Maintaining available access to liquidity and maximizing liquidity internally and externally were the top two financial risk management priorities in this year’s Association for Financial Professional’s annual Risk Survey.
One way companies do that is by reviewing their working capital performance. That means, of course, strengthening discipline around payables, receivables, and inventory. But that discipline doesn’t always last.
While at year-end 2022, the top 1,000 publicly held non-financial U.S. companies had improved their management of receivables and inventory, in the second quarter all three components of working capital exhibited negative trends, found The Hackett Group.
In part due to external influences and seasonality, companies reversed some of the gains toward higher liquidity they had achieved in 2022.
With receivables, for example, the 1,000 companies had cut days sales outstanding (DSO) to 38.7 in 2022, but by the middle of this year, DSO was back up to 40.2 days, 1% higher than last year’s comparable period.
The Hackett Group’s midyear update to the CFO/The Hackett Group working capital scorecard found the worsening of DSO occurred mainly in the health care, pharmaceutical, and biotech industries.
“Each of those industries experienced a downturn amid post Covid and increased competition, forcing them to soften their stance with their customers to sustain revenues,” explained The Hackett Group report.
For example, the medical specialties & services industry, noted the Hackett report, had a build of inventory, and to sell the excess inventory companies offered promotions and extended payment terms.
In 2022, days payable outstanding (DPO) fell for the first time in five years, as buyers changed supply chain strategies to build in redundant sources and find new suppliers and supplier locations. Often that meant less leverage with suppliers and needing to pay them earlier instead of delaying payments to maximize liquidity.
DPO for the 1,000 companies fell 1.1 days in the second quarter, to 54.7, down 2% from a year earlier and two-and-a-half days from yearend 2022. It is now at the same level as pre-pandemic. Machinery and consumer durables saw some of the largest DPO degradation, said the Hackett Group, with both industries “highly dependent on their key suppliers to maintain their production levels and meet demand.”
Hackett said the second quarter trend in DPO “further cemented the end of the era of heavy reliance by buyers to optimize their working capital through their suppliers.”
The weakest performance in working capital for the second quarter occurred with inventory — perhaps the most difficult area of it to improve — due to outside forces and seasonal trends that often throw off management plans. Days inventory outstanding rose 3.3 days to 50.5 days, over the second quarter of 2022.
Utilities and recreational products were among the sectors with the biggest declines in performance. “The inventory glut in recreational products is potentially a harbinger of softening consumer demand after the pent-up cycles of the last two years,” according to The Hackett Group. Utilities saw their days inventory outstanding (DIO) numbers worsen almost 30% at the top companies, as in the first two quarters of the year they “bulked up their inventory in preparation for hurricane and fire season,” said The Hackett Group.
Not all companies carried excess inventory. The consumer durables industry saw a 6% decrease in inventory balances as “retailer restocking levels were at historically low levels and supply chains started stabilizing, meaning companies shifted strategies back to just-in-time instead of stockpiling parts/components to combat availability issues,” according to The Hackett Group.
In the telecommunications industry, the 35% reduction in inventory balances was due to the seasonal slowdown in the release of new mobile devices in the first and second quarters.
“During this slower period, companies focus on improving gross profit margin by performing rationalizations of workforce and legacy business units to reduce costs,” said The Hackett Group.
The Hackett Group’s population of 1,000 companies saw their cash conversion cycles (CCCs) worsen on average in the second quarter. CCCs (how many days it takes a company to convert the cash it spends on inventory back into cash by selling its product) rose 15% from the second quarter, to 36 days.