The efficient management of working capital, defined as a firm’s current assets minus its current liabilities, is crucial for organizations to utilize their existing assets and enhance cash flow effectively.
Efficient working capital management and its impact on a firm’s performance can present a multifaceted challenge. This complexity arises from factors such as the global dispersion of supply chains, the diversity in supplier bases and product varieties, and the uncertainties associated with technology.
Recent findings from the University of Notre Dame underscore the importance of information technology as a pivotal investment for companies aiming to make well-informed, objective, and tailored decisions regarding working capital, which, in turn, could bolster performance.
The research, titled “Impact of working capital on firm performance: Does IT matter?” and set to be published in the Journal of Operations Management, is authored by Sarv Devaraj, the Fred V. Duda Professor of Management at Notre Dame’s Mendoza College of Business. This study delves into the investment in IT infrastructure, such as expenditure on servers and hardware, and IT personnel investment, which includes the recruitment and training of IT staff across 1,054 manufacturing firms in the US over 2011-2013.
It elucidates the distinct functions of IT infrastructure and IT labour in automating (leveraging technology to enhance process efficiency and precision) and informing (employing technology to generate new insights), thus influencing the relationship between working capital management and firm performance.
Devaraj points out that investments in IT infrastructure significantly bolster the positive correlation between working capital management and firm performance, more so than investments in IT personnel. This is attributed mainly to the structured and transaction-oriented nature of data involved in working capital processes.
The study identifies three key metrics influencing a firm’s working capital performance: Days Inventory Outstanding (DIO), Days Payables Outstanding (DPO), and Days Sales Outstanding (DSO). These metrics relate to the company’s inventory management, supplier payment, and sales revenue collection.
Strategic working capital management, by minimizing DIO and DSO and maximizing DPO, can enhance firm performance. Yet, overly aggressive strategies in extending payables, reducing inventories, or curtailing receivables can expose the supply chain to risks and adversely affect performance.
The research demonstrates that spending on IT infrastructure can amplify the positive impacts of DPO while mitigating the adverse effects of DIO and DSO on firm performance. While IT personnel investments also improve DPO’s positive impacts and lessen DIO’s adverse effects, they do not significantly affect the DSO-firm performance relationship.
The study suggests that IT infrastructure investments enhance the efficiency of working capital processes due to the structured nature of the underlying data. IT personnel also play a crucial role in this dynamic. For example, IT business analysts can interpret working capital data, assess key cash flow metrics, understand the implications of supply chain changes on working capital management, and communicate these insights to senior management and other stakeholders. They can also develop new processes to meet the needs of these stakeholders.
Devaraj emphasizes the importance of managers responsible for working capital management securing support from senior management for new IT investments. This study’s findings provide a strong case for such managers to advocate for increased investment in IT, especially in IT infrastructure, to enhance the management of working capital processes.
More information: Palash Deb, Suvendu Naskar, Sarv Devaraj et al, Impact of working capital on firm performance: Does IT matter?, Journal of Operations Management. DOI: 10.1002/joom.1244
Journal information: Journal of Operations Management Provided by University of Notre Dame