How Low Can It Go? The 2006 Working Capital Scorecard

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Asked to explain his company's success at driving down working-capital levels, Qualcomm CFO William Keitel demurs, saying, "You can always do better."

He's not being humble so much as capturing the dominant theme for working capital over the past several years. In 2005, for the fourth consecutive year, the 1,000 largest publicly traded companies in the United States managed to reduce the amount of money they had tied up in working capital as a percentage of sales. Data compiled for CFO by Hackett-REL, the Total Working Capital Practice of The Hackett Group, indicates that days working capital (DWC) for the average company shrank by 5.6 percent last year, following a 3.6 percent decline in 2004. Excluding the auto industry (which can skew results because of the huge lending arms the major players operate), the average decline last year was 4.0 percent, versus 2.5 percent in 2004. This was far better than the performance in Europe, where the average large company's DWC declined just 0.5 percent.

While many companies are riding this wave of success, the courses they have charted vary considerably. Some have achieved reductions by improving customer communication, others by adjusting their collections processes, and yet others by tying incentive compensation more closely to a successful reduction in working capital.

That approach, says Hackett-REL president Stephen Payne, may become more common. Not only has the rate of improvement jumped markedly between 2004 and 2005, he says, but the trend will continue "for at least the next few years." The reason: a stronger focus on working capital and free cash flow by the analyst community. That, Payne argues, has translated into "an increasing number of companies adding a cash-flow-based component to the variable compensation of executives, which will ensure that the focus continues."

And despite the consistent improvements by companies, Keitel's point that they can always do more appears to be on target. Hackett-REL calculates that the nation's 1,000 largest companies still have about $450 billion unnecessarily tied up in working capital in the form of past-due receivables, vendor invoices that were paid too early, and excess inventory.

Payne says that while it was difficult to discern much difference from one industry group to another last year — 43 sectors showed improvement in DWC, 35 worsened, and 4 were unchanged — there was a clear trend in companies making more progress in receivables than in inventory. Excluding the auto sector, the average company enjoyed a 3.9 percent reduction in days sales outstanding (DSO), versus a 2.6 percent reduction in days inventory outstanding (DIO). Payne offers two possible explanations. First, CFOs can make an impact on receivables far more directly than they can on inventory. That can prompt them to look to receivables as a starting point for working-capital improvement not only because it's more directly under their control but also because they may want to get their own house in order before telling other managers how to do their jobs. Second, as more and more companies embrace offshore manufacturing, they sometimes need bigger inventory buffers to account for the sheer distance that goods must be moved, particularly during periods of unexpected demand.

How Companies Succeed
Regardless of where the focus lies, working capital represents cash that is encumbered and therefore not available to grow the business. That's why Keitel and his finance team at Qualcomm closely track key working-capital metrics at the $5.7 billion provider of digital wireless-communications products and services. Last year, they helped pare their company's DWC figure by 34 percent, to 22.2 days, or two-thirds less than the 61-day median for the communications-technology industry. This followed a 10 percent reduction in 2004.

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