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How Low Can It Go? The 2006 Working Capital Scorecard

Companies continue to reduce working-capital levels, and they have 450 billion reasons to keep at it.
Randy Myers, CFO Magazine
September 1, 2006

Download the 2006 Working Capital Survey PDF

Asked to explain his company's success at driving down working-capital levels, Qualcomm CFO William Keitel demurs, saying, "You can always do better."

He's not being humble so much as capturing the dominant theme for working capital over the past several years. In 2005, for the fourth consecutive year, the 1,000 largest publicly traded companies in the United States managed to reduce the amount of money they had tied up in working capital as a percentage of sales. Data compiled for CFO by Hackett-REL, the Total Working Capital Practice of The Hackett Group, indicates that days working capital (DWC) for the average company shrank by 5.6 percent last year, following a 3.6 percent decline in 2004. Excluding the auto industry (which can skew results because of the huge lending arms the major players operate), the average decline last year was 4.0 percent, versus 2.5 percent in 2004. This was far better than the performance in Europe, where the average large company's DWC declined just 0.5 percent.

While many companies are riding this wave of success, the courses they have charted vary considerably. Some have achieved reductions by improving customer communication, others by adjusting their collections processes, and yet others by tying incentive compensation more closely to a successful reduction in working capital.

That approach, says Hackett-REL president Stephen Payne, may become more common. Not only has the rate of improvement jumped markedly between 2004 and 2005, he says, but the trend will continue "for at least the next few years." The reason: a stronger focus on working capital and free cash flow by the analyst community. That, Payne argues, has translated into "an increasing number of companies adding a cash-flow-based component to the variable compensation of executives, which will ensure that the focus continues."

And despite the consistent improvements by companies, Keitel's point that they can always do more appears to be on target. Hackett-REL calculates that the nation's 1,000 largest companies still have about $450 billion unnecessarily tied up in working capital in the form of past-due receivables, vendor invoices that were paid too early, and excess inventory.

Payne says that while it was difficult to discern much difference from one industry group to another last year — 43 sectors showed improvement in DWC, 35 worsened, and 4 were unchanged — there was a clear trend in companies making more progress in receivables than in inventory. Excluding the auto sector, the average company enjoyed a 3.9 percent reduction in days sales outstanding (DSO), versus a 2.6 percent reduction in days inventory outstanding (DIO). Payne offers two possible explanations. First, CFOs can make an impact on receivables far more directly than they can on inventory. That can prompt them to look to receivables as a starting point for working-capital improvement not only because it's more directly under their control but also because they may want to get their own house in order before telling other managers how to do their jobs. Second, as more and more companies embrace offshore manufacturing, they sometimes need bigger inventory buffers to account for the sheer distance that goods must be moved, particularly during periods of unexpected demand.

Best and Worst
Changes in DWC (% by industry)
Most Improved 
Distributors-12%
Pharmaceuticals-11
Chemicals (Commodity)-9
Containers/Packaging-8
Medical Supply-8
Telecom-7%
Worst Deterioration 
Cosmetics/Personal Care+38%
Newspapers+11
Software+11
Food producers+9
Computer makers+5
Household appliances+5
Other specialty retailers+5%
Source: Hackett-REL
Top Performers
Companies with substantial year-on-year reductions in DWC
($ millions)
 2005
ExxonMobil$4,545
*Caterpillar2,390
Cardinal Health1,698
Chevron Texaco1,369
McKesson1,149
General Electric1,007
Altria984
SBC Communications$924
* Weighted DWC reduction represents the total amount of cash released from working capital.
Source: Hackett-REL

How Companies Succeed
Regardless of where the focus lies, working capital represents cash that is encumbered and therefore not available to grow the business. That's why Keitel and his finance team at Qualcomm closely track key working-capital metrics at the $5.7 billion provider of digital wireless-communications products and services. Last year, they helped pare their company's DWC figure by 34 percent, to 22.2 days, or two-thirds less than the 61-day median for the communications-technology industry. This followed a 10 percent reduction in 2004.


Keitel credits a "continuous improvement" mind-set rather than any single breakthrough for the company's success. "We focus first on quality and customer service, and second on cycle times," he says. "If people do that, we're going to have good results, low costs, and high efficiency."

That's not to say that working-capital improvements magically accrue. Keitel concedes that his team did work at improving the accuracy of invoices last year, and also the way it communicates with customers who owe money. In the latter case, that meant providing more training to collections specialists, having them communicate with customers more frequently, and making sure they were better prepared for their conversations with customers when they did contact them. The net result was a significant improvement in Qualcomm's DSO, which was down 19 percent last year to 35 days, or just over half the median for its industry.

Of the 82 industry groups examined by Hackett-REL, only 12 managed to post a double-digit decline in DWC last year. Among them were distribution firms, which notched a 12 percent improvement. Brightpoint, a $2.1 billion distributor of mobile phones and other wireless products, pared DWC by 31 percent to a sector-best 13.1 days, or less than one-third its industry median. It also reduced DSO by 18 percent. Brightpoint CFO and treasurer Anthony Boor says the improvements reflect the continuation of an effort begun in 2000, when the company faced a call on some of its bonds and wasn't certain it would have the cash to buy them back.

"We really needed to clean up our balance sheet and squeeze out as much cash as we could," says Boor. Ultimately, the company succeeded in pulling the funds it needed from its balance sheets around the world, and in doing so it recognized that it needed to dramatically pare its working-capital levels. Brightpoint focused first on bringing its U.S. operations up to snuff and is now leveraging its newfound expertise across its international operations.

