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Cash Crop: The 2000 Working Capital Survey

Companies that mind their cash flow are enjoying bumper years.
Randy Myers, CFO Magazine
August 1, 2000

Is it possible to run a great company without minding your cash flow P's and Q's? Probably not. Money trapped in working capital is money not being used to grow the company. And in today's hotly competitive global marketplace, where product cycles are ever shorter, pricing power is often nonexistent, and technology changes on the fly, a company not growing efficiently risks not growing at all.

Which helps explain why Burlington Northern Santa Fe CFO Tom Hund, Vastar Resources CFO Steven Shapiro, Casey's General Stores CFO Jim Shaffer, and their counterparts place a high priority on converting sales to cash flow. Different as these three firms are, they all make cash-conversion efficiency one of the primary metrics by which they measure financial performance.

"We are in a capital- intensive, highly volatile commodity business with a depleting asset base," explains Shapiro, who is also senior vice president at Vastar. "That means we need a lot of cash flow to invest in replacing our assets, which are oil and natural gas reserves. Because we have no control over the price at which we sell our products, we focus on the things we can control. A basic, fundamental strategy of our company is to be absolutely as low cost as possible in everything we do. That's what we can give to our shareholders."

Give it has. Over the past five years, $1 billion Vastar, an oil and gas exploration and production company in Houston, has grown net income by an average of 11.1 percent per year on sales growth of just 6.1 percent, generating an average annual return on equity of 39.3 percent, according to Media General, or more than 10 times that of the independent oil and gas company industry.

Along the way, Vastar has also taken top honors in the fourth annual Working Capital Survey, a joint project between CFO magazine and REL Consultancy Group, a global management consulting firm headquartered in New York. The survey measures working capital efficiency at 1,000 public companies that posted 1999 sales of more than $500 million. The overall scores are based on an equally weighted combination of cash- conversion efficiency (CCE), which is calculated as cash flow from operations divided by sales, and days working capital (DWC), which represents a summary of unweighted days sales outstanding (DSO), payables, and inventory.

For the first time, the survey also measures average working capital over five years of published performance figures, rather than three. The results are encouraging. Over the past five years, the average company surveyed has reduced its days sales outstanding by 1.1 days, boosted its days payables outstanding (DPO) by 0.7 days, and improved inventory turns by 1.4 turns (4.5 days). Taken together, that equates to a 6.3-day improvement in DWC.

Stephen Payne, REL president, says some credit for the strong performance goes to a growing awareness of cash flow as an underlying indicator of business strength, as evidenced by the widespread embrace of value-based performance metrics such as Economic Value Added, cash flow return on investment, and even good old return on net assets.

Of the 33 industry groups examined, in fact, 26 showed improvement in days working capital, led by health-care equipment companies, specialty retailers, computer and office equipment makers, electric and gas utilities, and aerospace firms. All improved their DWC by more than 20 days, on average. Industries that failed to shrink their working capital included food companies (a gain of 4.5 days, the worst of the bunch), followed by transportation firms, petroleum companies, and food and drug stores.

That petroleum companies did poorly only throws into greater focus the outstanding performance by Vastar, a company that went public just six years ago and recently agreed to have its minority interest acquired by BP Amoco. In 1997, when we published the first Working Capital Survey, Vastar ranked 100th in days working capital at 13 days. This time, the company ranked 36th with just 1.5 days, versus an industry average of 40. And unlike some energy companies, which carry costly revenue-producing assets such as leased oil rigs off balance sheet, Vastar achieved its strong working capital results without any such sleight of hand.

"We have virtually no assets off balance sheet," explains Shapiro. "With a triple-B-plus debt rating, we find it more efficient to buy our equipment rather than lease it, and use the depreciation ourselves."

Vastar also boasts rock- bottom SG&A expenses that equate to about 11 cents per 1,000 cubic feet of natural gas. Vastar's main product, that gas currently sells for more than $4 per 1,000 cubic feet. Throw in production costs of about 44 cents per 1,000 cubic feet, and Vastar's total cash costs are still about 25 to 30 percent below the industry average, Shapiro says.

"Our goal is to be number one [in low costs] among large-cap independent exploration and production companies each year," he says. "We track that quarterly by reviewing everybody's financial statements, and we have been number one in almost every quarter for the last six years."

King of DWC
While Vastar ranked first overall in the 2000 Working Capital Survey, no company bettered $9.1 billion Burlington Northern Santa Fe (BNSF), operator of the second largest railroad system in the United States, in keeping working capital low. The company posted a remarkable ­57.2 days working capital, versus an industry average of 24. How the company did it is a story not only of industry dynamics, but of a concerted drive to reduce receivables outstanding as well.


