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Easing the Squeeze: The 2011 Working Capital Scorecard

As sales revive and coffers swell, companies seem less intent on wringing cash out of working capital.
David M. Katz, CFO Magazine
July 15, 2011

An abridged version of the 2011 CFO/REL Working Capital Scorecard can be found here.

For months after the Great Recession officially ended in June 2009, the need for cash trumped all else. With credit still scarce, companies continued to squeeze cash out of their supply chains. Finance chiefs led the charge to tighten bill collection, loosen their own payment terms, and dump inventory.

Today, cash is no longer a problem, as corporate coffers are filled to the brim. But don't be too quick to credit working capital improvement. The 2% decrease in days working capital (DWC) last year qualifies as downright modest, some say, although it is certainly an improvement, given that DWC increased 9.9% the prior year, the worst performance in half a decade. (Remember that a decrease in DWC represents improved working capital performance.)

Many CFOs disavow any connection between companies' strong cash positions and an apparent lack of emphasis on working capital. How strong? One thousand of the biggest publicly reporting nonfinancial companies registered an 11.5% jump in revenue last year, according to the 2011 CFO/REL Working Capital Scorecard. (By comparison, revenue dropped by 12.1% in 2009.)

Mixed Signals
All three components of DWC showed similarly scant levels of improvement. Days sales outstanding (DSO) declined 0.1%, while days inventory outstanding (DIO) and days payable outstanding (DPO) each improved just 1.1%.

To some experts, such sluggishness bespeaks complacency born of abundant cash. "The energy and focus have now been placed much more on the [profit-and-loss] statement," says Mark Tennant, a principal with REL, a working capital consulting firm. "There isn't a continuous focus on cash flow and working capital."

If, indeed, bulging coffers are to blame for a new spirit of complacency, the result could be a false sense of security. Corporate balance sheets may not be nearly as impervious as they seem, says Stephen Payne, Americas leader of working capital advisory services at Ernst & Young. Despite an impressive recent comeback in corporate productivity, high unemployment continues to plague the economy, he explains.

To produce sustainable growth, companies will "have to hire people and invest via capex, and that's going to start depleting their cash hoards," says Payne. (However, few companies seem poised to do that — see "Treading Water.") In the case of U.S.-based multinationals, much of that cash is sequestered abroad and more or less unavailable domestically, thanks to the 35% tax on repatriated profits.

Nevertheless, the stress that led many companies to try to wring cash from working capital during the recession has been eased by some signs that consumer demand is beginning to rebound. If sales forecasts continue to improve, corporations are bound to put more resources into driving revenue than into process improvements.

At The Kroger Co., which recently celebrated its 29th straight quarter of growth in food sales, for example, there's little doubt where its priorities lie. Acknowledging that he sees an opportunity to derive as much as $600 million in cash via working capital improvements at the $82 billion (in revenues) supermarket chain, finance chief Mike Schlotman says he would only go about it gingerly. "As the CFO, I could easily get it out and say I've got a few hundred million dollars of cash," he says. "But if it hurts sales, that's not such a great accomplishment."

Industrial Strengths — or Weaknesses
A major determinant (some might say limitation) of how a company regards the relationship between revenue and working capital hinges on its particular industry. There are severe curbs on how much cash a company like Integra LifeSciences Holdings can generate by slimming down its supply chain, demanding payment on time from its customers, or taking longer to pay its suppliers, for instance. Because of that, working capital improvements take a back seat to efforts to boost sales, according to Integra CFO John Henneman.

There's very little excess to trim in the supply line for the surgical implants and other time-sensitive orthopedic products that are Integra's specialties. "An awful lot of inventory is either held by sales reps — so they can be ready for surgery on very short notice — or held in hospitals for the same reason on consignment," Henneman says. "That requires quite a lot more inventory than you would need if you were in a business that had longer lead times."

Further, the $732 million company is caught in a receivables/payables squeeze: its hospital customers insist on longer payment terms than Integra can get from its own suppliers. "There's really nothing you can do about that if you want to play in the market, because other medical-device companies will take your business [otherwise]," he says.

On the other hand, the company must buy parts like screws or plates in such small quantities that it carries little clout with its vendors in negotiations on payment terms. Further, it must overbuy its inventory to have the right parts for any eventuality, even though most patients fall into a narrow range of possible needs.


