Supply Chain

Free Cash Profiles: Consumer Products

Tepid demand is putting a choke hold on the cash flow of consumer products companies.
David KatzFebruary 3, 2012

For quite a while now, consumer spending has been flagging. In December, despite the holiday season, personal consumption expenditures decreased by $2 billion, according to the U.S. Commerce Department. That followed tepid increases in October and November.

While lukewarm demand is putting a choke hold on the cash flow of many companies, it seems to be bearing down particularly hard on that of consumer products companies, says Charles Mulford, a Georgia Tech accounting professor and director of the Georgia Tech Financial Analysis Lab.

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In fact, the consumer products industry recorded an especially bleak median free cash profile (FCP) of  -8.14% for the trailing 12 months ended with the September 2011 quarter.  Based on data provided by Cash Flow Analytics LLC and developed by Mulford, the profiles provide a snapshot of a company or an industry’s ability to spawn free cash flow as it grows. (See chart and “How the Free Cash Profile Works” below.)

Countering the truism that growth tends to consume free cash, the metric shows that many organizations can actually generate free cash as they expand.

That’s not the case in the consumer products business, however. True, the industry’s negative profile can be attributed to the fact that it’s based on September-to-September figures. And autumn, when consumer products companies are building up big inventories in preparation for heavy year-end sales, is a time when such companies gobble up cash rather than produce it. 

Even if you correct for the effects of seasonality, however, the business still doesn’t sport a bright profile: its annual FCP was   -1.14% at the end of 2010.  In contrast, the overall median profile for all non-financial companies with revenues in excess of $100 million was +4.95%.

For the current snapshot, Mulford identified five main sub-industries that each had enough companies to provide a meaningful look: cosmetics and personal care, household cleaning supplies, household furniture and fixtures, appliances and house wares, and photographic equipment and supplies.

The companies with the highest FCPs include household names like Colgate Palmolive, Proctor & Gamble, and Whirlpool. The high fliers among a target group of middle-market companies (annual revenues of $300 million to $800 million) include Select Comfort, a bed manufacturer, and iRobot, which makes automatons for home and military use. The latter two companies featured particularly impressive scores in operating working capital to revenue – -7.25% and 1.81%. (When it comes to working capital, lower is better.)

Like the FCPs of most other sectors, the profiles of consumer products companies are determined most by working capital performance and revenues. While companies may have the ability to drive growth in sales, however, they’re stuck in an industry that’s heavy in inventory and receivables and light in bargaining power with vendors.

That spells inevitably weak working capital performance for the industry as compared with other sectors. Like the consumer products business, retailers, for example, must carry heavy inventories. But retail outfits can balance those backlogs with easily obtained cash and credit card payables – an advantage unavailable to consumer products makers, who often hang on to receivables due from distributors for lengthy periods. (Working capital is inventory plus receivables, minus payables.)  

Further, consumer products corporations tend to be smaller than their peers in other industries. “Smaller companies don’t have the same kind of power over their vendors” in terms of slower payments, says Mulford, “and they can’t finance very much of their working capital needs with vendor money [such as payables] like much larger firms can.”

For all those reasons, consumer products need bigger-spending customers.  “If we’re to see this industry move toward a positive free cash profile,” he says, “it’s going to require more consumer spending to give these companies a little more pricing power. That will translate into better sales at higher margins.”