In trying times, the old adage “cash is king” is never truer. For CFOs, ensuring their organizations’ working capital management strategies and processes are best-in-class is again a high priority. After all, tighter working capital performance means well-timed inflows and outflows of cash, essential for companies operating on a small cushion of safety.
Heading into the COVID-19-induced recession, though, working capital was not as optimized for many companies as it could have been. According to the 2020 CFO/The Hackett Group Working Capital Scorecard, the 1,000 largest U.S. companies had lots of room for improvement — nearly $1.3 trillion in capital needlessly tied up in receivables, payables, and inventory, about 10% of their combined 2019 revenue.
That’s good and bad news for 2020. Good because there’s room to raise cash levels and manage cash flows better simply from process improvements; bad because sloppy working capital practices may be hard to clean up, especially when management is focused on the business’s pure survival. The upshot? This year could be the most challenging on the working capital front for quite some time, as suppliers battle to get paid, customers delay remitting invoices, and past inventory methods become outdated.
The Data Says …
The CFO/Hackett Group Working Capital Scorecard, run annually for two decades, calculates the working capital performance of the largest nonfinancial companies based in the United States. Data is pulled from companies’ latest publicly available annual financial statements.
It’s somewhat understandable that finance departments weren’t too worried about working capital metrics in 2019. Cash on hand for the 1,000 companies rose 12%, the highest amount in 10 years, and debt increased similarly. Historically low interest rates made it easy to finance operations if cash didn’t flow smoothly.
Metrics like the cash conversion cycle (days sales outstanding plus days inventory outstanding minus days payables outstanding) became not so important, at least in some organizations. The CCC for the 1,000 companies crept up 2%, to 33.4 days.
Inventory and payables performance caused the lengthening of CCCs. Days sales outstanding (DSO) rose to 38.4 days from 37.6 days. Days inventory outstanding (DIO, or days inventory on hand) also bumped up, to 50.6 days from 50. (See “How Working Capital Works,” on how the metrics are calculated.)
In contrast, companies overall took marginally longer to pay their invoices (a positive for the CCC metric). The increase in days payables outstanding to 55.5 was part of a multi-year trend. Overall DPO of the companies in the scorecard is 10 days higher than it was a decade ago.
The slippage in working capital efficiency in 2019 had other contributing factors.
Supply chain financing (SCF), in particular, was a double-edged sword for working capital performance. Many large companies used it to lengthen payment terms, so it also explains slower collections happening at their suppliers, says Craig Bailey, associate principal at The Hackett Group. (SCF allows a supplier to collect a percentage of a receivable from a bank, rather than having to wait the full cycle to get paid by, typically, a larger buyer.)
“A lot of organizations (buyers) are using these programs to improve their DPO metric,” Bailey says, “And it’s naturally impacting the DSO. DSO is now the highest it’s been in 10 years — extended payment terms are becoming the norm.”
Companies relied heavily in 2019 on leveraging external financing programs rather than doing the heavy lifting of structural process redesign. That was in part due to a massive push by the financial industry to sell these products and because of robust merger and acquisition activity, Bailey says.
“Just the availability of cheap cash has meant there hasn’t been that burning platform to assess the organization,” Bailey says. “Instead, management is saying there’s cash out there and we can use these financial vehicles to improve our metrics.”
At the same time, M&A activity across industries has left organizations with multiple and disparate enterprise resource planning systems. “Consequently, companies are not looking at their own in-house processing.”
In the case of inventory management, that same M&A activity, combined with the global nature of supply chains, has created a higher level of risk and complexity. That makes it difficult for companies to improve their inventory levels on-hand, says Gerhard Urbasch, a senior director at The Hackett Group.
“With hundreds of sites, factories, and warehouses, it’s really hard to have a unified source of data to make optimal inventory decisions,” he says. What companies need to do is invest in digital transformation to create visibility of their inventory, Urbasch adds, which requires substantial investment in technology and uniform processes.
Over the years, the DIO numbers have been some of the most stubborn in the scorecard. Inventory on-hand jumped nearly 5 days in 2015 and has remained near the 50-day level since.
Fast-forward to mid-2020, the international COVID-19 crisis and the resulting economic fallout have raised the importance of process standardization and optimization.
The biggest opportunities for improvement in working capital performance for 2020 are receivables and inventory, but the slowdown in the global economy and the increase in bankruptcies also will force wider changes.
