Capital Ideas: The 2005 Working Capital Survey

"Working capital is a very good barometer of operational efficiency," says Payne. "Yes, companies are awash in cash, but most of it comes from reducing cap ex. But if working capital deteriorates, the company is probably not focusing on the core of its business."

At Whose Cost?
Overall, companies in our survey (excluding the automotive industry) continued to reduce their DWC, but at a slower rate (2.5 percent) than in last year's survey (4.2 percent). "It looks harder and harder to deliver on working capital performance," notes REL's chief financial analyst, Marc Loneux, who compiled the survey. At the same time, he says, "the decline also suggests that management focus is switching from the balance sheet back to the P&L as companies try to grow EPS and revenues."

Of the 78 industries surveyed, 55 improved DWC — up from 45 last year. But while more showed gains in payables (51 versus 35), the number of sectors improving receivables fell from 47 to 43. Inventory results also deteriorated, from 52 industries last year to 42. That's unfortunate; although delaying payables delivers a quick boost to cash, the resources payables represent are generally the least valuable portion of the cash tied up in working capital. Raw materials are worth less to a manufacturer than work in process or the finished product. A similar increase in value holds true for nonmanufacturers — the total value of airline tickets, for example, should be worth more than the airline pays out in fuel and other costs. "You get a bigger bang for your buck improving receivables or inventory, because they are worth more," notes Payne.

While companies may be managing supplier relationships more effectively, the widespread rise in days payables outstanding (DPO) suggests more companies are simply squeezing their suppliers through delayed payments or tougher terms. That can hurt a company in the long run, as suppliers raise prices to cover the cost of financing the goods.

Improving working capital on the backs of suppliers is usually counterproductive, argues Martin Jarvis, head of global sales and operations for consumer-products giant Unilever. Extending DPO, he says, could mean "trying to extract credit from olive growers in Spain who produce olive oil." That's absurd for a company with Unilever's access to capital. Even worse, he says, "one of the more obvious things that happens if you push on working capital blindly is that sister companies stop paying each other. That improves their numbers, but does nothing for the overall working capital of the company."

Forcing suppliers to hold inventory can also be self-defeating, even though it is cheaper to have more raw goods than finished products in the supply chain. "A supplier's cost of capital is actually going to be greater that Unilever's," explains Jarvis. "So by putting inventory back in its hands, you're probably costing yourself money." Not only are suppliers likely to raise prices, but the supply chain as a whole will still be carrying excess working capital.

At Unilever, a shipment of tea bought at auction in Kenya, Sri Lanka, or Indonesia might change hands three or four times before finding its way into Lipton tea bags or the iced-tea formula brewed in Ireland by UK-based Lipton Ltd. Along the way, it passes through both independent suppliers and Unilever companies. Historically, each supplier was urged to reduce working capital. "At each stage," recalls Jarvis, "companies would try to get the unit upstream or downstream from them to carry their working capital."

Today, says Jarvis, Unilever focuses on reducing working capital for the entire supply chain. "In the total chain of stock, ownership becomes secondary," he says. That means sharing information and resources. For example, Unilever works with its Kenyan bankers to make sure its independent tea suppliers have access to credit at Unilever rates. The result? According to Unilever's calculations, working capital fell 40 percent, or about $2 billion, from 2001 to 2004. "It's in everybody's interest to lower the total amount of working capital," says Jarvis, "but you need a fairly mature relationship to do that."

Tim Reason is a senior editor at CFO.

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