That effort boils down to people and processes. In addition to hiring and training new credit and collection personnel and equipping them with state-of-the-art technology, Boor says the company fundamentally rethought its approach to collections. "In the earlier days, we focused primarily on the collection effort itself," he explains. "In the past two years, we've made a bigger investment in the credit granting and monitoring capabilities of our businesses. We've learned that even the best collection specialists can't collect on somebody in a poor credit position."

A happy byproduct of this effort: the company has been able to reduce the number of credit collectors it employs. It also decided to outsource past-due accounts to third-party collectors earlier than it used to. "We found that by outsourcing more quickly on those accounts we knew would be hard to collect, we ended up with more money in our pocket," says Boor.

Brightpoint also reduced its days payables outstanding (DPO) by 5 percent, to 39.6 days, about the industry median. While the converse approach — stretching out your payables rather than shrinking them — is a "tool in your toolkit," Boor says it is not one he likes to use. "It's not going to help your relationship with your vendors, or make them more comfortable granting you more credit down the road, or in providing references to other potential vendors," he says. "We're focused on streamlining our supply chain instead of stretching payables. We have a saying here that inventory is like a melting ice cube; the longer you hold on to it, the less it's worth."

To keep its ice from melting, Brightpoint began using supply-chain-management software two years ago to improve internal forecasting and better manage its inventory. More recently, it has been working with customers to pull their sales data into that system. Eventually, the company hopes to extend the system to its manufacturers as well, so that they have real-time access to Brightpoint's inventory data. Beyond reducing inventory and speeding operations, Boor hopes these efforts will help to solidify Brightpoint's relationships with its customers by making the company integral to their own supply chains.

Bonus Time
Nucor, a $12.7 billion steel company that has managed to thrive in an industry that has laid low many of its former competitors, drives its working-capital improvements the old-fashioned way — by affixing a juicy carrot to them. Last year, Nucor trimmed its DSO 7 percent and reduced DIO 32 percent en route to a 25 percent improvement in DWC, which now stands at about two-thirds its sector median. Corporate controller Jim Frias attributes the short-term improvement largely to a global spike in demand in 2004, when steel manufacturers and their customers worried that there would not be enough steel to go around. "The price of scrap steel, which is our main feedstock, was rising by leaps and bounds starting in late 2003, so in 2004 we intentionally built inventories while we rode out this volatile period," says Frias. "By 2005, we were used to this new environment and became more comfortable with our ability to get material, so our divisions, without corporate direction, skinnied themselves down."

But that brief spike doesn't explain Nucor's consistently good working-capital performance. For that, look to the company's incentive-based pay system. "Our production employees are paid a bonus based on what they produce," Frias says, "but all the folks not directly tied to the production process are paid based on the return on assets for their business unit." Each plant, he explains, has its own controller, credit manager, sales manager, production manager, and general manager, all working together to "maximize working-capital efficiency, because that's the thing they have the most control over that improves their bonus. Everything they do, from making credit decisions to collecting cash, is done knowing that if they maximize profits and minimize assets, they'll have a better bonus."


From collecting receivables more efficiently to carrying less inventory, Frias says the quest for a "lower asset number" is on everyone's mind. And for good reason: Frias says a manager can double his or her salary through the return-on-assets bonus, and nonmanagers can reap about a third of their base pay.

Payne says that companies like Nucor provide a model that more companies will follow. "When push comes to shove," he says, "people are going to strive toward the things that give them the greatest rewards."

No one knows how much of that estimated $450 billion in potential improvements companies will ultimately achieve, but expect the focus on working capital to continue unabated. "The journey and the drive to get better never stops," observes Payne. "World-class companies understand that the best get better."

Randy Myers is a contributing editor of CFO.


How Working Capital Works

Days Sales Outstanding: AR/(net sales/365)
Year-end trade receivables net of allowance for doubtful accounts, plus financial receivables, divided by net sales per day.
A decrease in DSO represents an improvement, an increase a deterioration. Companies marked with an asterisk have securitized receivables, which can artificially improve DSO without changing actual customer-to-cash processes. The survey eliminates this distortion by adding receivables back on the balance sheet before calculating DSO.

Days Payables Outstanding: AP/(net sales/365)
Year-end trade payables divided by sales per day.*
An increase in DPO is an improvement, a decrease a deterioration. For purposes of the survey, payables exclude accrued expenses.

Days Inventory Outstanding: inventory/(net sales/365)
Year-end inventories divided by sales per day.*
A decrease is an improvement, an increase a deterioration.

Days Working Capital: (AR + inventory - AP)/(net sales/365)
Year-end net working capital (trade receivables plus inventory, minus AP) divided by sales per day.
The lower the number of days, the better. In the charts, a DWC change of -X% represents an improvement (even if DWC itself is negative), while a DWC change of +X% represents a deterioration. The percent change is marked NA (Not Applicable) if DWC moved from a positive to a negative number or vice versa.

*Note: Many companies use cost of goods sold instead of net sales when calculating DPO and DIO. The Hackett-REL methodology reflected on the working-capital charts uses net sales across each working-cap component to allow a balanced comparison across each DWC element and provide true comparison between industries. Reported sales have been adjusted for acquisitions and disposals during the year.




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