Proactive working capital management is essential to successful business operations. However, on average, businesses aren’t managing their working capital as efficiently as they have in the past, according to a new study by The Hackett Group, a digital transformation and AI strategy consulting firm.
The study found that all elements of the cash conversion cycle (CCC) deteriorated by an average of 1.3 days (or 4%) from 2022 to 2023. The sectors reporting the biggest CCC deterioration include marine shipping, biotechnology, oil and gas, and food and staples retail. Here’s why working capital management is so important, and how your business can avoid the trend revealed in the study.

Why working capital matters

Working capital equals the difference between current assets and current liabilities. Organizations need a certain amount of working capital to run their operations smoothly. However, excessive amounts can hinder growth and performance. The optimal amount of working capital depends on the nature of your company’s operations and its industry.

Working capital management is often evaluated by measuring the CCC, which is a function of three turnover ratios:
1. Days in accounts receivable outstanding,
2. Days in inventory outstanding, and
3. Days in accounts payable outstanding.

A positive CCC indicates the number of days a company must borrow or tie up capital while awaiting payments from customers. A negative CCC represents the number of days a company has received cash from customers before it must pay its suppliers. Cash businesses might have a low or negative CCC, while most conventional businesses have a positive CCC.

Ways to shorten your CCC

Here are three ways to reduce the amount your business has tied up in working capital:
1. Collect receivables faster. Possible solutions for converting accounts receivable into cash faster include: tightening credit policies, offering early bird discounts, issuing collection-based sales compensation and using in-house collection personnel. Companies also can evaluate administrative processes — including invoice preparation, dispute resolution and deposits — to eliminate inefficiencies in the collection cycle.

2. Reduce inventory levels. The inventory account carries many hidden costs, including storage, obsolescence, insurance and security. Consider using computerized inventory systems to help predict demand, enable data sharing up and down the supply chain, and more quickly reveal variability from theft.
It’s important to note that, in an inflationary economy, rising product and raw material prices may bloat inventory balances. Plus, higher labor and energy costs can affect the value of work-in-progress and finished goods inventories for companies that build or manufacture goods for sale. So rising inventory might not necessarily equate to having more units on hand.

3. Postpone payables. By deferring vendor payments when possible, your company can increase cash on hand. But be careful: Delaying payments for too long can compromise a company’s credit standing or result in forgone early bird discounts. Many organizations have already pushed their suppliers to extend their payment terms, so there may be limits on using this strategy further.

Make working capital a priority

Some businesses are so focused on the income statement, including revenue and profits, that they lose sight of the strategic significance of the balance sheet — especially working capital accounts. We can benchmark your company’s CCC over time and against competitors. If necessary, we also can help implement strategies to improve your performance without exposing you to unnecessary risk.

Accurate financial statements are essential to making informed business decisions. So, managers and other stakeholders may express concern when a company restates its financial results. Before jumping to premature conclusions, however, it’s important to dig deeper to evaluate what happened.

Uptick in restatements 

In June 2024, the Center for Audit Quality (CAQ) reported a recent uptick in financial restatements by public companies. The report, “Financial Restatement Trends in the United States: 2013–2022,” delves into a ten-year study by research firm Audit Analytics. It found that the number of restatements in 2022 had increased by 11% from the previous year.

More alarming is a trend toward more “Big R” restatements. Big Rs indicate that the company’s previously filed financial reports were deemed unreliable by the company or its auditors. Although most restatements are due to minor technical issues, the proportion of total restatements that were Big Rs rose to 38% in 2022, up from 25% in 2021. The 2022 figure is also up from 28% in 2013 (the peak year for restatements in the study) — and it’s the third consecutive year that the proportion of Big Rs has increased.

However, the CAQ report states, “It is too early to tell if the increase in restatements toward the end of the sample period is a true inflection point or simply a brief disruption of the previous downward trend.” Overall, financial restatements have decreased from 858 in 2013 to 402 in 2022.

Reasons for restatement 

The Financial Accounting Standards Board defines a restatement as a revision of a previously issued financial statement to correct an error. Whether they’re publicly traded or privately held, businesses may reissue their financial statements for several “mundane” reasons. For instance, management might have misinterpreted the accounting standards, requiring the company’s external accountant to adjust the numbers. Or they simply may have made minor mistakes and need to correct them.

Common reasons for restatements include:

1. Recognition errors (for example, when accounting for leases or reporting compensation expense from backdated stock options),
2. Income statement and balance sheet misclassifications (for instance, a company may need to shift cash flows between investing, financing and operating on the statement of cash flows),
3. Mistakes reporting equity transactions (such as improper accounting for business combinations and convertible securities),
4. Valuation errors related to common stock issuances,
5. Preferred stock errors, and
6. The complex rules related to acquisitions, investments, revenue recognition, and tax accounting.

Often, restatements happen when the company’s financial statements are subjected to a higher level of scrutiny. For example, restatements may occur when a private company converts from compiled financial statements to audited financial statements or decides to file for an initial public offering. They also may be needed when the owner brings in additional internal (or external) accounting expertise, such as a new controller or audit firm.

Material restatements often go hand-in-hand with material weakness in internal controls over financial reporting. In rare cases, a financial restatement also can be a sign of incompetence — or even fraud. Such restatements may signal problems that require corrective actions. However, the CAQ report found that only 3% of all restatements and 7% of Big Rs involved fraud over the 10-year period.

We can help

The restatement process can be time-consuming and costly. Regular communication with interested parties — including lenders and shareholders — can help businesses overcome the negative stigma associated with restatements. Management also needs to reassure employees, customers and suppliers that the company is in sound financial shape to ensure their continued support.

Accounting and tax rules are continuously updated and revised. So, your in-house accounting team may need help understanding the evolving accounting and tax rules to minimize the risk of restatements, as well as help them effectively manage the restatement process. We can help you stay atop the latest rules, reinforce your internal controls, and issue reports that conform to current Generally Accepted Accounting Principles.