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REL Working Capital Survey 2014

Businesses are benefiting from an increased focus on working capital, but sustaining improvement remains a challenge, reports Richard Crump

BRITAIN’S largest listed companies are starting to see the fruits of an increased focus on working capital, as costs and debt start to decrease and cash on hand and free cash flow increase. But sustaining working capital improvements still remains a major challenge.

According to REL’s 16th annual European Working Capital Survey, which analysed the published accounts of 993 of Europe’s largest public companies, only 14% of businesses improved days working capital (DWC) – a measure of the cash conversion cycle that gives insight about the underlying health of a business – for three consecutive years.

The survey, which analyses how effective businesses are at collecting from customers, managing inventory and paying suppliers, found that, despite declining European GDP resulting in lower company revenues and profit margins, the cost of goods sold is down 1.2% year on year, while total debt is down 1.6%. Meanwhile, cash on hand and free cash flow increased 2.1% and 8.1%, respectively.

Along with the improvements in costs, debt levels and cash positions, DWC also improved 2% year on year since 2012. This is a key metric because it measures the average number of days working capital tied-up in the operating cycle.

Working cap graphREL’s research found that, despite the positive working capital trend, there is still a total improvement opportunity among the companies studied of nearly €900bn (£720bn), the equivalent to 8% of European GDP. This is made up of a €300bn improvement opportunity in payables, a further €296bn in inventory and €293bn in receivables.

Indeed, the findings are borne out in similar research conducted by PwC, which found that businesses are failing to make the most of cash tied up on their balance sheets and will need to raise billions of pounds each year if they are to continue to grow.

According to PwC, companies are consuming more cash as improvements in working capital achieved immediately following the financial crisis have tailed off over the past four years. As working capital performance has stagnated, companies need an extra €103bn of cash each year to sustain current working capital levels without affecting capital investment.

If companies continue to grow at a modest rate of 1% each year, PwC has calculated, they would need to find more than €300bn in cash to finance working capital and incremental capex over the next three years.

“Instead of investing in growth, companies have had to invest in working capital,” says Daniel Windaus, working capital partner at PwC. “If you invest less and generate less cash and want to grow, sooner or later you will come into a bottleneck.”

Year-end heroics

Overall, the upper quartile of companies in the group studied by REL operates with 60% less working capital than typical companies within their respective industries – collecting from customers 2.5 weeks earlier, paying suppliers 2.5 weeks later, and operating with nearly 70% less inventory.

However, just one company, namely BMW, improved all three elements of DWC – payables, inventory and receivables – every year for three years. “You can’t just do on working capital initiative and focus one something else. The best companies never stop,” says Jonas Schoefer, a director at REL. “[BMW] has made managing working capital year on year an executive obsession.”

Windaus agrees that too often companies engage in “year-end heroics” to drive down and improve their working capital balance at time they prepare their financial statements.

“From a cash basis, it helps very little; it is more from a reporting perspective,” he says.

Where improvement has been most impressive is in managing receivables, or days sales outstanding (DSO). One of the companies that does the best at managing DSO is FTSE 250 recruiter Hays. The business was able to reduce DSO by two days, or 5%, over the past year and its finance director Paul Venables says the business has to be “on top of receivables” because of its business model, which involves paying temporary workers before collecting from the client. The key, he says, is having good credit controllers.

“There is not enough focus on the calibre of the people. You need good training,” he explains, adding that an element of role play is important. “If you are chasing 30 suppliers, you need to build a relationship and know the person on the other side.”


Hays has also spent a lot of time investing in its systems. The old system “just gave a report” and the business has since developed a credit control that acts as a “workflow system” which provides prompts about when to call a client and provides information about payment history.

Inventory, on the other hand, is not an issue for Hays. But for companies struggling to get credit from their banks, there has been a renewed focus on reducing inventory levels, explains Schoefer.

This can be a quandary for some companies as it is a justified concern that, when cutting back on inventory, service levels will suffer. Businesses, Schoefer says, need to focus on understanding their clients’ requirements.

“You can see companies integrating their supply chains. They are starting to share information,” he says. “They know what their customer needs and pass this on to their suppliers in order to manage inventory better.”

But suppliers never like to be squeezed – whether for information or on strict payment terms. According to American Express, some companies are looking at using a corporate credit card as a way to extend payment terms from their suppliers.

“Companies at the top end are looking at how they can improve cash flow and terms with suppliers,” says American Express vice president Alan Gillies. ?

BOX: How the UK compares

Working cap graphThe UK has a better performance in all areas of working capital compared to the rest of Europe, research by REL has found. Receivables and inventory performance is best in class compared to the top countries and only France has a better payables performance.

Although revenue declined in the UK by 1%, cash on hand increased by 8% and there was also a sharp increase of 192% in free cash flow since 2012, increasing from €19bn to €54bn (£15bn to £43bn).

Improvements in free cash flow performance are being driven by a culture where cash hoarding and cheap debt financing is an accepted process.

Corporate cash performance, or free cash flow, represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. This makes it important because it allows a company to pursue opportunities like acquisitions, develop new products, or reduce debt, ultimately enhancing shareholder value.

However, debt continues to increase among UK companies, up by 3% from 2012, and this has been the trend for several years.However, debt continues to increase among UK companies, up by 3% from 2012, and this has been the trend for several years.

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