A recession can bring out the best and the worst in corporate finance. The worst has been splattered across newspaper front pages for months now. Some of the best is happening in back offices, where companies continue to find ways to mine working capital — the amount of money they have tied up in operations — to increase cash flow. In a recession, however, the traditional methods companies use to extract that cash — calling in overdue payments, stretching out their own, and relentlessly paring down inventories — can lead to a gigantic, circular squeeze in which no one wants to cut a check to anyone else. This year’s working capital survey, our sixth conducted jointly with REL Consultancy Group, finds signs that companies are exploiting creative tactics to reduce working capital and improve cash flow without alienating customers or stringing out suppliers — much. But these methods pose challenges of their own.
Don’t Break the Chain
We noted a year ago that squeezing customers too hard might drive them into the arms of a competitor. This year, companies seem more worried about driving their suppliers into bankruptcy — particularly at a time when they need those suppliers to help them reduce inventory. “If you grow your supplier payments by too many days, that impedes your ability to work with them to manage your inventory,” notes Palm Inc. CFO Judy Bruner, whose days payable outstanding (DPO) dropped 13 days last year. And inventory turns are a far more lucrative source of working capital than payables, says REL Americas president Stephen Payne, because finished inventory has a higher value than the raw materials represented by payables.
Palm isn’t alone in treating suppliers well on payables. Across all industries, average DPO dropped by 5 days in 2001 to 32 days. “We don’t believe it is good business practice to extend payables,” says Kenneth A. Goldman, CFO of Siebel Systems Inc., whose DPO dropped from an already diminutive 5 days in 2000 to just 3 last year. “We did not make our cash flow on the backs of our vendors.” Software companies have no inventory, so most of Siebel’s payables are consulting fees, capital expenditures, and ordinary expenses such as rent and utilities. “Clearly we are going to pay those on time,” he says.
Manufacturers with large payables are particularly wary of squeezing suppliers. “In the automotive industry, financial pressure flows downhill,” says David C. Wajsgras, senior vice president and CFO of Lear Corp., which supplies most major automakers with the interiors of their cars under contracts that typically last the life of the car model. With so much riding on its supply chain, Lear goes the extra mile to ensure the financial viability of its suppliers.
“In a number of cases, we have supported suppliers financially,” says Wajsgras, even at the expense of DPO, which for Lear dropped 3 days to 53 last year. A few years ago, when some so-called tier-two automotive suppliers were in danger of going out of business, Lear formed a team of 15 people from the legal, purchasing, and finance departments to detect and aid hard-pressed suppliers. Today, this group is a permanent fixture that regularly monitors the health of Lear’s entire supply base. The payoff of such good supplier relations is a steady growth in Lear’s inventory turns, which improved from 23.4 to 28.6 in 2001. “One-day improvement in inventory turns will generate $15 million to $20 million in positive cash flow,” states Wajsgras.