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Tight Makes Right

Companies still have plenty of opportunity to squeeze more cash out of operations.
Randy Myers, CFO Magazine
December 1, 2008

Regal Beloit Corp. CFO David Barta has taken approximately 30 days out of his company's cash cycle over the past four years. But he and the rest of the leadership team at the $1.8 billion maker of motion-control products want more. "Our commitment to the board this year is to take another 3 days out of the cycle," Barta says. "That is not a huge stretch, but it is something for which my feet are held to the fire."

With the economy on its heels and cash scarce, many CFOs are feeling similar heat. Whether by slashing costs, extending payables, paring inventories, or tightening operations wherever they can, they are trying to squeeze more cash from operations come hell or high oil prices. Agilent, for example, cited tighter management of receivables as a source of cash flow in its 10-K for 2007. Terra Industries increased its cash flow by paying more attention to customer prepayments, while Procter & Gamble reported an emphasis on lower inventory levels, increased payables, and industry-leading lean receivables.

Trapped cash represents an immense opportunity, according to research and consulting firm REL, a division of The Hackett Group Inc. Using data furnished by Capital IQ, REL calculated that the 1,000 largest corporations in the country (excluding financial-services firms) can generate an additional $491 billion of cash flow — nearly four times the combined profits of the 10 largest companies in the United States. To make that happen, companies in the bottom three quartiles in each industry would simply have to match the "cash conversion efficiency," or CCE, of those in the top quartile.

Big improvements are possible. Despite a gloomy economic environment, Regal Beloit nearly doubled its CCE last year, to 11 percent, putting it just over the 10 percent average notched by the electrical-equipment industry.

Much of that improvement has hinged on making sure that everyone is focused on working capital and cash flow. "Every month, we review our performance in this area with our business leaders around the world and then go through the numbers with our CEO at both the company and business-unit level," Barta says. "We also make a presentation to the board on a quarterly basis." In addition to reviewing working capital performance by business unit, notes Barta, Regal Beloit chairman and CEO Henry Knueppel reviews details of the company's working capital performance with the executives in charge of inventories, accounts payable, accounts receivable, and sales.

Barta says Regal Beloit has held its days sales outstanding relatively flat over the past four years even as it has expanded into overseas markets where payment terms are traditionally much longer than in the United States. It has also pared days inventory outstanding from the mid 70s to about 60, and, working in concert with its suppliers, has pumped days payables outstanding from the high 20s to the mid-to-high 40s. All that shrank the company's cash cycle from 90 days–plus to the low 70s.

Adopting Six Sigma techniques also led to more-efficient and less-wasteful operations. "While the low-hanging fruit has obviously been taken, our plan is to continue to improve," Barta says.

A majority of the corporations in REL's 2008 Scorecard earned muted kudos last year. They increased the percentage of sales they converted to cash — or, more specifically, operating cash flow — by almost 6 percent. In isolation, that sounds robust. But they could have done better, according to REL. Additions to cash flow generally lagged behind a 9 percent bump in sales.

"When you see companies growing their revenue, you hope to see them taking full advantage of their growing scale. And we're just not seeing that," says REL financial analyst Karlo Bustos. "Now, as we start to see revenue growth slowing, we want to see companies cut costs and streamline processes such as accounts receivable and accounts payable."

Failure to coax a larger share of added revenue to the bottom line reflected several harsh economic realities at play last year. Higher commodity prices as well as higher energy and transportation costs drained cash flow, and many companies siphoned cash to satisfy higher debt-servicing costs.

Diverting cash in these directions may be sustainable when times are good. But this year, with the credit-starved economy driving sales down across multiple industries and restricting access to debt, companies will need to do better. For many, freeing more cash from operations will be the only way to win the financial freedom they need to invest in research and development, fund share-buyback programs, pay down increasingly expensive debt, or pay for acquisitions — activities that ultimately drive improved shareholder returns.

Across-the-board improvement last year put the CCE needle at 12.1 percent, up from 11.4 percent in 2006 — a move that represented $54 billion. To a large degree, the uptick reflected a 0.6 percent reduction in net working capital as a percentage of sales, a three-year trend.

A slim majority (529 of 1,000 companies) improved CCE last year. Meanwhile, that group of 1,000 also posted a modest 0.4 percent decline in gross margins; a 1 percent uptick in selling, general, and administrative (SG&A) expenses; and a 4 percent increase in capital spending as a percentage of sales. All this blunted the potential improvement in CCE, as did an 11.4 percent increase in debt.


Seven of 10 industry groups tracked by REL posted improvements in their CCE ratio last year, up from 43 percent in 2006. However, the average improvement among all 57 groups was just 14 percent, down from 29 percent in 2006. Industries showing the most improvement were, in order: independent power producers and energy traders, commercial services and supplies, electrical equipment, construction and engineering, and industrial conglomerates. The five worst: distributors, multiline retail, diversified consumer services, personal products, and multi-utilities.

Cooper Tire & Rubber Co. led the auto components industry in CCE last year, shepherding 13 percent of every sales dollar into operating cash flow, up from 4 percent in 2006. In part, the improvement reflected the cyclicality of the tire industry and its supply chain. It also applied a tough lesson: As 2006 began, says CFO Philip Weaver, Cooper's raw-materials costs were skyrocketing, and pricing was not keeping pace. Cash flow slid. Then, in late 2006, the trend reversed; raw-materials costs declined and tire prices started to rise. As raw-materials costs continued to moderate in 2007 while tire prices stayed up, Cooper implemented "some extremely focused programs to reduce working capital," says Weaver. The payoff? Thanks to well over $100 million in reduced inventories, Cooper was able to convert higher levels of sales to cash. That improvement, however, may be hard to repeat (see "Bumpy Road Ahead" at the end of this article).

A one-time transaction at Mirant Corp. gave an edge to independent power producers and energy traders. The $2 billion wholesale energy marketer booked a huge infusion of cash when it sold its Philippine and Caribbean businesses, as well as six U.S. power plants. As a result, Mirant's cohort grabbed first place in the CCE sweepstakes. The next best industry group, commercial service and supplies, improved its average CCE ratio by 35 percent. Overall, those companies eked out a 1 percent increase in gross margins while holding SG&A expenses flat as a percentage of sales.

Among laggard industries, distributors saw rising SG&A absorb cash. Multiline retailers and diversified-consumer-services companies both saw their margins on earnings before interest and taxes slip while net working capital rose.

Leaders or laggards, in times like these companies can ill afford to leave cash out of reach. Even if collapsing stock prices divert scrutiny away from cash flow today, skittish investors will soon demand evidence that their remaining financial assets are tightly managed. If boards don't hold their CFOs' feet to the fire, as they should, the marketplace will.

Randy Myers is a contributing editor of CFO.


Bumpy Road Ahead
Cooper Tire & Rubber

There is no denying that the tough business climate is throwing up new challenges to cash conversion efficiency, especially at companies highly vulnerable to external economic forces. For much of 2008, trends that helped improve 2007 cash flow at Cooper Tire & Rubber Co. were reversing, with oil prices spiking and tire prices not keeping pace. As a result, CFO Philip Weaver sounds a cautious note about cash flow. "We have made changes, and we need to continue to make changes, but I wouldn't want anyone to infer that because we did this in 2007 things are going to be even better in '08," he says. "There's been an overwhelming increase in commodity costs." — R.M.


To see the 2008 Cash Masters Scorecard, click here.




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