Management Accounting

Good to the Last Drop

Even though revenues are scant, plenty of cash remains to be squeezed from supply chains, says a new study.
David KatzMarch 12, 2010

Despite the overall lack of top-line growth during the economic downturn, many companies have stayed afloat by downsizing staff and eking out supply-chain efficiencies. In the face of continuing unemployment and the attendant lag in consumer demand, however, how long can companies maintain respectable margins merely by growing leaner?

Maybe longer than you might think. Opportunities still abound for doing more with less, according to a new study of the 1,000 largest U.S. companies (in terms of sales) by REL, a division of The Hackett Group. Indeed, the study concludes that those companies could wring a total of as much as $709 billion in excess cash flow from their supply chains by adjusting their inventory levels, getting their customers to pay their bills on time, and managing their accounts payable carefully, according to research on working capital for the third quarter of 2009. (Sizable as that number is, it’s considerably smaller than a year ago, when the same group of companies had an opportunity to take $854 billion out of their working capital.)

REL arrives at the $709 billion figure by calculating what would happen if all of the 1,000 companies could attain the working-capital performance of the top 25%. The biggest opportunity for improvement lies in the area of inventory, where REL reckons about $286 billion could be cut. The companies could also pick up $241 billion by doing a better job of collecting from their accounts receivable and $182 billion by managing their accounts payable more prudently.

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Cutting down on the amount of cash tied up in working capital (current assets minus current liabilities) is a good thing because it increases the amount of cash available for a company to invest in itself or return to its shareholders. During the downturn, companies have placed more emphasis on getting more usable cash this way because the ability to do so by producing more revenue has diminished.

At the same time, the opportunity to trim working capital has dropped because of the sales slump. Between the third quarter of 2008 and the same period of 2009, revenues for the group fell from $2.6 trillion to $2.2 trillion, providing a smaller pie from which to cut. Says Mark Tennant, president of REL: “If the overall magnitude of business decreases, you’d expect working capital to decrease, but by how much? If it’s decreasing proportionally, that’s fine. But if it’s decreasing at a slower rate [than revenues], that indicates issues within the business.”

By that measure, companies are cutting fast enough to keep up with revenue declines. In the third quarter of 2009, net working capital as a percentage of revenue rose by only 1% from the same period in 2008, from 8% to 9%. Further, working-capital performance, defined as inventory plus accounts receivable minus accounts payable, improved to $775 billion in the third quarter of 2009. That’s a productive decrease from the $784 billion recorded in the second quarter and the $864 billion recorded in the third quarter of 2008.

Nevertheless, Tennant believes that many companies have “muscled down” their working capital by taking short-term actions and setting tougher goals for accounts payable and receivable and for keeping inventory low. While such actions as delaying payments to suppliers and stopping production may have made sense at the time, they won’t improve companies’ ability to adjust to revenue opportunities just around the corner. To be nimble enough to adjust to sudden shifts in customer behavior, companies need to zero in on demand planning and forecasting and build more flexibility into their supply chains, according to Tennant.

Unless they move to more “sustainable” working-capital management, companies run a risk if their response to economic recovery is overly euphoric, Tennant contends. “The immediate risk would be if we start to take off the controls in terms of buying and producing, and we blow our inventories at a rate faster than we increase the absolute business,” he says. And that could happen, he notes, by companies “not producing according to true demand, but rather just producing.”


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