New Study Says Few Companies Sustain Improvements in Inventory

The ability of the largest U.S. companies to collect from customers and manage inventory improved just slightly in 2011, while payables performance worsened, according to the 14th annual working capital survey from REL Consulting, a division of The Hackett Group, Inc. and CFO Magazine.

Overall, working capital performance improved slightly for 1000 of the largest U.S. public companies in the REL/CFO analysis, and working capital performance remains near the best levels seen in the past decade. But in large part the improvement was due to revenue growth. As reported in SCMR, a recent IHS Global Insights report indicates the retail sales are staging a rebound.

The study found a tremendous improvement opportunity in working capital management. Companies in the study now have over $900 billion in excess working capital, a figure that represents nearly 7 percent of the U.S. Gross Domestic Product (GDP) and is the largest opportunity in this area in the past five years. Compared with top performers by industry, typical companies collect from customers 16 days slower, pay suppliers nearly 10 days earlier, and maintain nearly double the inventory, according to the REL/CFO analysis. The study also found that few companies have been able to generate sustainable long-term improvements to working capital performance.

The REL/CFO research found that while U.S. companies are beginning to reinvest in anticipation of growth, with capital expenditures rising by just over 23 percent, they are also continuing to stockpile cash, in part by relying on low-cost debt. Cash on hand levels rose to nearly $1 trillion for the companies in the REL/CFO analysis, an all-time high. Total debt increased by 6.8 percent since 2010 as well.

In addition, despite significant revenue growth, the REL/CFO study found that gross margins and EBIT margins were down slightly compared to 2010. Operating expenses were also up nearly 13%, outpacing revenue, driven largely by an increase in the cost of IT, finance, and other business services functions.

“One would have hoped that the recent recession taught companies a few lessons—manage debt, watch cash flow, and tighten our belts,” said REL Associate Principal Dan Ginsberg. “But this doesn’t appear to be the case. The opportunity for companies to generate cash through working capital improvements is larger than ever before. Yet few if any companies are able to make sustainable improvements in receivables, payables, and inventory. Instead of doing the hard work of squeezing cash out of their companies, they are taking a short-sighted approach, turning to banks to bolster their coffers.”

Days Working Capital shrank by nearly 2 percent in 2011, dropping to 37 days. Companies made a small improvement in collections, with Days Sales Outstanding (DSO) shrinking to 36.6 days. This improvement was offset in part by a 2.5 percent deterioration in Days Payable Outstanding (DPO), which shrank to 31.7 days. Days Inventory On-hand (DIO) continued to improve slowly, decreasing by 2 percent to 32.1 days. The 1000 companies in the REL/CFO study now have $910 billion in excess working capital (compared to top performers by industry). Nearly half of this opportunity could be realized by dramatically reducing inventory levels. Note - DSO and DIO performance improve by getting lower, while DPO performance improves by rising.

Few of the companies in the REL/CFO analysis showed any ability to generate sustainable working capital improvement. Less than 8 percent were able to improve working capital performance three years in a row, and not a single company was able to improve all three elements of working capital performance (DSO, DPO, and DIO) three years running.

The REL/CFO research also included a comprehensive set of 13 recommendations for companies seeking to improve working capital performance, including: make working capital optimization and cash flow improvement a strategic priority, with visible senior executive backing; link cash flow performance and working capital management to the compensation structure, and make it a key metrics for performance management within operations as well as finance; invest in improving demand forecasting and deployment of effective sales and operations planning process; standardize customer and supplier payment terms and control exceptions through an escalation process; and segment customers and suppliers according to value and risk to support a differentiated approach that applies the company’s resources to those customers and suppliers where there is maximum leverage to improve cash

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