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Cashing In

Squeezing cash out of operations is more important than ever, yet for most companies that is easier said than done.
John Zhu, CFO Europe Magazine
December 8, 2008

View the full results of the REL/CFO Europe 2008 Cash Masters Scorecard or only those results that appeared in print.

For most of the six years he has been CFO of Actelion, Andrew Oakley can't recall ever having to field questions from analysts seeking information about how efficiently Europe's largest biotech company generates cash. That has certainly changed in recent months. "Since Q3, a number of analysts seem to be looking more closely at the numbers, and especially the cash flow," he says.

According to CFO Europe's new cash scorecard, those analysts should be pleased with what they see. When it comes to cash conversion efficiency (CCE) — that is, the amount of cash flow that companies derive from operations as a percentage of sales — the SFr1.32 billion (€861m) Basel-based company is well ahead of many of its European peers, with a CCE of 30%, compared with the pharma sector's average of 15% and an overall average of 12.7%.

"Pharmaceuticals have been a surprise," says Gavin Swindell, managing director of Europe at REL, the research and consulting firm that compiled our scorecard after analysing the 2007 performance of 1,000 large European companies, excluding financial services, in 57 sectors. (See the end of this article for a link to the charts.) Being in a high-margin industry, he explains, means that focusing on freeing up cash might not — in theory — have the same urgency as in other sectors.

But Oakley notes that since the credit crunch began in 2007, freeing up cash from operations has been one of only a few ways companies such as Actelion can finance R&D. At nearly SFr300m, R&D at the company represents more than one-fifth of annual sales, which is higher than the sector average. But there are longer term reasons for pharma's heightened focus on cash. Actelion's leading drug, which generates 90% of current sales, comes off patent in 2015. "Cash on hand will be needed at every step of the way to ensure future revenue growth," says Oakley. What's more, he adds, "pharmaceuticals do occasionally find themselves [faced with] drug withdrawals or lawsuits."

One Step Beyond
As for companies in other sectors, a greater focus on cash is needed, particularly in the lowest ranking sectors such as electrical equipment and computers. A slim majority (530 out of 1,000) improved their CCE in 2007 from the previous year. Meanwhile, our group of 1,000 posted a modest 0.3% decline in gross margins; flat selling, general and administrative (SG&A) expenses; and a 5.9% increase in capital spending as a percentage of sales. All this blunted the potential improvement in CCE, as did an 8.3% increase in debt.

Given that operating conditions have become even harsher since the research was undertaken, getting a grip on cash efficiency will require CFOs to focus even more on customers and suppliers, asserts Marjorie Lao, finance chief of Tandberg, a $630m (€500m) Norwegian-US provider of video-conferencing technology.

The company's CCE of 22% makes it the highest-ranking firm in the communications equipment sector, whose average is 7.4%. Key to this has been the steady progress it has made in cutting days sales outstanding (DSO) to 57.8 at the end of 2007, from 62.5 in 2006 and 86.0 in 2005. As Lao explains, the reduction has hinged on a concerted effort to make sure that responsibility for credit and collection is not "simply confined to finance," moving outwards to the sales team as well as to external partners.

The effort will intensify in the months ahead. "One of the questions in 2009 will be, 'How can we continue to grow together with our business partners?,'" adds the finance chief. That, of course, will depend on how well Tandberg's partners weather the downturn. "For example, we have to ask: 'Will our business partners have the same sources of funding available in the near future to meet their needs?'"

So along with DSO and a weighted average of several measurements to monitor how well the company is realising cash from a sale, Tandberg also focuses on what Lao calls payment precision, a measure of how closely a customer adheres to payment terms. For instance, if a customer's terms are 30 days, payment precision measures the average actual number of days it takes to pay Tandberg. This is measured on an ongoing basis to see where credit limits and terms need adjusting.

They'll Be Back
Of course, not all customers that fall behind on payments should be treated equally. As Actelion's Oakley notes, while it's perfectly reasonable to give its US customers 30-day terms, in some European countries — notably Italy, Spain and Greece — it's had to deal with DSO in excess of 280 days.

Because governments are some of Actelion's biggest customers, Oakley isn't as concerned as other CFOs about invoices being left unpaid if the downturn causes a big wave of bankruptcies. Given this growing concern, many CFOs will be asking for prepayments, and may even turn their backs on financially wobbly customers trying to renegotiate terms.


However, such measures could be adding fuel to the fire, says David Zak, CFO of Vetropack Holding. The SFr700m glass-packaging manufacturer comes top of the containers and packaging sector on our scorecard, delivering 22% of every euro of sales into operating cash flow, compared with an 8% average. "Ours are long-term customers and will remember us when they get past the difficult months ahead," he notes. "We are preparing for a worsening of payment conditions, but we are not changing our terms to ask for money earlier because that would make the situation worse."

While most companies are battening down the hatches, putting growth plans on hold and cutting back on staff, our scorecard's top performers have big plans for their cash in 2009. For example, Vetropack's CEO, Claude Cornaz, recently told the Swiss press that he wouldn't rule out acquisitions, as well as investing in new production capacity.

As for Zak, he says Vetropack wants to keep a high level of net working capital as a percentage of sales, around 24% compared with a sector average of 18%. And Zak says that inventories may even go up next year. "We are willing to put cash into inventories so we can react to customers calling us because a competitor who has cut back cannot fulfil their order in time," he says. "This is a controlled process, of course, and we are in a lucky position to have a strong balance sheet that can support this strategy." Plenty of other CFOs must be wishing they could say the same.

John Zhu is senior staff writer at CFO Europe.

View the full results of the REL/CFO Europe 2008 Cash Masters Scorecard or only those results that appeared in print.





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