Vol 5 (2008) - Issue 2

Article preview

Improved Working Capital Management Can Deliver Rapid Improvements in Corporate Restructuring

It is in the nature of corporate recovery that the consequences of failure are the immediate drivers for action. Lessons from the successful practitioners of private
equity, and from leading corporates, offer strategies which can quickly deliver a one-off release of cash into the business, and related continuous cost savings.

These lessons, around managing working capital, are becoming increasingly important as the realisation of the accessible value becomes apparent. The scale of the potential savings is such that working capital management is now a strategic objective for many companies. Ernst & Young believes that the largest 1,000 European companies, by sales, have in total up to EUR 475bn of cash surplus to working capital requirements (USD 450bn for the top 1,000 US companies).

Strategic importance

Working capital is inherently complex, as it touches many business processes and people within an organisation, therefore offering scope for improvement. Poor working capital performance is often a symptom of breakdowns in operational efficiency generally leading to liquidity constraints and thus impacting the ability of a business to generate long term sales and profit.

Implementing best working capital practices will release cash quickly through reduction in trade receivable and inventories, and an increase in trade payables. It will also result in operating cost reduction as it affects COGS (cost of goods sold, through purchasing and logistics and distribution), SG&A (selling, general and administrative expenses, through the finance function) and provisions and write-offs (on receivables and inventories). Examples of these cost savings are:

-COGS can be reduced through supplier rationalisation aimed at improving both payment terms(cash) and purchase price (cost);
– SG&A can be influenced by a reduction of administrative rework through eliminating customer dispute root causes;
– Provisions and write-offs lessen due to reducing the level of slow moving and obsolete inventories or reducing the risk of bad debt;
– Improved cash flow may have significant impact on credit ratings and thus interest costs.

Trends in working capital management

Table 1 is based on Ernst & Young's study of the largest 1,000 European companies by sales. In 2006 European companies had on average 42.5 days of sales tied in working capital.

For 2006, the analysis reveals a year on year C2C (Cash to Cash) decline of 3.2% confirming the consistent reduction in the level of working capital over the
past four years. This performance was driven first by a combined decrease of 2.9% in receivables and 1.4% in inventories, however was partially offset by a decline of 1.4% in payables.

At the end of 2006, the total net operating working capital of the European companies sampled (excluding the auto manufacturing industry) amounted to 11.6% of sales and 16.7% of capital employed on a sales weighted average basis. Including the auto manufacturing industry, the figures were 14.2% and 20.1%
respectively.

When analysing working capital performance across and within industries, it is important to appreciate that market seasonality and cyclicality, year-end manipulation and reporting, changes in the trade-offs between the P&L and the balance sheet, and M&A activity within an industry may greatly affect year on year comparisons.