No Time to Lose: The 2008 Working Capital Scorecard

Read the complete results of the 2008 working capital survey, or review just those results that appeared in print.

Beware your survival instincts: they may dampen corporate performance more than you might expect. With a recession looming or quite possibly upon us, it can be tempting to ease up on receivables and retain inventory in order to placate cash-strapped customers. But those seemingly small sacrifices actually impose a steep cost, diverting precious cash to working capital. CFOs who want to bolster the case for strict working-capital policies may find plenty of support in the 11^th annual CFO/REL Working Capital Scorecard.

The 2008 scorecard ranks working-capital performance at the largest 1,000 public U.S.-headquartered companies. Overall, 61 percent of the 57 industries covered in the scorecard improved their days working capital (DWC) number last year by an average of 8 percent. But there is still much room for improvement.

In a market climate where pennies per share affect shareholder returns, changes in working capital invite scrutiny. Taking note, one securities analyst has called working capital his microscope into the competence of a management team.

Reducing working capital confers benefits for any industry, from high tech to chemicals to manufacturing. "Every dollar we free up from working capital can be deployed back into the business," says Ken Hannah, CFO of MEMC Electronic Materials Inc., a $1.9 billion silicon-chip maker.

On a weighted working-capital basis, the 10 most improved companies released $1 billion or more each, a 26 percent improvement on their average DWC. Such opportunities beckon to CFOs. Were a median company in the 2008 scorecard (approximately $10 billion in sales) to match companies with the leanest working capital, REL estimates that the company could trim its working capital by $1.4 billion, or 14 percent of sales. That's a tidy sum for finance executives to invest in growth without tapping credit lines. Savings in interest expense go straight to the pretax bottom line, notes Karlo Bustos, financial analyst at REL, a division of The Hackett Group Inc.

Scorching Pace
As the current working-capital leader in the semiconductor sector, MEMC set a scorching pace last year, trimming its working capital to just 13 days from 36 days in 2006 and 46 days in 2005. The most recent one-year improvement liberated nearly $340 million in cash flow, REL estimates, a sum approaching 18 percent of 2007 sales.

Besides the virtues of leaner operation and ready access to $340 million, another way to calculate the payoff fits the back of an envelope. Had MEMC been forced to borrow $340 million to finance working capital at a modest 5 percent rate, the tab for interest payments (excluding amortization) would drain $17 million a year from cash flow for each year the debt remained outstanding.

Besides bracketing capital expenditures between 10 percent and 15 percent of revenue, CFO Hannah credits MEMC's success to a "maniacal" focus on cash conservation and trimming costs — twin benefits of better working-capital management.

"It all comes down to asset turns," Hannah reports. Direct-order contracts transfer ownership of goods to customers once those goods leave MEMC's shipping docks. The company trimmed inventory levels by adopting more just-in-time manufacturing processes. On the receivables front, MEMC reduced its days sales outstanding (DSO) by leveraging the current high demand for its products through requiring some customers to pay for goods before delivery.

MEMC does not stretch out payments to suppliers, however. "We're a cash generator," Hannah explains. "I can take that cash, invest it, and earn, say, 4 percent. Alternatively, I can pay my suppliers 30 days earlier and get, in some cases, a 10 percent discount on their product."

A determined focus on cash conservation characterizes top working-capital performance in every industry. "We have a very experienced management team that has seen some of the best of times and some of the worst of times in a cyclical industry," says Dan Greenwell, senior vice president and CFO of Terra Industries Inc., a $2.4 billion manufacturer of nitrogen fertilizers that has pared its DWC to 30 from 51 over the past two years, far below its industry median of 72. Like MEMC, Terra has taken advantage of recent robust demand to negotiate better sales terms. It also has shuttered distribution centers to minimize inventories and prepays supplier invoices in exchange for discounts.

Overall Improvement
Excluding automakers, which skew results disproportionately due to their lending operations, the 2008 results show overall, if marginal, improvement since last year's scorecard, but not in every corner of working-capital performance. Days inventory outstanding (DIO) shrank, on average, to 29.7 days from 30.7 days. Somewhat surprisingly, despite a looming recession, REL found only a slight uptick in days payables. In fact, says REL's Bustos, big companies seldom conserved cash in 2007 by making vendors wait. For the group, excluding automakers, days payables outstanding (DPO) edged up only slightly, to 32.5 days from 32.1. DSO also moved in the wrong direction, edging up to 41 days from 39.7 in 2006 and 40.5 in 2005.

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