20 billion
when the SMEs creditors were netted off,
leaving a net balance of 20 billion to fund.
This net balance was the amount owed to
SMEs by non-SMEs and, coincidentally,

Table I
Small and medium-sized enterprises debtor
levels ( billions)
Item

Management Decision
34/2 [1996] 5963
MCB University Press
[ISSN 0025-1747]

Grossa
debtors

Netb
debtors

Total
40
20
Overdue
20
10
Notes:
Small and medium-sized enterprises are taken as those
with less than 5 million turnover, VAT registered
aTotal debtors
bDebtors less creditors

equated almost exactly with the SMEs

overdue debtor level.
Netting overdue debtors and creditors
leaves a net SME overdue balance of 10 billion. Again, this is the overdue balance owed
to SMEs by non-SMEs, essentially by large
companies with more than 5 million turnover. (The netting process should eliminate
all intra-SME transactions.)
To summarize this rather convoluted set of
data, SMEs are effectively providing 20 billion of net funding to their larger customers.
Half of this arises from net late payment of
the SMEs debtor accounts. The small supplier often has little redress in this situation,
believing strenuous collection effort could
jeopardize his volume.
The total interest incurred by small businesses to fund 10 billion of late payments by
larger companies will be about 1.5-2.0 billion per annum. The SME cost to fund the
total net debtor balance of 20 billion will be
3-4 billion per annum. (These estimates are
based on average business cycle SME borrowing rates of 15-20 per cent.) These are very
large sums indeed. Most of this interest cost
will, of course, be offset by interest savings in
the larger companies, which is small consolation to the SMEs.
However, the annual system oncost would
be 300-500 million, based on a typical SME
financing penality of 3-5 per cent.
What system-wide financial or operating
benefits could conceivably arise from this
situation? Somehow smaller companies
must pass on their increased borrowing
(and administrative) costs, although they
frequently seem to perish in the attempt.
Working capital starvation is generally credited as a major cause if not the major cause
of small business failure in the UK.
However, these interest and administrative
penalties cannot usually be quantified precisely by the SMEs larger customers. They
are subsumed in the complex web of data
developed during price negotiations. As a
result, these oncosts can often be simply
ignored, apparently on the principle that if a
phenomenon is not readily apparent in the
numbers, it does not exist. However, it is
evident that there are significant penalties
arising from this situation. Ultimately these
penalties must enter the product cost stream.

[ 59 ]

Maynard Rafuse
Working capital management:
an urgent need to refocus
Management Decision
34/2 [1996] 5963

Very close supplier-customer partnerships

are an essential characteristic of modern
lean value systems. These systems, as so
much else, were developed by Toyota and
others in Japan over a period of 20-30 years.
They entail tightly controlled, preventionbased processes; no duplication of effort or
capability; shared continuous improvement;
and more technical (and more relevant)
aspects such as extensive data sharing, EDI,
paperless ordering and delivery systems,
automatic payment techniques, etc.[3-6].
There is now a large body of evidence to
demonstrate that lean production and distribution are systematically superior to traditional mass production in all essential
respects quality, cost and customer service
by an order of magnitude. The data in Table II
shows the level of performance advantage
achieved.
The lean approach has been adopted by
many of those companies which could be
characterized as world-class. Lamming[5]
and his colleagues argue persuasively that all
significant product value systems will ultimately adopt the lean approach, particularly
in respect of those technical transactional
elements most relevant here. A detailed
review of the operational characteristics of
lean world-class companies is beyond the
scope of this article. However, one key characteristic they exhibit is what might be termed
an enlightened approach to supplier
management.
As a simple example, a selection of worldclass UK companies would include such
names as Beecham, Glaxo and Welcome (as
was) in health care; Sainsbury and Tesco in
food retailing; and Boots, Great Universal
Stores and Marks & Spencer in general retailing. Recent creditor levels for this group of
companies were almost 30 per cent lower (in
terms of payment days outstanding) than for
comparable large firms in the health, food

Table II
World-class (WC) plants
Category
Productivity index
Defects index
Space index
Capacity utilization(%)
Stock index
Deliveries/day:
From suppliers
To customers

WC
plants

Non-WC
plants

100
1
100
94
100

45-68
16-170
108-220
84
150-290

1.4
2.7

Note: WC plants = 13; Non-WC plants = 58

Source:[6]
[ 60 ]

