Dash for Cash

With credit at a premium, freeing up funds from working capital gains a new urgency.

Karlheinz Hornung takes nothing for granted. He joined a subsidiary of German conglomerate Metallgesellschaft in the late 1970s, shortly before the group’s 100th anniversary, and worked his way through the ranks. Then, in 1993, he was despatched to the company’s head office in Frankfurt to help save the group from bankruptcy as the markets moved against huge, ill-judged derivatives positions built by oil traders in a US unit. Hornung participated in negotiations for the massive rescue package that saved the firm from collapse, later becoming finance chief of the smaller, humbler company. “That’s where I learned my lessons,” he says.

Now, as CFO of MAN, a €15.5 billion commercial vehicles, engines and engineering group, Hornung is teaching colleagues across the Munich-based company about the importance of liquidity. Aided by a working capital reduction programme launched in 2006, the lessons appear to be taking hold. Last year, MAN’s operating cash flow grew nearly threefold, to more than €2 billion.

Thanks in part to its CFO’s foresight, MAN has not been caught out by the credit crunch. The same cannot be said for many other firms, according to the latest annual working capital scorecard compiled for CFO Europe by REL, a research and consulting firm. Working capital performance deteriorated in 2007 for the 1,000 largest non-financial companies based in Europe. Excluding carmakers, average days working capital (DWC) rose to 47.3 in 2007, an increase of 1% over the previous year. (See “Hardly Working” at the end of this article.) As a result, more than €7 billion in cash was trapped in operations across the sample of companies, a loss of liquidity that few companies can afford given current credit conditions.

The deterioration was driven by a spike in days inventory outstanding (DIO), which rose by 4.6% in 2007, and a modest rise in days sales outstanding (DSO), which grew by 0.3%. This was more than enough to offset an increase in days payables outstanding (DPO), which grew by 3%.

The spike in DPO has a whiff of panic about it. (See “Payables Panic” at the end of this article.) If a company is hard up for funds, withholding payments to suppliers is probably the easiest solution. However, it may not be the most constructive, argues Gavin Swindell, REL’s European managing director. “There’s nothing to be gained in the long run by not paying suppliers on time and not answering the phone,” he says. “Collecting receivables is an easy, legitimate way to boost cash. Everyone is worried about the credit crunch, but DSO is flat.” The average DSO in the research sample, at around 55 days, is much longer than typical standard payment terms, Swindell adds. “No one is doing business on 55-day payment terms. There is an opportunity there.”

Seizing this and other working capital opportunities will rise up the list of corporate priorities as economies slow and external finance becomes more scarce and expensive. In a recent global survey of more than 350 senior executives by the Economist Intelligence Unit, a sister company of CFO Europe, around 60% of respondents said that increasing operational efficiency will be a key factor in boosting return on equity in the next three years, compared with fewer than 40% who said that this has been as important over the past three years. (See “Inside Job” at the end of this article.)

Work Out

As Hornung can attest, it was much harder for finance chiefs to focus their colleagues’ attention on cash before the credit crunch. When he joined MAN in 2004, one of his first contributions at a board meeting was to claim that the group could release at least €1 billion from the €5 billion that was tied up in working capital. Gaining support for this goal occupied Hornung for the best part of the following year, as colleagues came up with “all sorts of arguments about why this was not possible,” he recalls. Results were positive and cash flow was healthy, so why was he agitating for widespread changes? Based on past experience, he argued that “more liquidity is always good. Since last August, nobody argues against having more liquidity on the balance sheet.”

According to REL, MAN released more than €1.3 billion in cash over the past two years, cutting DWC from around 160 in 2005 to 120 in 2007. For companies now scrambling for cash, the measures taken by MAN and other forward-looking firms could serve as useful guides to freeing up much needed funds from working capital.

Hornung’s breakthrough came in 2006, when MAN sold 65% of its printing-systems business to a private equity firm. Shortly after the sale, the printing firm’s chairman, a long-time critic of Hornung’s working capital reduction plan, conceded that Manroland — as the firm is now called — could indeed release millions of euros of trapped cash. This change of heart kickstarted a MAN-wide initiative which will run through to next year.

Within two months, “we found ways to achieve my famous €1 billion reduction in working capital,” says Hornung, who chaired the project’s steering committee. The first steps were to adjust incentives for staff, alter collection conditions and change payment practices.

Each quarter, MAN’s board decides on a credit line to extend to each subsidiary from its central cash pool. A hefty 14% interest rate is now levied on any amount drawn beyond this limit. Charged to the unit’s P&L, this affects profit-linked bonus schemes for a number of employees.