"A lot of our performance in this area is driven by the fact that we have large accruals for payroll and benefit-related costs, such as health and welfare plans and medical accounts, as well as for purchases of long-lived assets," says BNSF senior vice president, CFO, and treasurer Tom Hund. "So like a lot of companies in this industry, we end up with very low or negative working capital. But what gets us deeply into the negative is what we've done with receivables."

For starters, the company makes it a practice to factor its receivables, anathema to some firms. But, says Hund, "the financing terms we receive on secured receivables are really quite good. As an alternative to commercial paper, it works a little bit in our favor, and as an alternative to long-term debt, it is quite favorable."

More important, the company has made the efficient collection of receivables a priority since struggling with it following the 1995 merger of Burlington Northern Inc. and Santa Fe Pacific Corp. that created Burlington Northern Santa Fe. At the time, bills were taking too long to get sent to customers, weren't always correct, and were often paid late. "We split receivables into two worlds, one of which we referred to as days-to-bill, the other as days-to-pay," Hund recalls. "On the days-to-bill side, we found that a lot of the problems centered on the timeliness and integrity of our data, so we addressed that with technology initiatives designed to eliminate errors and to get much of the billing process out of human hands."

Progress was phenomenal. During the company's worst period, in late 1997 and early 1998, it had about 50,000 bills on hand on any given day that were not rated and therefore not rendered to customers. Recently, that number has been around 15,000.

"On the collections side, the solution was really a matter of basic blocking and tackling rather than technology," Hund says. "Our average bill is a little over $1,000, so we have a lot of them. With some of our larger customers, we found that if they had a dispute with any of our bills, they wouldn't pay the whole batch. We said that was unreasonable, and started having the marketing arms of our business units work on why we had disputed bills and how we could correct them. We got great support from those folks. At the time, our days sales outstanding, by our calculations, was about 50. Now we've got it down to 29."

"As a general theme, we've become very cash-flow-oriented," Hund concludes. "After our merger in late 1995, we went through a period of years in which we were not generating free cash flow, because we had heavy capital expenditures. In 1999, we began generating free cash flow, and we've begun to focus on all the elements that drive it. For example, while a lot of companies forecast income, we go through a fairly rigorous cash forecast once a month. It covers everything from payables to receivables to inventory to revenue to everything else on the P&L side."

The benefit of free cash flow, of course, is that it allows the company to invest in its own business. "Everything falls like dominoes from free cash flow," Hund says. "It provides us with alternatives. Right now, the alternative of choice is buying back our stock; we're in the midst of a fairly substantial buyback program. But it could be increasing dividends or making acquisitions. All those things are not even on the radar screen if you don't have free cash flow."

Technology Titan
Jim Schneider, senior vice president and CFO of $25.3 billion Dell Computer Corp., would agree. His firm is legendary for its just-in-time inventory controls, which allowed it to post inventory turnover in this year's survey of 35.7, or the 46th best performance of the 1,000 companies surveyed. That's up from inventory turnover of 14 in the 1997 survey, which ranked it 153rd that year.

But the company wasn't always a cash machine. Schneider, who arrived in 1997, explains that in the mid-1990s, Dell was generating marginally positive cash flow or, in some cases, negative cash flow. "We were enjoying profitless prosperity," he says.

Fortunately, he found a company where paying attention to working-capital metrics was already a part of the corporate culture. So rather than change direction, the company put even more focus on cash flow. For example, Schneider took a domestically oriented asset management team in the United States and transformed it into a global financial services group that would share best practices with Dell business groups around the world. In the area of receivables, it prodded Dell's international operations to push harder for leasing and credit card payment plans, which lead to faster payment of receivables.

Schneider also pushed responsibility for collecting receivables into the business units, where it could be best handled by the people closest to the customers, while retaining a centralized structure for accounts payable, with one accounts payable center for all of the United States, one for Europe, and one for Asia.

Meanwhile, Dell also continued to refine its Web-based supply-chain structure.

"One of the biggest benefits from keeping inventories down was that it allowed us to capture declines in component costs very efficiently," observes Schneider. "The less inventory we had as component costs declined, the better off we were. That led to bigger cash balances, more interest income, and the chance to take that cash and invest it in ways that benefit our shareholders." Schneider notes that Dell has invested $800 million in Dell Ventures, a venture capital operation; and, from February 1996 through April 2000, it bought back 817 million of its shares at a cost of $4.6 billion.