0.5
0.8

and retail sectors. Simultaneously the

operating margins of these eight world-class
companies ranged from 40 per cent to 150 per
cent above their sector comparators. For the
most part the companies designated as worldclass also had far lower stock levels, particularly Sainsbury, Tesco and Marks & Spencer.
These three companies are bywords for excellence in British retailing and also stand up
well in international comparisons.
It is of course unlikely that there is a direct
critical causal relationship between creditor
days and margins achieved. Both are outcomes of a wide range of operating factors.
However, the substantially lower level of creditors would appear to reflect a fundamental
difference of approach to supplier management within the world-class companies.
Wal-Mart, the US retail discounter, provides
another revealing example. Wal-Mart has
grown at an extraordinary pace over the past
15 years, to become the largest, most profitable retailer in the world[7,8]. In the process,
Wal-Mart has revolutionized operating practices in the US retail industry, a quite remarkable achievement. Very close, responsive
supplier relationships have been a key strategic element in this development. Wal-Mart
expects the highest standards of performance
from its suppliers. It provides excellent performance in return, for example better terms,
with the average time to pay suppliers just 29
days. This compares to 45 days for K Mart (i.e.
55 per cent higher). Back in 1979 K Mart was
much larger than Wal-Mart, with eight times
as many stores. Today it is a poor second in
every important respect (e.g. over 40 per cent
more stock).
Clearly there is much more to Wal-Marts
success than how quickly suppliers are paid.
Nevertheless, responsive supply partnerships, what has been termed shared destiny
procurement, is clearly a key element contributing to the success of Wal-Mart and the
best lean, world-class companies. Sainsbury,
Tesco and Marks & Spencer in the UK display
a similar pattern. In essence, suppliers must
be treated with the same care and consideration as employees. (No responsible manager
would dream of paying his staff 50 days late.)
However, shared destiny relationships
can quickly founder when a large company
embarks on a working capital programme.
Extending the supplier payment period is
always the easiest option. Outdated and
discredited adversarial attitudes soon
re-emerge. There is a good deal of evidence to
support the view that UK companies are particularly remiss in this area. For example, the
level of late payment in the UK is much
higher than elsewhere in the EEC, even compared with such supposedly poor performers
as Italy, Ireland or France[9] (see Table III).

Maynard Rafuse
Working capital management:
an urgent need to refocus

Table III
Late payment of business debts (average
number of days beyond agreed terms)

Management Decision
34/2 [1996] 5963

Country

1989

France
28
Germany
18
Italy
34
Ireland
34
Sweden
18
UK
51
Source: Dunn & Bradstreet data quoted in[2]

1994
24
19
37
34
18
49

Why should this be so? Why do UK managers

routinely ignore the terms of the bargains
they have struck with their suppliers?
Very similar arguments can be advanced in
the case of debtors, where aggressive collection action by large companies only succeeds
in transferring resources from their smaller
customers. No net system benefits whatsoever will arise from this process.

Possible solutions
Proposed solutions to the SMEs overdue
debtor problems often seem to be highly questionable. In particular, the statutory right to
interest on overdue accounts (as proposed
for example by the FPB and others) is clearly
not the answer. This is a lawyers solution.
Most small companies would hesitate to
invoke the right for fear of alienating their
customers[10]. In any case, suppliers do not
want interest, they want their money. They
want to be paid what is due to them, when it
is due and not have to waste a lot of time and
effort on collection. They certainly do not
want to have lawyers involved. This would
only serve to destroy any lingering shared
destiny relationship that might still exist.
A much better proposition has been put
forward by Professor Colin New of Cranfield
Universitys School of Management. His proposal is that buyers could only reclaim input
VAT on suppliers invoices which are paid
within a specified maximum period, say 30
days or end-month following. This
approach would quickly level the playing
field, concentrating large (and small) buyers
minds, eliminating much wasteful collection
effort. A cost penalty of 17.5 per cent would
change payment priorities very rapidly. The
proposition is, of course, entirely nondiscriminatory as between large and small
businesses.
By this one means the Government could
take a major constructive initiative on
behalf of SMEs, eliminating many of the
inequalities (not to say iniquities) inherent in

the relationships between large and small

companies which currently prevail. (However, one could no doubt anticipate strong
objections from many large companies.)
It has often been said that the UK suffers a
comparative lack of entrepreneurial smallbusiness people. The issues discussed earlier
must be contributing factors for many who
conclude that these sterile battles are simply
not worth the fighting. The simple proposition on VAT payment rules would change this
situation quickly and completely.

