Improving working capital
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Why it matters
Working capital is the cash tied up in the everyday running of a business. The ability of a company to keep low levels of working capital and still satisfy business requirements can result in higher returns on invested capital and more cash to fund growth.
If all companies in our study were to improve their working capital efficiency to the next performance quartile, this would represent a cash release of €1.2 trn. This means that global companies would have enough cash to boost their capital investment by 48% - without the need to access additional funding or put pressure on cash flows.
What’s the story?
Looking at the financial performance of the largest global listed companies in the last 5 years, we noticed three worrying trends:
1) Deterioration in ROCE
We’ve seen a reduction in the Return on Capital Employed (ROCE) of global listed companies. Whilst profitability is at a 5 year high, leverage has dramatically increased, which has led to the aforementioned pressure on returns. Improving working capital management (WCM) can be the key to reducing debt burdens and improving returns.
2) Reduced investment
In the same 5 years, CAPEX (as a % of revenues) has plummeted, as companies appear to be managing operating cash flows by cutting investment. In the long run, this will leave companies under-invested, which poses a threat to their growth. By optimising working capital global companies can release the necessary cash to fund investment while at the same time managing operating cash flows.
3) Working capital propped up through payables stretch
Whilst working capital days have not changed significantly in the last 5 years, having deteriorated by 0.8 days, it appears this may have been achieved in a manner which is placing increased pressure on the supply chain. Days Sales Outstanding (DSO) and Days Inventory On-Hand (DIO) have both worsened in the 5 year period, with Days Payables Outstanding (DPO) dramatically increasing to offset the deterioration on the asset side. Higher DPO levels may be indicative of increased creditor stretching activity, which might not be sustainable in the long term. Additional focus on the asset side of the balance sheet (receivables and inventory) may be warranted as a means of releasing cash and efforts to optimise payables should consider the impact on the supply chain.
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Key findings
Whilst sector level trends give us an indication of the challenges facing certain industries, there is a wide spread of performance within in each sector and we’ve broken this down in this report.
Whilst working capital ratios and returns on capital employed (ROCE) rations The sectors shown in this graph extract have seen ROCE deteriorate, whilst net working capital days (NWCDs) have continued to increase. As such, working capital should present an opportunity for companies in the following sectors: Energy & Utilities, Retail, Chemicals and Industrial Manufacturing. When we look at how sector performance has evolved over the last 4 years, some have fared better than others. In fact, only 7 sectors out of 17 have shown an improvement since 2012. Of the companies that showed an improvement, it was the Consumer sector that saw the greatest reduction in net working capital days.
PDF, 3.3mb; Page 7
See here for more industry insights
When it comes to working capital performance, size matters!
The gap between large and small companies has widened from a difference in net working capital days of 36.6 days in 2012 to 41.6 days in 2016. The common assumption that large companies achieve this performance by squeezing their smaller suppliers, undoubtedly has some truth to it. However, the numbers show that small and medium sized companies have much longer payables cycles than larger companies. Large companies also generate a higher level of return on capital employed (ROCE 8.6%), compared to small and medium sized enterprises. This is partly due to higher profitability, but also a direct result of better working capital performance. Large companies lead at 40.8days, medium businesses are second at 66 net working capital days and small enterprises are last with an average of 82.4 days.
PDF, 3.3mb; Page 13
Find out more about why size matters here
Within any given territory, there is a wide spectrum of working capital performance.
The average performance is not necessarily representative, but analysis by territory can provide excellent insights into the impact of legislation, market trends and myriad factors on company value and financial performance.
PDF, 3.3mb; Page 17
Discover more about the international trends here
The finance function traditionally plays a central role in the coordination of working capital management.
In fact, businesses often place an over-reliance on finance to solve working capital problems when many of the underlying drivers are operational. Working capital management is a broad topic with commercial and supply chain touchpoints where the value of cash is not always front of mind. Finance has a big role to play in helping the business to make good decisions in the midst of often competing financial objectives and incentives.
PDF, 3.3mb; Page 15
Learn how to optimise working capital management by getting operations involved
Depending on the sector and regions in which an organisation operates, indirect taxes can account for around a fifth of the cash flow associated with all its sales and purchases.
This is a significant amount and is often the third largest cash figure under management, behind turnover and cost of sales, yet it is incorrectly seen as a wash through by manyand the true impact it has is poorly understood. There is significant variance in the tax authority rules around the world and whilst many VAT regimes are similar in the principles they work to, the mechanics of these systems can be wildly different. This can improve or adversely affect the impact of VAT on individual organisations’ cash flows.
PDF, 3.3mb; Page 21
Explore how transaction taxes impact working capital strategyHow does my company rate?
Find out how you compare with your peers in our interactive data explorer, with breakdowns by company size, territory and industry.
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How we can help
We help our clients to deliver the following outcomes:
- Rapid identification and realisation of cash and cost benefits across the end to end value chain (commercial terms right through to transactional processing)
- Optimised processes that underpin the working capital cycle
- Visibility on performance through leveraging analytics
- Capability to identify opportunities, control performance and track benefits on a sustainable basis
- Creating and embedding a ‘cash culture’ within the organisation, optimising the trade‑offs between cash, cost and service
