How Working Capital Can Help Meet Customer Service Levels
Posted May 24th, 2021
A Service Level Agreement (SLA), the agreement between you and your customer on what each can and should expect from the other, is central to meeting customer demands and expectations, and working capital is essential to meeting the SLA parameters. Working capital represents the assets or cash flow available to make payroll, pay suppliers and cover other production expenses. While working capital has a tremendous impact on a manufacturer’s ability to meet a customer’s SLA, the two are rarely discussed in the same conversation. In part, these conversations are siloed by the two departments that manage them — finance or accounting and operations, respectively. When you bring them together, however, you can immediately see how working capital can help your manufacturing business meet your customers’ service levels.
The importance of a service level agreement
We live in an instant-gratification world, and this “I want it when I want it” mentality has already moved beyond same-day Amazon drops and into business relationships. Manufacturers need to ensure they can meet customer demands quickly, which also means their suppliers must be equipped to meet the manufacturers’ demand for raw materials.
A service level agreement ensures the manufacturer and the customer are on the same page. The SLA covers expectations regarding pricing, batch or order sizes, timelines, minimum quality standards, and more. A comprehensive SLA between your company and all of your customers allows you to determine the ready rate and safety stock needed to satisfy a customer order from stock on hand. If your company manufacturers custom products based on customer orders, an SLA helps determine the expected order cycle and the lead time you and your suppliers need to meet that cycle.
The importance of working capital management
Working capital is one of the biggest challenges manufacturers face, and recent escalating costs have only made it more critical. Manufacturers face cash flow challenges regularly as their industry’s business model is built upon supplier and production expenses being accrued well in advance of goods being sold to customers. Additionally, many customers have extended payment terms — or simply don’t pay on time — compounding the issue for manufacturers.
When your current assets minus current expenses equals a negative number, you have negative working capital. Negative capital is one step away from cash flow problems, and cash flow is one of the top reasons manufacturers (and all other small businesses) eventually collapse. Working capital management aims to spot these cash flow issues early and resolve them in advance.
How working capital management leads to better service level compliance
Available working capital allows manufacturers to plug the gaps in cash flow caused by production costs at the start of a new project as well as those caused by slow-paying clients. In addition, freely available capital (cash on hand not already allocated to an expense) can be used to make smart, strategic decisions that improve service level compliance. This may include buying materials from additional suppliers to increase the stock on-hand for a rapidly re-ordering customer, shortening the lead time between an order and fulfillment.
Working capital can also be used to improve quality through changes in suppliers or in the operations on the floor of the plant. Finally this capital can be re-invested into the company for digital transformation, equipment maintenance plans, new hires, and more.
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