Supply Chain

Big Working Capital Opportunity Seen in Europe

European companies could get almost €900 billion out of their balance sheets through better working capital management, research suggests.
Andrew SawersJuly 24, 2012

European companies could improve their working capital by almost €900 billion in aggregate through better management of their receivables, payables, and inventory, a consultancy specializing in working capital management has calculated.

REL, part of the Miami-based Hackett Group, has analyzed the accounts of 925 companies across Europe and found that working capital performance increased slightly in 2011 (or, in fact, remained almost flat, if you exclude the volatile oil and gas sector), but that there is still €886 billion that could be squeezed out of working capital and added to corporate cash piles. That’s equal to 12% of total company sales.

The analysis found that top-performing companies have about half the working capital of typical companies, collect from customers 16 days faster, pay suppliers 16 days slower, and hold about half the inventory.

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When you look at the detail, what’s particularly interesting is the potential upside:

  • On days’ sales outstanding (DSO), companies in the top quartile have 30% less working capital than the median (37.1 days versus 52.8) — equal to €42.9 million of cash flow per €1 billion of sales.
  • On days’ inventory outstanding (DIO), top quartile performance is 67% better than the median (12.7 days versus 38.6), equal to €70.9 million of cash flow per €1 billion of sales.
  • On days’ payable outstanding (DPO), top quartile performance is 47% better than the median (52.9 days versus 36.1), equal to €46.2 million of cash flow per €1 billion of sales.
  • Overall, then, top quartile days’ working capital (DWC = DSO + DIO – DPO) is 54% better than the median (24.6 days versus 53.8), equal to €159.9 million of cash flow per €1 billion of sales.

(As defined by REL, DSO is year-end trade receivables net of allowance for doubtful accounts, plus financial receivables, divided by one day of average revenue. A decrease in DSO represents an improvement, an increase a deterioration. DPO is year-end trade payables divided by one day of average revenue. An increase in DPO is an improvement, a decrease a deterioration. REL defines DIO as year-end inventory divided by one day of revenue. DWC is accounts receivable + inventory – accounts payable/total revenue/365. The lower the number of days, the better.)

Aggregating the firm’s findings, REL calculates the total opportunity through better working capital management:

  • Receivables opportunity: €316 billion
  • Inventory opportunity: €288 billion
  • Payables opportunity: €282 billion
  • Total working capital opportunity: €886 billion

To be sure, different companies have different working capital dynamics depending on their industry sector and business model. But the variation, even within sectors, shows there is no shortage of benefits to be had through better working capital management. Portugal Telecom, for example, has 45 days’ working capital, while BT Group has -25 days. Fiat Industrial’s working capital is tipping the balance sheet scales at 229 days, while Volvo has just 18 days.

Gavin Swindell, European managing director of REL, tells CFO European Briefing, “You still find a lot of CFOs are uninterested in this subject, particularly when they’ve got cash. But why is that an excuse to waste money on working capital? Your shareholders should be appalled. It’s no excuse to waste money that’s sluicing around the system sitting in somebody else’s pockets.”

Swindell adds that companies typically look at this as a period-end issue: their focus is on balances, not flows or processes. “I don’t think they’re doing it cynically just to make the numbers look good, but what’s driving that behavior? It’s because someone has told you, ‘Don’t forget about the cash metric.’ It’s still something that comes second.”

Whether it’s because the focus just isn’t there, or whether it’s because it’s simply a harder thing to work at than most companies expect, sustainability of achieved results remains a problem: only 99 out of the 925 companies included in the research managed to improve their days’ working capital position every year for three years. Of those, not a single one managed to improve all three components of working capital — DSO, DPO, and DIO — each year for three years.

It’s notable that, as European companies came out of the recession, their working capital management fractionally improved by 0.7 days: revenues increased by 10.7% but net working capital increased by just 8.8%. The improvement in DSO from 52.1 in 2010 to 50.9 in 2011 was slightly offset by the worsening in DIO from 38.3 to 38.7. DPO remained flat at 45.5.

Sectors and Companies
Electric utilities saw a notable improvement in working capital, from 27 days in 2010 down to 21 last year. Trasmissione Elettricita Rete Nazionale of Italy was particularly impressive, turning negative working capital of 7 days into negative working capital of 72 days. Most companies in the sector improved, though Electricité de France wasn’t one of them: its working capital opportunity is estimated at almost €26 billion, equal to one third of the European sector.

The wireless telecommunication services sector managed to get its small 8 days’ working capital down to zero with particularly good performances from Dutch group VimpelCom and the UK’s Vodafone. Diversified telecommunication services went from 7 days in 2010 to -2 last year, but Deutsche Telekom and Telefonica could each get an extra €4 billion out of their working capital, REL estimates.

Sectors that struggled with working capital included specialty retail — 26 days in 2010, up to 36 in 2011 — and energy equipment and services, 64 days up to 79.

Andrew Sawers is editor of CFO European Briefing, a CFO online publication.


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