Administrative costs and value

added
It is clear that the bulk of the effort devoted to
managing debtors and creditors throughout
the economy is essentially wasted. These
administrative processes add no value. An
interfirm (that is, a transactional) process
needs to be examined in the same manner as
any other operating process and steps should
be taken to drive out the waste elements.
Operating parameters necessary to ensure a
no waste, right first time, process must be
established initially. Prevention-based controls are then implemented to maintain the
process within these limits. This systematic
approach to process management is not
essentially different from controlling an
operation in a factory.
Greatly improved transactional systems
have been achieved in a number of cases, for
example with auto industry suppliers in
Japan, the USA and the UK. Many of these
buyer-seller relationships will involve:
long-term supply contracts;
regular, small volume call-offs and deliveries, based on EDI and minimized order
instability;
incoming inspection eliminated at buyer
plants, based on strict process control at
vendor plants;
similarly, duplicated clerical routines eliminated at buyer plants, such as part counts,
receiving slips, invoice matching, price
checking, etc;
electronic data entry, using barcodes,
electronic Kanban, etc., based on shipping
plant inputs;
vendor billing using EDI links;
programmed supplier payments at set,
short intervals from delivery (e.g. four
weeks maximum) using digital transmission arrangements;
requisite process controls on the administrative elements.
Several of the major UK retailers have made
significant progress along these lines. There
are also a number of programmes in North

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Maynard Rafuse
Working capital management:
an urgent need to refocus
Management Decision
34/2 [1996] 5963

America to reduce transaction and replenishment costs in the retail industry. These socalled quick response (QR) or efficient consumer response programmes are essentially
designed to improve lead-times and customer
service, while substantially reducing stocks
and transaction costs. They frequently
involve direct supplier access to daily retail
sales and stock data, coupled to automatic
replenishment arrangements. Ambitious
targets have been established to drive excess
cost out of distribution systems. Apart from
the immediate profit potential, it is important
to improve the cost position of conventional
retailing systems in the face of growing competition from electronic shopping media[1115].
The potential reduction in the traditional
cost of debtor and creditor management, at
both ends of the supply chain, is apparent.
Ultimately it should cost companies little
more to manage supplier payments and
customer receipts than it does to manage
employee payments. The key requirements
are to eliminate unneeded or duplicated
process steps and to ensure fully digitized
processing is implemented at all stages in the
transaction systems. Forward-looking
finance managers will be well advanced along
this path.

Stock management
None of the serious deficiencies associated
with creditor and debtor management applies
to stock reduction. This is a wholly beneficial
process, if managed properly. Most stock is
simply physical evidence of wasted time and
wasted resources throughout a value system
over 80 per cent of the stock in
most systems[16,17].
Reducing stock produces major financial
benefits by simultaneously improving cash
flow, reducing operating cost levels, lowering
the asset base and reducing capital (capacity)
spending. No other single management action
can generate such a high degree of financial
leverage. These savings are not trade-offs.
They arise from genuine waste reduction, not
simply transfers from one company to
another. Of perhaps even greater importance,
process quality and customer service are
greatly enhanced as waste stock (that is,
excess lead-time) is driven out of value systems. The truth of these statements is apparent from Table II. This demonstrates that
lean world-class companies are systematically better than their comparators in every
important respect and the characteristic
which makes a company lean is low stock
levels.

[ 62 ]

Reducing stock is not as simple or readily

understandable as increasing creditors or
reducing debtors. As a result it can be bypassed by those looking for quick, seemingly
easy solutions[18]. However, the benefits of
stock reduction are real and substantial and
not simply a result of shuffling resources
around a value system. Stock reduction is
where working capital management attention
should be concentrated, particularly by
senior finance personnel in large companies.
In our experience a good proportion of
these finance managers will take the view
that these arguments are good in theory, but
not in the real world. In the event, when cash
flow pressures arise, suppliers (and even
customers) are invariably the first to feel the
draught. Apart from being ethically questionable, this reflects dangerous short-termism.
Sustaining such attitudes will surely serve
only to undermine the position of financial
managers in the longer term. Ultimately most
of the wasteful activity now found in transaction processes will be eliminated. That is the
way capitalism works. The thoughtful manager will be pursuing these important opportunities today.