For example, Hackett’s Bailey expects DPOs, which have been pushed near the limit the last few years, to decline, “reversing a 10-year trend.”
“Every organization is being even more affected by the resilience (or lack of) of their suppliers. We would anticipate, for the first time in recent memory, that some organizations will shorten payment terms if they believe their suppliers need support,” he says.
“They may also look at discounting [paying earlier in exchange for a discount on the invoice] to improve supplier liquidity.”
In a recessionary economy, in particular, buyers need to be careful not to further destabilize supply, says Shawn Townsend, director of strategy and operations at Hackett.
“Now that there’s a bigger risk of pushing the supply base into bankruptcy, destabilizing the supply chain is probably not a good idea for your overall business model,” Townsend says.
Some of this, of course, requires improved relations between customers and suppliers. “The COVID 19 pandemic has brought an increased need for communication, for collaboration, for being more transparent and open about the financial health across the extended supply chain,” Bailey says.
Another change will be how CFOs think about cash flows and cash levels and the priority of such information. More companies are monitoring cash closely on a daily basis, says Bailey. “Organizations are rationalizing their reporting to focus on the key reports that matter and bring those up to the C-suite level.”
Some companies are also seeing a revival of “cash culture.” Increasingly, management is aware that working capital is a cross-functional accountability, Bailey notes.
“Organizations are saying, ‘We can’t focus on working capital in finance and treasury if, for example, the sales team is trading terms for revenue in the field; if the procurement team is trading terms for cost; or if the inventory and the supply chain teams are buffering stocks against uncertainty,” he says.
Not only are CFOs tracking whether these practices are occurring, they are also putting more pressure on sales, procurement, and supply to develop their own action plans and targets, as well as to model different performance scenarios. “Scenarios are being continuously adjusted with the latest information — how those scenarios will impact cash flow and how that ties into DPO and DIO,” says Bailey.
Integrated business planning, as well as operations and inventory planning, have never been more important, Urbasch observes.
For example, in the case of days inventory on-hand, traditionally companies performed inventory segmentation based on revenue or contribution margin, the variability of demand, or, in some cases, the variability of supply.
“What’s really important is to include another variable — the business resilience of suppliers,” Urbasch says. Finance must evaluate the financial health across the extended supply chain to see where the risks are, and to discover when to support existing suppliers or re-evaluate the supply base. These topics were on the agenda previously, he adds, but weren’t at the top. “Now they’re critical priorities for the CFO,” he says.
The same need to assess business resilience applies to evaluating customers, says Todd Glassmaker, director, strategy and business transformation, at The Hackett Group.
When examining receivables trends, companies will need a better view of their customers’ risk exposures and how they could potentially impact the timing and amount of their future revenue. “We’re seeing a need and a desire to have an understanding of customers’ credit profiles and their ability to pay outstanding receivables,” says Glassmaker.
Management increasingly wants that information integrated into upfront sales tools, whether it be Salesforce or another customer relationship management platform, Glassmaker adds.
Technology advances will also drive the working capital agenda, says Townsend, especially in procure-to-pay (the process of requisitioning, purchasing, receiving, paying for, and accounting for goods and services). Townsend expects the rate of adoption in that category to accelerate due to the COVID-19 crisis.
“Technology not only offers the opportunity to streamline processes but to reduce cost and increase efficiency and effectiveness. It also offers real-time visibility into the overall supply chain and procure-to-pay performance. Right now, that is key for cash-flow forecasting,” he adds.
Moreover, the relationship between the chief procurement officer and CFO may become more important, this year and in the long run, he notes. “People have realized that increased collaboration between the CPO and CFO is key in ensuring that companies have a viable supply chain that is resilient and agile.” When sales are hard to come by or slowing, the last thing a business wants to do is fail to meet a customer’s order on-time.
That means more focus on demand planning (the process of forecasting, or predicting, the demand for products to ensure they can be delivered and satisfy customers).
“Organizations that may not have put a priority on this in the past because they were able to rely on inventory buffers. They are now tightening up in terms of identifying all sources of information available — data from inside the business and externally from the supply chain and from customers.”
If finance departments handle this well, we should see shorter days inventory outstanding when the numbers for 2020 come out next year. Then again, finance has a lot to deal with this year. Inventory level worries may wind up on the back burner once again.