One key metric that provides valuable insights into a company’s financial efficiency is Return on Working Capital (AM.1.3). This metric evaluates how well a company is using its working capital to generate revenue through its supply chain operations, offering a clear picture of the investment’s effectiveness.
What is Return on Working Capital?
Return on Working Capital (RoWC) measures the return generated from a company’s working capital, specifically within the context of its supply chain. It assesses the magnitude of investment relative to the company’s working capital position versus the revenue generated. This metric is crucial because it highlights how effectively the supply chain contributes to the overall financial health of the business.
The calculation for RoWC is as follows:
Return on Working Capital = (Supply Chain Revenue – Total Supply Chain Management Cost) / (Inventory + Accounts Receivable – Accounts Payable)
This formula allows businesses to determine how efficiently their supply chain is converting working capital into revenue, taking into account key financial components such as inventory, accounts receivable, and accounts payable.
note that supply chain revenue relates to revenues from sales derived from supply chain activities, proceeds from financial instruments, rent etc should be excluded.
Data Collection for RoWC
One of the advantages of calculating RoWC is that the necessary data is typically already captured within a company’s existing business systems. These include:
- General Ledger System
- Accounts Receivable System
- Accounts Payable System
- Purchasing System
- Production Reporting System
- Customer Relationship Management (CRM) System
The data from these systems is imported and transformed using business rules into the required analytics, enabling companies to monitor and manage their RoWC effectively.
Why is RoWC Important?
RoWC is a powerful metric because it provides a focused view of the financial returns generated specifically by the supply chain. Unlike broader revenue metrics, RoWC isolates the supply chain’s contribution to the company’s financial performance. This is crucial for businesses looking to optimize their operations and improve profitability.
For example, a high RoWC indicates that a company is effectively managing its inventory, accounts receivable, and accounts payable, leading to better cash flow and reduced costs. Conversely, a low RoWC may signal inefficiencies in the supply chain that need to be addressed, such as excessive inventory levels or poor receivables management.
Applications and Best Practices
Several best practices can help organizations improve their RoWC:
- Supply Chain Optimization (BP.024): This involves refining the entire supply chain to ensure that all processes are aligned with the company’s financial goals. This could include optimizing inventory levels, improving demand forecasting, and enhancing supplier relationships.
- Inventory Optimization (BP.028): By maintaining optimal inventory levels, companies can reduce the costs associated with holding and storing inventory, thereby improving their RoWC.
- Network Optimization (BP.029): This practice focuses on determining the best locations for manufacturing and warehousing to reduce transportation costs and improve delivery times, which can have a positive impact on RoWC.
- Batch-Size Reduction (BP.038): Reducing batch sizes can help companies become more agile, reduce lead times, and lower inventory costs, all of which contribute to a higher RoWC.
- Days of Supply-Based Material Requirements Planning (MRP) (BP.090): Implementing an MRP strategy based on days of supply can help companies manage their inventory more effectively, reducing excess stock and improving cash flow.
Conclusion
Return on Working Capital is a vital metric for any organization looking to optimize its supply chain performance. By understanding and managing the components that influence RoWC, such as inventory, accounts receivable, and accounts payable, companies can enhance their financial efficiency and drive better business outcomes. Implementing best practices like supply chain optimization and inventory management can further improve RoWC, ensuring that the supply chain contributes positively to the overall financial health of the business.
