Net working capital (NWC) — the difference between a company’s current assets (cash, accounts receivable/customers’ unpaid bills, and inventories of raw materials and finished goods) and its current liabilities (such as accounts payable and debts), according to Investopedia — is a funny measure.
Too low an NWC could betray a slowdown in sales or short-term financing problems, and too high an NWC can signal inefficiency or, on the positive side, the investment needed to corral a fresh sales opportunity.
This year’s CFO/The Hackett Group Working Capital Scorecard showed the 1,000 largest U.S. companies increased net working capital by 11% in 2022, to $1.54 billion. That’s to be expected when assets such as accounts receivable and inventories increase.
(Truly, performance varied. According to the Hackett Group, the top 10 performing industries in the Hackett 1,000 lowered NWC by 18% as a percentage of revenue in 2022. And the ten worst performers increased NWC by a collective 34%.)
Overall, the 1,000 companies also saw cash on hand decline by 7%.
According to the Hackett Group, “combined with the decrease in total debt, [this] seems to indicate companies have been using the cash they have hoarded during the pandemic to continue cleaning up their operational performance (change in EBITDA margin) and financial performance (paying off debt).”
Coupled with the overall increase in the cash conversion cycle (CCC) to 36.4 days from 35.2 days, higher net working capital (for those with that result) and lower cash suggest companies may have inefficiencies in working capital management, like holding too much inventory. In other words, they may not have been as liquid last year as they would have liked.
“There are times when you want to be able to have that flexibility to be able to add debt or add working capital that you need to grow the business. — Rajesh K. Agrawal, Arrow Electronics
And liquidity is important, not just in times of weak economic growth, rising interest rates, and higher cost of goods sold.
Arrow Electronics has a healthy balance sheet, with a current ratio of 1.6x as of the first quarter of 2023. CFO Rajesh K. Agrawal told the BofA global technology conference on June 7 (according to the S&P Global Intelligence transcript) that the company tries to maintain flexibility for “large swings in cash, in inventory and working capital that happen in [its] business.”
Arrow also maintains an investment-grade rating because “there are times when you want to be able to have that flexibility to add debt or add working capital that you need to grow,” said Agrawal.
Not Enough WC
Of course, adding to working capital is not easy for some companies. They may have insufficient liquidity to grow working capital quickly when opportunities arise. That requires some deft maneuvering by finance.
Pyxus, an independent leaf tobacco merchant (not among the Hackett 1,000) has been working on increasing liquidity through working capital management to fund operations and growth. But to do so, the North Carolina company has tapped credit lines and is using securitization facilities to accelerate receivables payments, according to Flavia Landsberg, the company’s CFO, speaking on a June 6 earnings call.
“Our working capital management program has reduced the length of our operating cycles by speeding up receivables turnover,” she said.
Pyxus is fortunate. Tightening credit markets will negatively impact the working capital of some early-stage companies and small to midsize businesses that rely on borrowing to fund the cash cycle.
In the rooftop solar industry, according to Sunworks’ CEO Gaylon Morris on May 25, lenders are reducing their risk by shifting milestone payments to the borrower “to later stages of the project, negatively impacting working capital,” he said on an earnings call. So Sunworks, among other actions, entered into a $2.5 million factoring agreement in May based on commercial customer receivables.
Too much working capital is a problem some companies would like to have.
To receive the full working capital scorecard report from The Hackett Group, go here.