Transparency Is Crucial
It’s how the numbers are used, and who sees them, that make the difference. “Probably one of the biggest things we’ve embarked on recently is to develop metrics that increase the transparency of performance and publish those metrics so that everybody sees where everybody else is,” says Jim DeLess, vice president and treasurer of Total Holdings USA Inc., the U.S. subsidiary of the French oil and chemicals giant. “Those numbers are looked at scrupulously on a monthly and daily basis” by top management from the U.S. subsidiaries, DeLess adds.
Attention at the CEO level not only adds pressure to perform better but encourages executives at the business units to understand how their working capital performance fits into the parent company’s model for creating shareholder value. In some cases the negative experiences of the current economic downturn have enforced this lesson. The shipping industry was rocked by two large bankruptcies several years ago that Andreas Rothe — CFO of global container transportation company Hapag-Lloyd North America Inc. — says were tied directly to delinquent accounts. These prompted Hapag-Lloyd and other big container shippers to stop extending any credit for imports, and instead demand cash up front. Since then, working capital has been “extremely high in importance,” says Rothe. “I look at it every second or third day when I don’t travel,” he adds — and the president of the company reviews the top accounts that are past due every week.
In other cases, the way the business has grown forces management to think about the impression that working capital performance makes on shareholders. At biotech company Invitrogen, “We spend a lot of time talking about how the cash you collected funded the products we just acquired from that new company — products that you’re now able to go out and sell, and achieve a higher variable comp payment,” says Travis Chester, vice president of finance. “And so we keep repeating that those collections are a direct contributor to shareholder value.”
Better metrics make it possible to draw these connections, and in turn to link executives’ compensation to their working capital performance, completing the chain of incentives that companies are creating. Indeed, nearly three out of four survey respondents say they either currently tie compensation to improvements in working capital management or plan to do so in the next two years. The proportion of compensation at risk is usually not large — perhaps 5-10 percent of the overall formula, say executives interviewed for this report — but it serves to increase individuals’ awareness of their responsibility.
Not every company takes the best possible approach, notes Stephen Payne, CEO of REL Consultancy Group. “Working capital is now one of the key metrics that senior executives get rewarded on,” he says. “But it’s at a point in time — as of the end of financial year — whereas what we’d like to see is for it to be measured on the average of the 12-month period. Because if you work hard and generate $12 million of free cash flow in November and December, you don’t want to just give it back in January.”