VideoKarlheinz Hornung takes nothing for granted. He joined a subsidiary of German conglomerate Metallgesellschaft in the late 1970s, shortly before the group's 100th anniversary, and worked his way through the ranks. Then, in 1993, he was despatched to the company's head office in Frankfurt to help save the group from bankruptcy as the markets moved against huge, ill-judged derivatives positions built by oil traders in a US unit. Hornung participated in negotiations for the massive rescue package that saved the firm from collapse, later becoming finance chief of the smaller, humbler company. "That's where I learned my lessons," he says.
Now, as CFO of MAN, a €15.5 billion commercial vehicles, engines and engineering group, Hornung is teaching colleagues across the Munich-based company about the importance of liquidity. Aided by a working capital reduction programme launched in 2006, the lessons appear to be taking hold. Last year, MAN's operating cash flow grew nearly threefold, to more than €2 billion.
Thanks in part to its CFO's foresight, MAN has not been caught out by the credit crunch. The same cannot be said for many other firms, according to the latest annual working capital scorecard compiled for CFO Europe by REL, a research and consulting firm. Working capital performance deteriorated in 2007 for the 1,000 largest non-financial companies based in Europe. Excluding carmakers, average days working capital (DWC) rose to 47.3 in 2007, an increase of 1% over the previous year. (See "Hardly Working" at the end of this article.) As a result, more than €7 billion in cash was trapped in operations across the sample of companies, a loss of liquidity that few companies can afford given current credit conditions.
The deterioration was driven by a spike in days inventory outstanding (DIO), which rose by 4.6% in 2007, and a modest rise in days sales outstanding (DSO), which grew by 0.3%. This was more than enough to offset an increase in days payables outstanding (DPO), which grew by 3%.
The spike in DPO has a whiff of panic about it. (See "Payables Panic" at the end of this article.) If a company is hard up for funds, withholding payments to suppliers is probably the easiest solution. However, it may not be the most constructive, argues Gavin Swindell, REL's European managing director. "There's nothing to be gained in the long run by not paying suppliers on time and not answering the phone," he says. "Collecting receivables is an easy, legitimate way to boost cash. Everyone is worried about the credit crunch, but DSO is flat." The average DSO in the research sample, at around 55 days, is much longer than typical standard payment terms, Swindell adds. "No one is doing business on 55-day payment terms. There is an opportunity there."
Seizing this and other working capital opportunities will rise up the list of corporate priorities as economies slow and external finance becomes more scarce and expensive. In a recent global survey of more than 350 senior executives by the Economist Intelligence Unit, a sister company of CFO Europe, around 60% of respondents said that increasing operational efficiency will be a key factor in boosting return on equity in the next three years, compared with fewer than 40% who said that this has been as important over the past three years. (See "Inside Job" at the end of this article.)
Work Out
As Hornung can attest, it was much harder for finance chiefs to focus their colleagues' attention on cash before the credit crunch. When he joined MAN in 2004, one of his first contributions at a board meeting was to claim that the group could release at least €1 billion from the €5 billion that was tied up in working capital. Gaining support for this goal occupied Hornung for the best part of the following year, as colleagues came up with "all sorts of arguments about why this was not possible," he recalls. Results were positive and cash flow was healthy, so why was he agitating for widespread changes? Based on past experience, he argued that "more liquidity is always good. Since last August, nobody argues against having more liquidity on the balance sheet."
According to REL, MAN released more than €1.3 billion in cash over the past two years, cutting DWC from around 160 in 2005 to 120 in 2007. For companies now scrambling for cash, the measures taken by MAN and other forward-looking firms could serve as useful guides to freeing up much needed funds from working capital.
Hornung's breakthrough came in 2006, when MAN sold 65% of its printing-systems business to a private equity firm. Shortly after the sale, the printing firm's chairman, a long-time critic of Hornung's working capital reduction plan, conceded that Manroland — as the firm is now called — could indeed release millions of euros of trapped cash. This change of heart kickstarted a MAN-wide initiative which will run through to next year.
Within two months, "we found ways to achieve my famous €1 billion reduction in working capital," says Hornung, who chaired the project's steering committee. The first steps were to adjust incentives for staff, alter collection conditions and change payment practices.
Each quarter, MAN's board decides on a credit line to extend to each subsidiary from its central cash pool. A hefty 14% interest rate is now levied on any amount drawn beyond this limit. Charged to the unit's P&L, this affects profit-linked bonus schemes for a number of employees.
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