Companies are improving in the are of working capital. Top companies now collect from customers over two weeks faster, pay suppliers nearly three weeks slower, and maintain less than half the inventory of typical companies in their industry, according to new working capital research from The Hackett Group Inc.
Overall, top performers are nearly 3 times faster at converting working capital into cash, with a cash conversion cycle (CCC) of only 17 days, nearly 30 days faster than typical companies.
The 2017 U.S. Working Capital Survey, which examined the performance of 1,000 of the largest public companies in the US in 2016, found that typical companies now have more than $1 trillion unnecessarily tied up in working capital.
CCC improved by 4% in 2016, largely because companies paid suppliers nearly four days (7.6 % slower.)
At the same time, debt increased by nearly $350 billion (7.3%).
There is also a direct relationship between sustained working capital optimization and improved earnings and profitability, according to another study by The Hackett Group. By reducing the key working capital metric of cash conversion cycle (CCC) by 7 days, companies can add 1% to earnings before interest, tax, depreciation and amortization (EBITDA) margin, increasing profitability by about 20% (for a company with an EBITDA margin of 5%), the research found.
The working capital profitability research used advanced regression analysis to establish the strength of the relationship between working capital performance and improved profitability and to demonstrate that working capital performance was causing the profitability improvement and not vice versa. The research examined working capital performance over a 10-year period.
A seven-day reduction in CCC can add an additional 1% to EBITDA margin in the top 20 industries, the research found – a striking number given that EBITDA margins in many industries today are in the single digits. In the top 10 industries, the potential impact was even greater, totaling over 2% EBITDA margin improvement. Assuming an initial EBITDA of 5%, this can represent a 20%-40% improvement, generating significant cash and improving profitability.
“Overall, it’s clear that most companies still don’t see a pressing need to focus on working capital improvement,” said Veronica Wills, associate principal, North America working capital practice lead, The Hackett Group. “Companies came out of the recession knowing they need cash to survive. But they continue to rely on financial instruments like cheap debt and supply chain financing rather than do the fairly straightforward tactical work of optimizing payables, receivables, and inventory.”
“This research provides finance leaders with the ammunition they need to make a business case for working capital improvement,” said Wills. “It tells business leaders precisely how much working capital improvement can be worth on their balance sheet. By making sustainable changes companies can generate real cash that can be used to bolster the bottom line, fund new initiatives and acquisitions, or reduce the need for outside investment.”
“It truly takes a village to drive working capital improvement, because sales, procurement, supply chain, and others need to be on board, as they own key parts of the underlying processes,” said Wills. “Cross-functional transformation can be challenging, and the support of corporate leadership is key. We hope finance leaders take this research to their CEOs and COOs, and use it to make the case for change.”