Abstract
If you need to release cash, particularly during a recession period or when sales are falling, you should look to your working capital. Optimization of your working capital will improve efficiency, liquidity and potentially investor ratios like the dividend yield, if the dividend payment can still be maintained.
One of the blockers or reasons not to reduce working capital is the potential effect on customer service levels. Any deterioration of customer service could jeopardize the initiative straightaway, have long-term consequences on revenue due to lost sales, and lead to counterproductive results such as overstock.
For this reason, any inventory and receivables optimization need to go hand in hand with optimal service level targets. Service level in this context means the probability that all customer orders arriving within a given time interval will be completely delivered from stock on hand, that is, without delay.
Often influenced by the sales department, too many companies pursue the same service level target for all their clients. Not only is this unrealistic, it is dangerous, for three different reasons. On a cost basis, margin can deteriorate due to a wide product portfolio, rush orders and express shipments offered to unprofitable and low profitability clients. On a cash basis, a high service level for all clients requires a correspondingly high inventory level of finished goods and components, with cash tied up unnecessarily and a high obsolescence risk. Finally, on a service level basis, there is a risk that low-profit customers will get a higher service than the profitable ones.
