VideoIs it possible to run a great company without minding your cash flow P's and Q's? Probably not. Money trapped in working capital is money not being used to grow the company. And in today's hotly competitive global marketplace, where product cycles are ever shorter, pricing power is often nonexistent, and technology changes on the fly, a company not growing efficiently risks not growing at all.
Which helps explain why Burlington Northern Santa Fe CFO Tom Hund, Vastar Resources CFO Steven Shapiro, Casey's General Stores CFO Jim Shaffer, and their counterparts place a high priority on converting sales to cash flow. Different as these three firms are, they all make cash-conversion efficiency one of the primary metrics by which they measure financial performance.
"We are in a capital- intensive, highly volatile commodity business with a depleting asset base," explains Shapiro, who is also senior vice president at Vastar. "That means we need a lot of cash flow to invest in replacing our assets, which are oil and natural gas reserves. Because we have no control over the price at which we sell our products, we focus on the things we can control. A basic, fundamental strategy of our company is to be absolutely as low cost as possible in everything we do. That's what we can give to our shareholders."
Give it has. Over the past five years, $1 billion Vastar, an oil and gas exploration and production company in Houston, has grown net income by an average of 11.1 percent per year on sales growth of just 6.1 percent, generating an average annual return on equity of 39.3 percent, according to Media General, or more than 10 times that of the independent oil and gas company industry.
Along the way, Vastar has also taken top honors in the fourth annual Working Capital Survey, a joint project between CFO magazine and REL Consultancy Group, a global management consulting firm headquartered in New York. The survey measures working capital efficiency at 1,000 public companies that posted 1999 sales of more than $500 million. The overall scores are based on an equally weighted combination of cash- conversion efficiency (CCE), which is calculated as cash flow from operations divided by sales, and days working capital (DWC), which represents a summary of unweighted days sales outstanding (DSO), payables, and inventory.
For the first time, the survey also measures average working capital over five years of published performance figures, rather than three. The results are encouraging. Over the past five years, the average company surveyed has reduced its days sales outstanding by 1.1 days, boosted its days payables outstanding (DPO) by 0.7 days, and improved inventory turns by 1.4 turns (4.5 days). Taken together, that equates to a 6.3-day improvement in DWC.
Stephen Payne, REL president, says some credit for the strong performance goes to a growing awareness of cash flow as an underlying indicator of business strength, as evidenced by the widespread embrace of value-based performance metrics such as Economic Value Added, cash flow return on investment, and even good old return on net assets.
Of the 33 industry groups examined, in fact, 26 showed improvement in days working capital, led by health-care equipment companies, specialty retailers, computer and office equipment makers, electric and gas utilities, and aerospace firms. All improved their DWC by more than 20 days, on average. Industries that failed to shrink their working capital included food companies (a gain of 4.5 days, the worst of the bunch), followed by transportation firms, petroleum companies, and food and drug stores.
That petroleum companies did poorly only throws into greater focus the outstanding performance by Vastar, a company that went public just six years ago and recently agreed to have its minority interest acquired by BP Amoco. In 1997, when we published the first Working Capital Survey, Vastar ranked 100th in days working capital at 13 days. This time, the company ranked 36th with just 1.5 days, versus an industry average of 40. And unlike some energy companies, which carry costly revenue-producing assets such as leased oil rigs off balance sheet, Vastar achieved its strong working capital results without any such sleight of hand.
"We have virtually no assets off balance sheet," explains Shapiro. "With a triple-B-plus debt rating, we find it more efficient to buy our equipment rather than lease it, and use the depreciation ourselves."
Vastar also boasts rock- bottom SG&A expenses that equate to about 11 cents per 1,000 cubic feet of natural gas. Vastar's main product, that gas currently sells for more than $4 per 1,000 cubic feet. Throw in production costs of about 44 cents per 1,000 cubic feet, and Vastar's total cash costs are still about 25 to 30 percent below the industry average, Shapiro says.
"Our goal is to be number one [in low costs] among large-cap independent exploration and production companies each year," he says. "We track that quarterly by reviewing everybody's financial statements, and we have been number one in almost every quarter for the last six years."
King of DWC
While Vastar ranked first overall in the 2000 Working Capital Survey, no company bettered $9.1 billion Burlington Northern Santa Fe (BNSF), operator of the second largest railroad system in the United States, in keeping working capital low. The company posted a remarkable 57.2 days working capital, versus an industry average of 24. How the company did it is a story not only of industry dynamics, but of a concerted drive to reduce receivables outstanding as well.
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