Collections and payments offered plenty of “low-hanging fruit,” Hornung says. At the start of the working capital project, he identified more than 300 payment terms. Today, this has been reduced to around 30 standard collection conditions. Hornung also changed the finance department’s payment run from Friday to Monday. Suppliers receive payments at the same time as always, but now it is MAN, rather than the bank, that earns a weekend’s extra interest on the cash.

Spin Cycle

Such simple measures generate a lot of cash for a company of MAN’s size. Another company that finds it’s the little things that count — quite literally — is Indesit.

In 2004, when Andrea Crenna joined the €3.4 billion Italian white-goods manufacturer as CFO (it was then known as Merloni Elettrodomestici), it was leading its sector in terms of working capital performance, with a ratio of net working capital to sales of only 3%. At the end of last year, the ratio was down to 0.1% — or 0.1 DWC — the lowest it could go without the company turning into a retailer or utility, Crenna jokes. The median DWC for Europe’s household-durables sector is 100.

Despite an impressive working capital track record, a 50% plunge in profit at Indesit in 2005 led to the creation of a new three-year plan that meant an even stronger emphasis on cash generation. Operating cash flow was added to the incentive scheme for senior and middle managers, who subsequently released more cash from Indesit’s already lean processes by “attacking the areas that were somehow neglected,” Crenna says.

Hidden in the dark corners of the accounts-receivable department in the UK’s after-sales service operation, for example, were a host of delinquent, albeit small, payments — in some cases overdue by a year or more. “If you don’t put a specific focus on these receivables, it’s very easy for them to become neglected,” Crenna says. “In theory, nobody worries about collecting £20. In reality, we were sitting on a huge amount of receivables, though each individual bill was for a small amount.”

More trapped cash was found in the company’s spare-parts inventory. The stock is worth around €30m today compared with around €40m three years ago. “This was a good result that came just from paying the same level of attention to spare parts as to finished products,” Crenna says. In general, Indesit has been able to improve working capital performance through “fine-tuning rather than launching epic projects.” Over the past two years, according to REL, Indesit has released €115m from its working capital processes.

Liberation Hero

With cash now an increasingly scarce resource, companies will want to tap internal sources of funds, however small. Even an industry-leading company such as Indesit has been able to shake sizeable sums from “areas of inefficiency that were thought to be immaterial,” Crenna explains. Now he’s mulling over a more targeted approach to extending credit to customers and, when the markets improve, the possibility of securitisation.

But in the short term, the CFO expects Indesit’s working capital to rise from its currently low level. “I want it to remain a concern,” he says. “If the CFO doesn’t fly the flag about the importance of working capital management, it’s easy for the company to lose focus and end up with trapped cash.”

At MAN, Hornung is similarly eagle-eyed. “You have to push people, follow up and have power behind it,” he says. “Otherwise, there will be a lot of discussions, a lot of good ideas, but no execution.” The company must continue to improve, Hornung maintains, as by his calculations MAN still lags behind its key competitor, Volvo, by 10-15 days of working capital. (REL’s calculations put them even further behind.)

When the current working capital programme ends next year, “we will start again,” the CFO says, “analysing which areas we can still do better.” As he already knows, and many other finance chiefs are now learning, abrupt changes in business conditions can hit companies hard. Cash is the best cushion.

Jason Karaian is deputy editor at CFO Europe.

Payables Panic

Rather than double efforts to collect what they’re owed, many companies’ initial reaction to the credit crunch has been to squeeze suppliers. At least, that’s one way to explain the jump in days payables outstanding in the latest working capital scorecard for Europe’s largest 1,000 firms. (See “Feel the Squeeze” at the end of this article.)

While some of it may be due to a unilateral refusal to pay on time by cash-strapped companies, there are “win-win” ways to extend payment terms, notes Gavin Swindell, European managing director of REL, a research and consulting firm. “A lot of businesses aren’t worried about getting paid in 40 or 45 days, but are more interested in the certainty of payment on a specific date,” he says.

Jas Sahota, a partner in Deloitte’s UK restructuring practice, says that three-month extensions are common, “as long as the supplier can see that there is a plan.” In times of stress, he says, it’s important to negotiate with only a handful of the most important partners — squeezing suppliers large and small only generates grief and distracts employees with lots of calls.

More fundamentally, the benefits of pulling the payables lever in isolation is “questionable,” notes Andrew Ashby, director of the working capital practice at KPMG in London, “especially as the impact on the receivables balance is typically a lot more than the payables balance.” It’s surprising, he says, to see so little movement in average collection times in the latest data.

Improving collections, such as achieving longer payment terms, relies on the strength of relationships built over time, notes Robert Hecht, a London-based managing director of turnaround consultancy AlixPartners. “You can’t wait for a crisis, and then expect suppliers to step up and be your best friends.”



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