In a feat rare for a company so large and fast-growing, Dell posted better numbers in every category of our survey this year when compared with last year, including a decline in DWC, from 13.6 to 9.3. That ranked it third in its industry group, behind Cisco Systems Inc. and Adaptec Inc.

Conversion Factors
Unlike Dell, Cisco wasn't able to improve in every category of our survey this year. But the $12.2 billion (fiscal 1999 revenue) company, which makes three-quarters of the world's routers, switches, and related computer-networking equipment, did find a way to convert more of its sales to cash last year. Its CCE rating of 27.8 percent was up from 25.6 percent in 1999, and was good enough to rank it first in the computer office equipment category for the second consecutive year and 61st overall.

Interestingly, Cisco vice president and treasurer David Rogan credits Dell, indirectly, for a role in Cisco's good performance. "About two-and-a-half years ago Tom Meredith, who was Dell's CFO at the time, came to talk at one of our financial managers' meetings and mentioned that Dell was doing a much better job of managing its working capital than Cisco," Rogan explains. "He sort of threw down the gauntlet, and it prompted us to start improving our inventory turns and DSO. Since then, we've made a concerted effort to do that, with this important caveat: we do not want to do anything in the inventory area that would impact customer satisfaction with regard to getting shipments out on a timely basis, or that would inhibit our growth in any way."

To drive down its DSO, Cisco thoroughly reexamined its activities and discovered problems in its accounts receivable practices. Most important, it learned that its customers were not always looking at the same information available to its own staffers, which led to inevitable disputes over how much was owed and when. Cisco responded by developing a Web-enabled information system that allows customers to look at the same information available to its accounts receivable staff. "Now, we also try to prompt our customers, between days 10 and 15, to look at what we're looking at," says Rogan. "If there are any issues outstanding with regard to an invoice, we can get those issues raised before the money is actually owed to us, and hopefully get them resolved before day 30."

Cisco also now sets weekly, monthly, and quarterly goals for its accounts receivable teams in which the target is to have no more than 10 percent of cash accounts receivables more than 30 days past due. Rogan reviews the numbers weekly, and teams that meet their goals are recognized with a Cisco Achievement Award, which carries a modest monetary incentive.

"In a sense, this sort of recognition for cash flow and DSO actually goes all the way to the top [of the executive ladder] because our investors look at that as a way to gauge the overall health of our business," Rogan says. "To the extent we can keep our working capital in good shape and in particular our DSO and inventory turns, investors understand that the business is well managed."

Casey's at the Cash
Casey's General Stores Inc., a $1.3 billion operator of more than 1,100 convenience stores, could hardly be more different from Cisco or Dell in terms of size or sex appeal. But like Dell, it works with an exceedingly low amount of working capital (­0.6 days in the latest survey), and like Cisco leads its industry group in CCE, at 5.9 percent. (While the company is only a middling performer in that category overall, the average CCE for its industry group, food and drug stores, is only 2.9 percent.)

Also like Dell, the company credits corporate culture for its success in controlling working capital. "We're not so much managing our cash flow as we are managing our business," says Casey's vice president and CFO Jim Shaffer. "The cash flow follows from the way we do that."

A number of factors conspire to allow Casey's to perform with little or no cash tied up in working capital. One is its line of business, another is the way it prosecutes that business. "Not only are we a convenience-store operator, but we also run our own distribution center, while most of our peers buy through wholesalers," Shaffer explains. "Because we run our own center, we are very conscious about managing inventory, and will turn our warehouse 27 or 28 times a year."

Combine an inventory that is held only about two weeks with 30-day payables, and Casey's is able to sell most of its products, usually for cash, before it must pay for them. The same holds true for gasoline, which accounts for about half the company's revenues. Casey's stocks about five days' worth of gasoline sales in its tanks at any one time, but has 10 days to pay for its gas purchases.

Still, tight ships aren't run on serendipity alone. Shaffer ventures that the company has probably never missed an early-payment discount on payables, a practice he credits with bolstering relationships with its suppliers. "They know we're prompt to pay, and I think they take that into consideration when negotiating with us for space in our stores," he says.

Shaffer also notes that store managers can be confident of receiving "about 99.5 percent" of everything they order from the company's warehouse each week, despite its aggressive turnover rate. And while it may not contribute directly to cash flow, the timeliness of those deliveries speaks volumes about the Casey's approach to doing business. "Those orders get delivered within 15 or 20 minutes of the same time, the same day, every week," Shaffer says. "We're very consistent."


And that, of course, is what working capital management is all about. By consistently pushing the envelope on inventory turnover and artfully managing accounts receivable, the companies that do the best job of converting sales to cash today also give themselves the best chance of succeeding tomorrow.




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