Notes and references

1 Statistics are taken from the paper published
by the FPB[2], a small-business lobbying
organization, based on a survey of 18,000 VAT
registered small companies with less than 5
million turnover. The data from the detailed
survey were tested and analysed by the University of Nottinghams Economics Department to
produce the summary report. The output is
considered to be sound and, if anything, underestimates the scale of the problem, as not all
small businesses were covered. It essentially
corroborates earlier studies in this area.
2 Report on Small Firms & Late Payments,
Forum for Private Business, Cheshire,
31 March 1994.
3 For further discussion of lean systems
see [4-6]. These essential documents originate
from the International Motor Vehicle
Programme, co-ordinated by MIT during
1985-1990, with substantial UK input.
4 Womack, J.P., Jones, D.T. and Roos, D., The
Machine that Changed the World, Rawson
Associates, New York, NY, 1990.
5 Lamming, R., Developing lean supply
chains, paper presented to the British
Production & Inventory Control Society Conference, October 1994.
6 The Second Lean Enterprise Report, Andersen
Consulting, Cardiff Business School and University of Cambridge, December 1994.
7 See[8]. This important article provides,
inter alia, a potted history and analysis of
Wal-Marts rapid and sustained progress.

Maynard Rafuse
Working capital management:
an urgent need to refocus
Management Decision
34/2 [1996] 5963

8 Stalk, G., Evan, P. and Schulman, L.E., Competing on capabilities: The new rules of corporate strategy, Harvard Business Review,
Vol. 70 No. 2, March-April 1992, pp. 57-69.
9 The data in Table III corroborate our own
experience in several European and North
American markets.
10 Even today supplier terms frequently incorporate an interest on overdue accounts
clause. These are rarely implemented, being
either overridden by the buyers terms, or
simply ignored by one or other of the parties.
11 For further discussion of these issues see [12].
This describes Heinzs ECR programme in
North America. Alternatively see [13] for a
description of VF Corporations QR programme in the US jeans market. There are
many other descriptions of QR and ECR programmes. For an interesting description of a
UK world-class performer see [14, p. 15]. New
technology links have been made between
suppliers and the Companys distribution
network, to create supply chains that are
among the most responsive and shortest[sic.]
of any retailer in the world. Our analyses
confirm that this is no idle boast.
Also see[15]. This, despite its title, is an
interesting evaluation of rapidly developing
electronic competition in retail markets.

12 Perry, D. and Palmatier, G.E., The role of

S&OP and demand management in EDI and
ECR, 1994 Conference Proceedings of the American Production & Inventory Control Society,
pp. 462-7.
13 Weber, J., Just get it to the stores on time,
Business Week, 6 March 1995.
14 Marks & Spencer, 1994 Annual Report, Marks &
Spencer, London, 23 May 1994.
15 Benjamin, R. and Wigand, R., Electronic
markets and virtual value chains on the
information superhighway, Sloan Management Review, Winter 1995, pp. 67-72.
16 For further discussion of these issues see[17].
17 Rafuse, M.E., Value added mapping tools for
managing system stock, waste and cycle time,
British Production & Inventory Control Society
Conference Proceedings, May 1995, pp. 117-28.
18 While many large companies have improved
their working capital levels, there appears to
be little evidence of any widespread and significant reduction in stocks, despite a great deal
of attention to this subject. A survey we made
of some 50 large UK companies showed stock
levels (in terms of days supply) had not
changed to a statistically significant degree in
the five years to 1993. Virtually all the
improvement in working capital thus arose
from changes in debtor and creditor levels.

Application questions
1 Have we planned to implement low waste,
integrated, digital transaction processes
with suppliers and customers?
2 Have we established shared destiny relationships with suppliers? Are these supported throughout the company?

3 Do we comply with the spirit and in the

letter of the agreements we have reached
with our suppliers?
4 Are our debtor management policies consistent with our broader goals of partnership with our customers?

[ 63 ]