Working It Out: The 2010 Working Capital Scorecard

The recession triggered a meltdown in working capital performance, but also inspired numerous efforts to improve. Will they last?

Moreover, for quite a few companies, adversity proved the mother of sustainable invention. By the fourth quarter of 2008, senior executives at Cytec, a large chemical supplier that shone in this year’s scorecard, knew they had to act to deter a difficult situation. The company had $250 million in debt due in 2010, and “investors were questioning our liquidity,” says CFO David Drillock, adding that the company also had to alter its cost structure because sales volumes were dropping. Based on previous benchmarking, management saw an opportunity to squeeze cash out of Cytec’s supply chain. The company then launched a major effort to increase its performance across all three major areas of working capital.

In its efforts to lower its DSO, Drillock consulted with finance chiefs at several private-equity firms because of that industry’s reputation for excellence in managing accounts receivable. They advised him not to overanalyze accounts but to contact customers before problems arose. Following their lead, Cytec focused “on proactive collections, rather than waiting for something to be late.”

To better manage inventory, the company divided its various products into low- or high-volume sellers. Managers then made decisions about which products to stock and which to make to order based on sales volumes. Cytec similarly employed different accounts-payable strategies for its low- and high-volume suppliers. “On the infrequent, low-volume vendors, it was easy to just extend terms as new purchases were made,” Drillock said. “On the higher-volume vendors, we worked with them,” sometimes offering them more volume for better payment terms.

The overall results were impressive: Between 2008 and 2009, Cytec’s DWC dropped from 77 to 59. Thus, while its revenue was off by 23% in 2009, the company was able to mitigate the shortfall by shaving 24% off working capital days.

To make sure those processes stuck, Cytec reduced its previous emphasis on earnings and tied 40% of the compensation of most salaried employees to corporate achievement of certain working capital goals. That percentage will drop to 20% this year because the company exceeded its working capital targets in 2009. But a third of the 2009 working capital bonus was “banked,” meaning that it will be paid in 2011 only if the company’s fourth-quarter 2010 achievement matches that of the same quarter of 2009. “The incentive there is to hold those levels,” says Drillock.

Even at companies with abundant cash flows, the recession provided “a perfect springboard into a much more disciplined process around working capital,” says Jeff Edwards, CFO of Allergan, a medical-device and pharmaceutical company. Thus, while the incentive-compensation packages of the Allergan CFO and its CEO have long contained individual working capital and inventory targets, “we decided to push those across and down the organization” in 2009.

The company set “aggressive” working capital targets for the rest of senior management, as well as for the company’s regional directors and controllers, according to Edwards. The results included a 20% DIO improvement and a 15% DPO expansion.

As for what motivates a company in a cash-rich industry like health care to make a concerted effort to boost its working capital performance, the answer is simple: cash. “More cash is a good thing,” says Allergan’s finance chief, because it allows the company to “fund business-development opportunities without having to rely on the capital markets or banks for funding.”


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