Integrated Capital Management in Aerospace & Defense: Charting the Course to Emerge from the Pandemic

Traditional approaches to performance improvement have tended to focus on EBITDA improvement or cash flow improvement as separate challenges that can be addressed by separate teams and are owned by separate functions. Sales are responsible for growing revenue; procurement is responsible for lowering cost; operations are responsible for inventory; and finance and shared service centers are responsible for cash. However, we believe that integrating these approaches is critical for Aerospace & Defense industry organizations. Those with a unified capital management strategy will not only weather the current turbulence but emerge as market leaders in the post-COVID-19 world.

Cash is still King…

Cash will always remain the “lifeblood of any business”, as our colleagues Charles Lowrey and Christopher Duggan wrote recently. They go on to say that while CFOs must continue to embed a “cash culture” in the business, for those that seek to emerge from the disruptions of the last 12 months as leaders, this can and should be part of a broader conversation.

Historically, we have seen firms treat performance improvement programs as primarily EBITDA-oriented. This has often led to a token working capital aspect, or firms aggressively focus on working capital without considering the impact on margin. Consider these typical examples that we have observed over the years:

• Early payment discounts – When EBITDA is the sole focus, procurement teams are incentivized to seek early payment discounts from suppliers, reducing the unit price in exchange for faster payment. When working capital is the sole focus, teams seek to extend payment terms, adjust invoice triggers and payment frequencies, and hold onto cash.
• Plant optimization – When operational efficiency is the sole focus, programs often target overall equipment effectiveness (OEE) improvements, while plant teams are incentivized to maximize assets’ performance. When working capital is the sole focus, teams seek to reduce raw, work-in-progress (WIP) and finished goods inventory, even if this means pausing production or producing smaller batches.
• Customer invoicing – When focusing solely on growth, sales teams are incentivized by revenue and margin. However, this dynamic often causes unintended side-effects such as invoicing early to hit monthly revenue targets or rushing to book the sale without all the necessary information. While revenue may grow, these incentives rarely consider the impact on margin of collecting from poor payers, re-invoicing customers and settling disputes.

A proper diagnosis of the issues may correctly identify the triggers, noted above, as root causes and address them in a targeted fashion; however, all too often we see teams become a “hammer looking for a nail” and focused on their area of specialty while ignoring the bigger picture.

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