Print this article | Return to Article | Return to CFO.com
Acquiring and managing accurate data on working capital is the first step toward improved performance. New, custom metrics and greater transparency can demonstrate the importance of working capital management to the overall business.
Eric Laursen, CFO Research Services
December 29, 2004
Understanding working capital starts with data. Korn/Ferry International, the executive recruiting firm, used an SAP database to build a capability "to look every day at how much new business is booked across the world," says COO and CFO Gary Burnison. "We've also got an online analytical system that consultants can go to from their desktop and actually see, in real time, their book of business and all the activity in their clients' accounts."
Korn/Ferry began developing a tighter grasp of its working capital performance two and a half years ago, when the firm went through a major consolidation, cutting its personnel worldwide from about 3,000 to some 1,400. Better data reporting through an enterprise resource planning (ERP) system by the 150 or so legal entities through which the firm operates around the world — and better understanding of that data — are the reasons Burnison says Korn/Ferry has been able to cut its average DSO from 60-70 days down to 44.
At The New York Times Co., DSO and days payable outstanding (DPO) are broken down differently than in other industries: DSO is calculated as advertising DSO, circulation DSO, and other DSO; DPO as trade DPO and raw materials DPO — the latter mostly for the newsprint used in newspaper production.
Reports on all six metrics go out each month to the senior executives and financial officers at all 30 of The New York Times Co.'s operating units. Mention of DSO performance often finds its way into senior management's monthly operations meetings, and even occasionally into presentations to securities analysts.
At Keane Inc., an information technology services company where top management began focusing on working capital improvement four years ago, the corporate finance office sets DSO targets by business unit and sometimes by individual client. When the days outstanding number goes up for a particular business unit or client, the matter moves to a cross-functional team that decides how to address the problem. The team includes representatives from field operations and sales, finance, treasury, billing, and accounting.
Keane also had its internal systems team develop analytics that break down DSO by geography and individual client. And it created an internal Website that explains and disaggregates DSO calculations and allows business unit operating teams to build what-if scenarios about their clients' behavior.
The result of all this deeper knowledge: DSO reduced from an average of about 95 days in 1999 to 53 days as of the end of the second quarter of 2004, says Mate Converse, Keane's vice president of finance.
One change Keane made was to pick DSO apart, analyzing days to bill and days to collect to figure out whether the inefficiencies were in its billing or its collections process (see chart). But while DSO is among the most-used metrics in the working capital toolkit — over 75 percent of respondents to the CFO survey cite it as important — some companies have designed new measurements tailored to their particular business. Eastman Chemical Co. — which pays a price for keeping some chemicals in inventory too long — looks at days inventory outstanding, in addition to the more common inventory turns, and breaks out inventories for specific raw materials.
The Walt Disney Co. has developed several new metrics to fit the fact that as a diversified media company it pulls in revenue from many different streams: advertising from broadcast and cable TV commercials and print media, box office receipts, merchandise, theme park tickets and hotel receipts, and so on.
"From the day an invoice becomes due to the day it gets paid is what we'd like to measure — how efficient are they?" says Kathy Clark, vice president of credit and collections at Disney. Accordingly, it uses a collection effectiveness index (CEI), which represents the total amount of money currently billed that should be collected. The important number is the percentage of that total Disney has collected over a given period. Another is days to close, a measure that Disney created, which day-weights the number of transactions outstanding, from the day an invoice is issued to the day payment is actually received. Knocking, say, one day or half a day off that figure generates significant improvement, says Clark.
Better data allows finance executives to monitor business units' performance on accounts receivable more closely and bring pressure to bear where it's needed. Stoller sends a monthly report to financial executives at each of The New York Times Co.'s business units with a note summarizing the trends he is seeing in each of these areas. When he sees a problem, he sends a follow-up note to the CFO of the unit in question.
The variety of metrics that companies use to measure their working capital performance doesn't always help them benchmark against each other, however. For example, Eastman Chemical found that it was difficult to compare its trade accounts payable numbers against other chemicals companies' numbers, because the accounting rules allow a lot of flexibility in how current liabilities can be shown on the balance sheet, requiring the reader to look carefully at the footnotes for details. So treasurer Mary Hall assigned a staff member last year to look deeply into some 15 companies' annual reports and 10-ks and to figure out how to align comparable data to create a trend line showing how best performance shifted over time. What she found: "We stack up pretty well — not best in class, but kind of in the average-to-better end of the scale."
The good news is that better metrics and a stepped-up working capital reporting calendar don't have to cost a fortune. Often, a company just needs to make better use of the analytic and database resources it already has. "We've helped several large clients in the forecasting arena to develop Excel-based models that work very well," says Susan Skerritt, partner at consulting firm Treasury Strategies. These work well as long as the reporting processes behind them — the "non-technological elements" — are well-designed and focus on data that really helps the company to achieve its goals.
