How to squeeze your Working Capital (GMROWC)

March 22, 2009

Gross Margin Return On Working capital is a great measurement used by companies to explore their inventory investment and the return on that investment in relationship to their Cash Conversion Cycle. Using GMROWC you will be able to determine the contribution each product, product mix, or division adds to the bottom line of your company; this analysis will depend on the granularity of your available data. You can also use GMROWC to help you obtain better terms with your suppliers so they understand the contribution they bring to the overall value stream. You will need the following measurements for this calculation:

Required Information

    Gross Margin Return On Working Capital, GMROWC

  • Product Sales for Month Annualized
  • Recorded Cost of Product for Month Annualized
  • Accounts Payable
  • Accounts Receivable
  • Inventory Value

See figure 1 for a visual depiction of the GMROWC. Click Here For Calculator

The calculations for determine your GMROWC on the surface may appear simple, but if you start exploring your GMROWC from a top down analysis it can start to get complicated. For instance, if you initially want to know the total GMROWC for your entire inventory portfolio, this is straight forward, but if you start exploring the GMROWC by product group, by product, or by vendor you need to make sure you data is granular enough for these calculations.

Example

Gross Margin Return On Working Capital, GMROWC

GMROWC Calculator "Click Here"

To gain an understanding of the power of this simple measurement I have created a snapshot of a distribution company which appears to be in distress. Let’s explore the GMROWC for a distribution company with the following characteristics:

  • Current Accounts Receivable=$17M
  • Yearly Sales=$80M
  • Current Inventory Value=$26M
  • Yearly Cost of Goods Sold COGS=$58M
  • Inventory Accounts Payable=$5.5M

Product GM%; ( Sales-Cost)/Sales, ($80M-$58M)/$80M)=28%

DSO=AR/(Year Sales/365), $17M/($80M/365)=78 Days

DIO=Inventory/(Year COGS/365), $26M/($58M/365)= 164 Days

DPO=Inventory AP/(Year COGS/365), $5.5M/($58M/365)=35 Days

Calculate Cash Conversion Cycle DSO+DIO-DPO=207 Days

Calculate Working Capital Turnover 365/207=1.77 Turnover

Calculate GMROWC=1.77 X GM%=49

A sampling of the observations you can make from these calculations are as follows:

  • This Distribution company is only making a 28% product Gross Margin, the marketplace must be competitive or the purchasing department is not cohesively tied together to take advantage of it’s buying power and not negotiated rates properly. A lot of action items can come out of this observation.
  • The days in inventory is too high at 164, their could be a lot of dead inventory, or the company could be holding too much inventory. This area is rich for analysis.
  • The DPO=35, the company may be paying it’s vendors too quickly or a couple vendors may be pulling this figure down. Look into obtaining better terms from the vendor.
  • With your receivables figure high at 78, collections may need a new strategy to allow for quicker turnaround on payments from customers.
  • Overall the cash conversion cycle is 207; working capital turnover is therefore 1.77. This figure needs reduced and by exploring the DPO, DSO, and DIO in more detail a plan will materialize to lower this figure.
  • The GMROWC is only 49, by pulling the different levers available to this distribution company from just a sampling of the available resolutions mentioned above the GMROWC metric can be tracked and improved upon.

This hypothetical company profile shows the power behind tracking a reliable metric and then making plans to attack areas that can be improved upon. The GMROWC should be explored from many angles, a few of which are:

  • By Division
  • By Warehouse
  • By Product
  • By Product Group
  • By Vendor
  • By Purchasing Manager
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Comments

2 Responses to “How to squeeze your Working Capital (GMROWC)”

  1. Susan Kishner on March 22nd, 2009 7:41 pm

    Great Blog post. I am going to bookmark and read more often. I love the Blog template

  2. BoeyCY on May 10th, 2012 9:30 am

    Thanks for sharing.. this is reallly great. I have a question though, if the cash conversion cycle is negative (for eg. Dell’s situation), what it mean for the GMROWC.. which means it would be negative? What is the observation of that? Thanks.

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