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Forget the Float? The 2001 Working Capital Survey

In a tough operating environment, negative working capital isn't always a plus.

Working capital efficiency can be a beautiful thing, as any finance executive familiar with the Working Capital Survey conducted by CFO magazine and REL Consultancy Group should know by now. The idea, as we explained in our first survey four years ago, is straightforward enough. If you minimize your working capital — that is, the amount tied up in receivables, payables, and inventory — you maximize your cash flow. The freed cash can then be reinvested in the business, thereby enhancing your prospects for growth. This year’s survey once again shows how companies stack up within their industries according to this measure of financial performance. Included are operating companies with at least $600 million in sales and a significant amount of receivables, payables, and inventory.

Acquiescence Required

The recent downturn in the economy calls into question the assumptions underlying a strategy of minimizing working capital. To the extent that it means reducing the number of days that sales (or receivables) are outstanding, increasing days that payables are outstanding, or both, the effort requires the acquiescence of customers and creditors, respectively.

And if either constituency doesn’t go along, the idea can backfire. After all, dunning customers and stiff-arming suppliers — otherwise known as “playing the float” — may be easy enough to pull off during good times, but when the economy slows, those tactics may drive hard-pressed customers into the arms of more-lenient competitors, and scare suppliers into refusing to provide product on credit. To the extent that the strategy risks bringing about either of these unintended consequences, notes Adam Levy, an analyst for Epoch Partners, in San Francisco, “negative working capital can work against you.”

This doesn’t mean abandoning attempts at managing working capital aggressively. Just ask Amazon.com. Granted, investors now pore over the hugely unprofitable E-tailer’s working capital trends to discern just how much leeway it has with suppliers. That, naturally enough, eliminates the possibility of mining cash from the company’s payables, as Amazon CFO Warren Jenson is the first to admit. When describing how working capital figures into the company’s shift in strategic emphasis from growth to profitability, Jenson notes: “This isn’t about trying to string our vendors out.”

However, a second route to increased cash flow from working capital that’s plied by many companies — decreasing days of receivables outstanding — isn’t available to Amazon either, simply because it operates more or less on a cash basis, as credit card payments are made within two days of customer orders. In short, the company has little, if any, room for improvement there.

That leaves inventory. Managing inventory more effectively, as reflected in increasing turnover, is now a key tactic in Amazon’s search for black ink. “We have to manage our assets very carefully so that we aren’t tying up investment dollars,” says Jenson.

The effort is taking place on two fronts. For starters, Jenson says, the company is working with book publishers to provide just-in-time delivery, so that it holds inventory for shorter periods. And he asserts that Amazon has had good results here: “We’ve gotten much better at working with the publishers.”

Second, Amazon is looking to outsource inventory management in new product areas when that makes sense. Consider the arrangement the company signed last year with Toys R Us. While Amazon fulfills all toy orders placed through its Internet site, Toys R Us is responsible for the inventory. Amazon plans to take the same approach with its newly announced foray into personal computers. “Fulfillment is where we add value,” notes Jenson, though the company has also been trying to make its warehouse system more efficient.

Liquidity Needed

Naturally enough, outsourcing inventory increases Amazon’s turnover, since it is expressed as a ratio of cost of goods sold to inventory held. So far at least, the results of Amazon’s inventory efforts are encouraging, as overall turnover increased from an average of 9 times annually at the end of the first quarter of 2000 to 13 at the end of this year’s, according to Epoch’s Levy. And while the fact that third parties are responsible for the inventory entitles Amazon to book only a small portion of the revenue derived from it, profit these days is a much higher priority.

Still, much depends on Amazon’s continued ability to get credit from its suppliers. And while the company’s stated objective is to reach profitability by the end of the current fiscal year, or December 31, a truer test of its business model’s viability won’t come until the end of the first quarter of the next year. That’s when Amazon will have to pay off suppliers for goods it sells during the coming Christmas season, when roughly a third of the company’s revenues are likely to be generated.

As a result, observes Andrew Ebersole, a bond analyst at KDP Investment Advisors, suppliers are likely to keep close tabs on the amount by which the company’s cash balances exceed its payables during that period. “Come January and February, Amazon will have to pay [for] those goods at the same time that its revenues will be declining,” says Ebersole. At that point, he says, Amazon will need “a lot of liquidity.”

That helps explain why negative working capital, while perhaps a current fact of life for Amazon, is not a goal, except “over time,” as Jenson puts it. It also suggests that other companies may have to be sufficiently profitable to win the confidence of their suppliers before they can manage working capital aggressively enough to become more profitable still.

For a look at companies best able to squeeze cash flow out of working capital, see the tables that begin below.

Ronald Fink is a deputy editor at CFO.

When Push Comes to Shove

The temptation to delay payments to suppliers may be especially hard to resist during an economic downturn, says Stephen Payne, president of REL Consultancy Group. “The short-term, knee-jerk reaction is to take as long as you can to pay,” he points out.

But, Payne warns, that approach “can bite you in the rear end.” He explains that when you next order product, suppliers treated in this fashion may simply increase their prices to “offset the abuse.” After all, while the tactic decreases your days of payables outstanding, it increases your suppliers’ days of receivables outstanding.

To be sure, he notes, “the whole idea behind supply-chain improvement is to get somebody else to carry the can.” But buyers can manage that only if they’re in a stronger position than their suppliers. “It all depends on your clout,” says Payne.

Still, “if you want a genuine partnership,” he adds, “it may be worth it to carry that debt.” How to weigh the trade-offs involved? Much depends on whether you’re focusing on top-line growth or profitability. For that reason, says Payne, companies that are new or trying to gain market share should be less draconian with suppliers, while those focusing on the bottom line may be better off taking a firmer approach. —R.F.

Behind the Rankings

The management of working capital combines two measures, weighted equally:
1. Days of Working Capital (DWC) = (Receivables + Inventory ­ Payables) ÷ (Sales ÷ 365 Days). If payables exceed the sum of receivables and inventory, DWC is negative.
2. Cash Conversion Efficiency (CCE) = Cash Flow from Operations ÷ Sales.

The overall ranking: (Highest Overall CCE ­ Company CCE) ÷ (Highest Overall CCE ­ Lowest Overall CCE) + (Lowest Overall DWC ­ Company DWC) ÷ (Lowest Overall DWC ­ Highest Overall DWC). Days of Sales Outstanding (DSO), Inventory Turns, and Days of Payables Outstanding (DPO) are not part of the overall ranking criteria. Industry averages consider all companies in an industry, not just the top five.

Sources: REL Consultancy Group, Piranha Web

2001 Working Capital Survey Charts

Click on an industry to view the companies best able to squeeze cash flow out of working capital.

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