In addition to such limitations, the high gross margins of the orthopedics industry diminish the incentive to make supply chains more efficient. Because Integra and firms like it retain a big portion of their sales as gross profit, it's worse for them to lack the inventory to fill a back order than to pay for redundant supplies, says Henneman.

For competitive reasons, however, companies in industries where working capital improvements are hard to come by may still be moved to make them. For example, inventory-turnover ratios in the aerospace and defense industry "are not world-class," says Bob George, CFO of Esterline Technologies, a $1.5 billion specialized manufacturer that derives most of its revenue from those sectors. Yet, Esterline is working hard to bring that ratio down.

In 2010, for instance, the industry saw its median DIO rise to 53 from 52 and its DWC increase to 90 from 86. In contrast, the auto-components business recorded median inventory days of 29 last year, down a day from the previous year, and 29 days of working capital — more than 9 days less than it was in 2009.

Indeed, given the length of time it takes to design and fashion a jet, just-in-time manufacturing "is not really a general concept that we wrestle with" as much as automakers do, adds George. Still, Esterline is striving to "crush lead times" in order to stay at the top of its class as a supplier, he says. The numbers appear to bear him out: between 2009 and 2010, the company reduced its DIO from 71 to 63, a 12% improvement compared with the 2% median deterioration of the industry as a whole.

Contrary to the theory that abundant cash leads to poor working capital performance, George sees the two spheres as completely separate. He says the incentive to streamline the company's supply chain is driven by the demands of its customers for shorter lead times and flexible terms. "They want to say, 'Look, I don't want inventory until I need it, and I want you to be able to respond,'" says George. Ultimately, it boils down to the promise of future revenue, since Esterline's major customers, which include Boeing and Airbus, want suppliers that can operate as leanly as possible.

Having a significant cash cushion has nothing to do with how hard the company works to turn around its inventory, says the finance chief: "Simply because we have cash on the balance sheet does not influence that focus at all."

Give It to the Shareholders
Bob Daleo, CFO of Thomson Reuters, maintains that companies that fail to manage their working capital are doing a great disservice to their investors. "So because we have more cash, we're going to let customers and vendors keep our cash longer? That's dumb," he says. "Instead of giving it to their vendors and customers, why don't they give it back to their shareholders?"

Thomson Reuters, a $13 billion information, data, and news provider, has little inventory to cut. With 40% of its revenues coming from outside the United States, the company is also geographically locked in to a mix of longer bill-collection times. Thus, it devoted its efforts to making working capital improvements in the area over which it has the most control: payment terms. The effort yielded an increase in DPO from 12 in 2009 to 15 in 2010.

As part of its focus on improving its working capital performance, Thomson Reuters consolidated its payment process in India, using a centralized payment-processing team to implement standardized policies," says Daleo.

In the current economic climate, however, the top line of the income statement appears to be a much higher priority than cash on the balance sheet. Yet while the focus on improving working capital performance may have dimmed, some companies are striving to sustain the gains they achieved during the recession.

Take Cytec Industries, for example. In the wake of the 2008 financial meltdown, Cytec, a $2.7 billion supplier of specialty chemicals and materials, was faced with debt and liquidity challenges. To make sure it had adequate cash on hand, the company embarked on a major effort to boost its working capital performance. As part of the push, Cytec curbed its past focus on net income and linked employee pay to the company's working capital goals.

By the end of 2009, the company's DWC dropped 27%, from 90 to 66. Although its revenues decreased 22% that year, it was able to offset the loss with the cash it had freed up by cutting working capital days. Spurred by the revival of the chemical industry in 2010, Cytec's revenues rebounded by 13% that year. With its incentive-compensation programs in place, however, the company was able to cut its DWC even further, to 61 days. The decrease in DWC improvement from 27% in 2009 to 8% in 2010 may simply mean that the company had made the most of its existing opportunities in 2009, says Cytec CFO David Drillock.

Still, the reduction in working capital days has produced enough cash flow to enable the company to reinvest in itself as well as restore dividend payments and launch a share-buyback program. "It really doesn't matter what industry you're in — if you have strong cash flow, you're generating value for shareholders," says Drillock. But if sales pick up in a big way, it may be hard for other finance chiefs to follow suit.

David M. Katz is New York bureau chief and senior editor for accounting at CFO.




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