Let the Games Continue

The practice of manipulating working capital in the fourth quarter appears to be alive and well.

Last year, when we first took a look at the corporate propensity to prop up fourth-quarter results at the potential expense of the following quarter’s performance (see
Fourth and Goal,” November 2007), recession loomed on the horizon. Today everyone from Warren Buffett to a bevy of economists to, in fact, CFOs say that the recession isn’t just looming, it’s here — and it’s not leaving anytime soon.

Given that, one might expect companies to direct their attention to activities that offer sustainable financial-performance advantages. Guess again. A subsequent look at 55 companies indicates that fourth-quarter gamesmanship remains a popular corporate pastime.

The analysis, conducted by Atlanta-based research and consulting firm REL, suggests that many companies contort themselves in December in order to improve their working-capital numbers and thus post more-favorable year-end results. For instance, they discount prices to move products, put off vendor payments, or aggressively step up their collection efforts.

Working capital improves in the fourth quarter, only to deteriorate the next quarter, sometimes with a vengeance. Altogether, the 20 companies tracked in this updated REL study — none of which has a seasonal business — improved their working capital by $7.1 billion, or 6.6 percent. However, many of these same firms (which were chosen based on the availability of year-end data at press time) are likely to slide back within the first three months of 2008, in many cases more than erasing their gains. “The underlying processes and culture truly drive quarter-to-quarter habits that offer no true benefits in sustainability,” says Karlo Bustos, financial analyst with REL.

One might argue, so what? Isn’t a final year-end push standard practice, and perhaps even healthy in providing a rally-the-troops focus? Some go further and point to the realities of the calendar: Praxair says the December holidays may slow sales in the final days of the fourth quarter, depressing accounts receivable, while capital spending rises as projects budgeted for the year are completed, increasing accounts payable. Dow Chemical argues that seasonality influences many apparently nonseasonal businesses, and that hedging strategies, M&A, and other factors all influence working-capital metrics.

REL says its analysis reveals there is often more at work as companies pull out the stops to end on a high note, in the process skewing demand forecasting and antagonizing suppliers and customers.

Fourth-quarter games may also diminish the importance of working capital by treating it as an easily pulled lever rather than as a critical facet of the business. When Minerals Technologies Inc., a $1 billion technology-based minerals-processing company, hired CEO Joseph C. Muscari last year, he made it clear that how the company managed its working capital mattered a great deal. “He recognized that people weren’t focused on improving the balance sheet, but were income statement–focused,” says senior vice president and CFO John Sorel.

While the company had shown small, consistent quarterly improvements in working capital for the past few years — and without backsliding at the beginning of each subsequent year — it improved by $29 million between the third and fourth quarters of 2007. One reason is that variable compensation for the heads of the company’s three business units is now tied to working capital, says Sorel. For instance, the businesses, rather than treasury, are now responsible for following up on delinquent accounts.


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