This article is based on a presentation given by Liudmila Gudina, Global Working Capital Manager at Fagron, at our FP&A Summit, London in 2024. Catch up on this presentation, and others, using our OnDemand service. And for more exclusive content, check out your membership dashboard.

Working capital is often the last thing on the agenda in leadership meetings. After discussing profit and sales, everyone is drained, and few want to dive into the operational details of working capital.

However, it's the only tool businesses can use to generate cash effectively. With rising interest rates and increasing borrowing costs, mastering working capital is more critical than ever.

Understanding the complexity of working capital

The pharmaceutical industry offers a perfect case study for the challenges of managing working capital. With operations across North America, Latin America, and EMEA, balancing cash flow, product availability, and payment terms is an ongoing struggle.

1. Product availability vs. cash flow

High product availability is crucial, especially when patient trends are unpredictable. The COVID-19 pandemic highlighted this volatility and companies were left with millions in unsold stock as demand suddenly shifted.

Some diseases can be forecasted, but others emerge unpredictably, making inventory management a complex challenge.

2. Diverse payment terms

Hospitals, particularly public ones, have their own payment schedules that companies can't control. Small pharmacies also follow unpredictable payment cycles, adding another layer of complexity.

Regional differences impact how companies negotiate payment terms with suppliers, often limiting opportunities for optimization.

The role of working capital in generating cash

Once operating profit is accounted for, companies have capital expenditures (CapEx) and taxes to consider. Beyond that, investors focus on cash generation.

Given that interest rates are rising and will likely never return to zero, borrowing costs continue to increase. Unlike operating costs, borrowing costs grow exponentially with scale. Managing working capital efficiently is the best way to mitigate these financial pressures.

How to use Grok 3 in finance and FP&A
Elon Musk’s artificial intelligence venture, xAI, has unveiled its latest AI model, Grok 3, calling it “scary smart.” Let’s see if it’s got what it takes to assist you in financial planning, analysis, and beyond.
Finance AllianceSabrinthia Donnelly

How to optimize working capital

Each region, industry, and company has its own challenges, requiring tailored solutions. Here’s how companies can better manage working capital:

1. Data-driven budgeting and forecasting

  • Exclude one-off events when budgeting and forecasting. Many companies mistakenly include extraordinary expenses or revenues from past years, distorting their financial outlook.
  • Ensure clean and accurate databases before investing in external solutions. If you hire someone to optimize your working capital, you need to ensure they have accurate payment terms and transaction records.
  • Set clear assumptions based on top suppliers and procurement data rather than generic percentages. Using general reductions in overdue payments as a target is meaningless without identifying the underlying operational factors driving these figures.

2. Shifting focus from KPI reporting to actionable insights

  • Traditional KPIs like DSO, DPO, and DIO are reporting metrics, not drivers. If you rely on 12-month averages, you miss real-time decision-making opportunities.
  • Instead, align calculations with operational cycles. For example, if your pharmacy clients pay within 30 days, analyzing trade receivables against two months of sales is more insightful than relying on a rolling annual metric.
  • Always analyze in ratios, not just in values. Inflation, industry shifts, and volume changes make value-based analysis misleading. You need to compare percentage changes over time to gain real insights.

3. Incentive programs for collections and procurement

  • Incentives improve collections efficiency, but if budgets are tight, a strong scorecard system can serve as an alternative.
  • Scorecards should measure both process efficiency and results, weighted across different regions. Don't just track end results—monitoring improvement steps provides a clearer picture of effectiveness.
  • Procurement savings should align with payment term strategies; otherwise, companies may optimize one at the expense of the other. If procurement teams are incentivized to focus only on cost reductions, they may ignore opportunities to extend payment terms, hurting overall cash flow.
  • There is often a contradiction between procurement savings and working capital improvements. If a procurement team negotiates cost reductions at the expense of longer payment terms, the benefit can be lost. These two aspects must be separated in negotiations.
Cost-benefit analysis: 5 steps to turn data into smarter choices
If you want to learn more about what cost-benefit analysis is and how to do it, keep reading as we dive into five key steps to streamline your financial evaluations and drive smarter decisions. 🧠
Finance AllianceSabrinthia Donnelly

Speaking the right language

One of the biggest mistakes finance professionals make is discussing financial KPIs with operational teams. They simply don’t resonate. Instead:

  • Procurement: Talk about weighted average payment terms.
  • Commercial teams: Focus on contract terms.
  • Supply chain: Discuss days of coverage, safety stock, and forecast accuracy.

If you increase payment terms from 30 days to 60 days, you must give something back—like ensuring on-time payments. Similarly, you need substitute suppliers in place to handle any disruptions.

Improving demand planning for better inventory management

Rather than looking at overall forecast accuracy, focus on high-margin, high-cost items. These have the most significant impact on working capital. Companies often get stuck in outdated inventory management practices, failing to revise ABC categorization over time. The result? Expired stock and unnecessary write-offs.

  • Avoid focusing on total forecast accuracy, as it does not reflect financial impact. Instead, prioritize high-margin, high-cost items that drive the biggest inventory costs.
  • Review ABC categorization annually—items that were once categorized as low-priority (C items) may have shifted, leading to unnoticed write-offs and expirations.
  • Recognize that an outdated ABC model may not reflect operational realities. By revising categories dynamically, businesses can optimize inventory levels without overcommitting resources to slow-moving stock.

The bottom line

Working capital is not just an operational metric—it is a strategic tool for cash generation. If you aspire to leadership roles in FP&A or beyond, understanding and optimizing working capital is essential. It requires a tailored approach, cross-functional collaboration, and a shift from traditional KPI reporting to actionable business strategies.

By integrating working capital into budgeting, forecasting, and operational decision-making, businesses can improve cash flow, reduce financial risk, and ultimately drive sustainable growth.

Action points

  • Analyze the database to exclude one-off events and focus on operational drivers.
  • Link receivables and payables metrics to the operational cycle, not just 12-month averages.
  • Implement incentive programs or scorecards for collections, focused on process improvements, not just results.
  • Align procurement savings targets with payment term negotiations to avoid conflicts.
  • Discuss working capital initiatives with operational teams in their own language, focusing on their key metrics (e.g., weighted average payment terms, forecast accuracy).
  • Prioritize inventory management based on cost and margin impact, not just ABC classification.