A medical equipment manufacturer in the southeastern US has called youin because it feels its working capital requirements are much higher thanthose of its competitors. How will you help it solve its problem?Suggested Frameworks
This problem calls for a recollection of financial accounting. Remember that working capitalconsists of cash + inventory + accounts receivable (current assets) less accounts payable +short term debts (current liabilities). Look at each one to determine where the problem lies.
Going through the list of items that increase working capital (i.e., currentassets) reveals that the client's inventory levels are inordinately high.
The client organization is made up of three divisions. The inventoryproblem can be traced to a division that was acquired by the client abouttwo years ago. This division manufactures equipment for orthroscopicsurgery, namely capital equipment and blades (something like razors andrazor blades, only much more expensive).
It turns out that the technology for this equipment has been changingrapidly and the rate of obsolescence of inventory is extremely high. Asearlier sales forecasts had been overly optimistic, the client now finds itself loaded with obsolete finished goods inventory.
As a corrective action, decide on the appropriate level of inventory byadjusting forecasts, getting an idea of manufacturing lead times, anddetermining customer expectations of order lead times.
After appropriate levels of inventory are determined, it turns out that theclient has 2.5 years of capital equipment inventory while none needs to becarried since these items can be manufactured after receiving the order. Tohelp take the finished goods inventory off the books, finished goods couldbe dismantled and sold. Also, idled manufacturing capacity could beadapted to make other goods if the facilities are flexible enough.