The New York Times Co. consolidates information on all of its customer accounts in a Lotus Notes database that it maintains on a shared area of its corporate intranet, where people can also post collection trends and relevant data from customers' credit files. Keane says it did not have to purchase new software while putting its new system into place. And at The Walt Disney Co., enhancing working capital reporting merely meant creating a simple "dashboard" that allows Disney credit and collections executives worldwide to post once-a-month reports on their non-adjusted accounts receivable and collection activity over a certain dollar amount.
Transparency Is Crucial
It's how the numbers are used, and who sees them, that make the difference. "Probably one of the biggest things we've embarked on recently is to develop metrics that increase the transparency of performance and publish those metrics so that everybody sees where everybody else is," says Jim DeLess, vice president and treasurer of Total Holdings USA Inc., the U.S. subsidiary of the French oil and chemicals giant. "Those numbers are looked at scrupulously on a monthly and daily basis" by top management from the U.S. subsidiaries, DeLess adds.
Attention at the CEO level not only adds pressure to perform better but encourages executives at the business units to understand how their working capital performance fits into the parent company's model for creating shareholder value. In some cases the negative experiences of the current economic downturn have enforced this lesson. The shipping industry was rocked by two large bankruptcies several years ago that Andreas Rothe — CFO of global container transportation company Hapag-Lloyd North America Inc. — says were tied directly to delinquent accounts. These prompted Hapag-Lloyd and other big container shippers to stop extending any credit for imports, and instead demand cash up front. Since then, working capital has been "extremely high in importance," says Rothe. "I look at it every second or third day when I don't travel," he adds — and the president of the company reviews the top accounts that are past due every week.
In other cases, the way the business has grown forces management to think about the impression that working capital performance makes on shareholders. At biotech company Invitrogen, "We spend a lot of time talking about how the cash you collected funded the products we just acquired from that new company — products that you're now able to go out and sell, and achieve a higher variable comp payment," says Travis Chester, vice president of finance. "And so we keep repeating that those collections are a direct contributor to shareholder value."
Better metrics make it possible to draw these connections, and in turn to link executives' compensation to their working capital performance, completing the chain of incentives that companies are creating. Indeed, nearly three out of four survey respondents say they either currently tie compensation to improvements in working capital management or plan to do so in the next two years. The proportion of compensation at risk is usually not large — perhaps 5-10 percent of the overall formula, say executives interviewed for this report — but it serves to increase individuals' awareness of their responsibility.
Not every company takes the best possible approach, notes Stephen Payne, CEO of REL Consultancy Group. "Working capital is now one of the key metrics that senior executives get rewarded on," he says. "But it's at a point in time — as of the end of financial year — whereas what we'd like to see is for it to be measured on the average of the 12-month period. Because if you work hard and generate $12 million of free cash flow in November and December, you don't want to just give it back in January."
In either case, however, adding working capital metrics to compensation formulas makes the whole area more visible. As part of its working capital overhaul, The New York Times Co. added DSO, among other items, into the benchmarks that it uses in the annual bonus computation for certain executives. The result, says Stoller, is "focus and visibility. People need to know why they're doing something, what it means to the company, and what it means to them."
Keane has added a DSO target alongside the revenue target in its compensation formula for business unit executives — and particularly for its salespeople, who are now expected to help accounts receivable address the problem when customers become late payers. Eastman Chemical has DSO targets for the heads of its divisions and business units that are a component of their performance evaluations. Hall, the treasurer, says these targets are essential for translating corporate-level goals for working capital improvement into sustainable, everyday practices.
Some companies use more tailored metrics. For example, fragrance company Coty Inc. uses management cash flow, which measures cash flow capability at the local level using only those variables the local business unit is able to control. Kellogg Co. uses percentage of net sales — the 12-month average of receivables and inventories, less the 12-month average for payables, divided by the last 12 months of sales performance.
Either way, the incentives have to be linked to every individual who touches the working capital process, some executives say. At Merillat Industries LLC, a manufacturer of kitchen and bathroom cabinetry, "it's top to bottom," says CFO W. Jay Potter. "Even our accounts payable clerks' compensation includes days purchases in payable metrics, because a lot of what they do affects how quickly you issue the check."
This article is excerpted and adapted from Excellence in Working Capital Management, a report that summarizes the findings of a mail survey of executives at 196 companies and in-depth interviews with executives at 16 companies. CFO Research Services and GE Commercial Finance developed the hypotheses for the research jointly. GE funded the research and the publication of the findings; CFO Research Services produced the final report. You may download a copy of the full report by filling out a brief form.