Easing the Squeeze: The 2011 Working Capital Scorecard

As sales revive and coffers swell, companies seem less intent on wringing cash out of working capital.

Industrial Strengths — or Weaknesses

A major determinant (some might say limitation) of how a company regards the relationship between revenue and working capital hinges on its particular industry. There are severe curbs on how much cash a company like Integra LifeSciences Holdings can generate by slimming down its supply chain, demanding payment on time from its customers, or taking longer to pay its suppliers, for instance. Because of that, working capital improvements take a back seat to efforts to boost sales, according to Integra CFO John Henneman.

There’s very little excess to trim in the supply line for the surgical implants and other time-sensitive orthopedic products that are Integra’s specialties. “An awful lot of inventory is either held by sales reps — so they can be ready for surgery on very short notice — or held in hospitals for the same reason on consignment,” Henneman says. “That requires quite a lot more inventory than you would need if you were in a business that had longer lead times.”

Further, the $732 million company is caught in a receivables/payables squeeze: its hospital customers insist on longer payment terms than Integra can get from its own suppliers. “There’s really nothing you can do about that if you want to play in the market, because other medical-device companies will take your business [otherwise],” he says.

On the other hand, the company must buy parts like screws or plates in such small quantities that it carries little clout with its vendors in negotiations on payment terms. Further, it must overbuy its inventory to have the right parts for any eventuality, even though most patients fall into a narrow range of possible needs.

In addition to such limitations, the high gross margins of the orthopedics industry diminish the incentive to make supply chains more efficient. Because Integra and firms like it retain a big portion of their sales as gross profit, it’s worse for them to lack the inventory to fill a back order than to pay for redundant supplies, says Henneman.

For competitive reasons, however, companies in industries where working capital improvements are hard to come by may still be moved to make them. For example, inventory-turnover ratios in the aerospace and defense industry “are not world-class,” says Bob George, CFO of Esterline Technologies, a $1.5 billion specialized manufacturer that derives most of its revenue from those sectors. Yet, Esterline is working hard to bring that ratio down.

In 2010, for instance, the industry saw its median DIO rise to 53 from 52 and its DWC increase to 90 from 86. In contrast, the auto-components business recorded median inventory days of 29 last year, down a day from the previous year, and 29 days of working capital — more than 9 days less than it was in 2009.

Indeed, given the length of time it takes to design and fashion a jet, just-in-time manufacturing “is not really a general concept that we wrestle with” as much as automakers do, adds George. Still, Esterline is striving to “crush lead times” in order to stay at the top of its class as a supplier, he says. The numbers appear to bear him out: between 2009 and 2010, the company reduced its DIO from 71 to 63, a 12% improvement compared with the 2% median deterioration of the industry as a whole.


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