"Working capital is the cheapest source of finance; companies have an opportunity to take their destiny into their own hands and not go to the external market if they do this efficiently." -
John Dwyer, Global Deals Leader
Hello, I'm John Dwyer, Global Deals leader at PwC. In the context of the current credit crunch, and particularly the contraction of credit facilities available in Europe, we are here today to talk about a very important topic - working capital efficiency. And we at PwC have done a study which analysed the largest 4,000 European companies and looked at the respective working capital performance by reference to receivables, payables and inventory over a five year period. And we found that the top performing companies consistently get better and the least efficient companies have got worse, with a difference of over £300m on average by company. This is an incredibly large amount of money and obviously appealing to growing companies, this effectively represents free cash for companies. And today I’m joined by two of our experts, Robert Smid and Simon Boehme from our Working Capital team who have led the research. So Robert, can you tell me a little bit more about the findings?
Yes, we classified that the population that we looked as 4,000 companies into the top performers the best 25%, with the lowest percentage working capital ourselves, and the bottom 25% as the lower quartile, with the highest working capital as a percentage of sales. What we found was that whilst these companies grew on average their sales were 40%, the upper quartile, the best 25% managed to improve their working capital both in relative and absolute terms, so they were able to release £91m on average from working capital. Whilst the lower quartile, the bottom quartile, actually deteriorated both in absolute and relative terms and they had to find additional funding for £226m on average per company, which basically means that the gap between the two companies widens by more than £300m.
And interestingly this finding was consistent across Europe. We looked at 35 countries in Europe and the finding was very much the same. The difference between the different countries is colour coded on the map as you can see, and the larger European countries in the south actually had the biggest gap. And for the UK, that meant £195m gap.
Wow, these are big numbers and I guess there are significant untapped opportunities gives for the less efficient companies, and even more specifically, for the growing companies. So what are the pointers you would give to those companies in terms of improvement?
Well, as we come out of recession and the economy is starting to grow again, companies will start growing their revenue as well and you typically expect working capital to grow in line with revenues, requiring additional funding. And, as we’ve seen from our study, that if you focus on working capital, you can actually release cash for working capital whilst the revenue is growing. And we did some modelling to see what would happen if the lower quartile, the bottom 5% in terms of performance, would match the upper quartile performance. And they would actually be able to release up to 30% of their sales in value, from the working capital, equating to a staggering £400 bn across Europe.
Wow, so I guess Robert and Simon, we all want to be in the upper quartile. That’s where all our clients would like to be. What are the pointers that you would give them to get into that upper quartile?
Well, first of all there is no silver bullet, there’s no magical solution to improve working capital over night. It is a long term improvement over time and the more successful companies always move away from year end window dressing to more sustainable changes. There are probably four key levers of success. The first one in commercial terms: it is very clear what underlying commercial terms there are in place, with customer suppliers optimising those from cash in a cost perspective. The second key lever is round process optimisation, being very clear on the individual processing of receivables payables and inventories and optimising each lever within those sub processes. The third point is around compliance and being very clear on controlling compliance, measuring compliance and eradicating cases of non compliance. And finally, the best companies have established a so called cash culture. This is a culture whereby cash is very much in the top three priority points and often top management is incentivised on cash flow and as we know, that often focuses the mind.
There are actually three critical success factors when we look at our clients. Number one is a dedicated cross functional project team, working on the working capital improvements. Number two being executive or corporate board level sponsorship to make sure that delays, hurdles, and obstacles can effectively be removed. And the third one is a real commitment to change. And we see that actually the number of our large publicly quoted clients, they communicate their working capital targets to the market, share them with the analysts and of course make sure that they hit those targets as well. And basically, working capital is a great source of cash - internal funding and therefore it sits very well within a transaction environment, financing of transactions or debt restructuring as well.
Thank you Robert and Simon, and as Robert has just said the working capital is the cheapest source of finance. And the key message that I've taken out of this is that companies have an opportunity to take their destiny into their own hands and not go to the external market if they do this efficiently.
Working Capital efficiency enables growth without additional funding requirements.
Between 2007 and 2011, European companies that were most efficient at managing their working capital got better, those that were least efficient got worse.
Please click here to view the working capital performance gap across Europe
The ‘most efficient’ performers were able to fund their own growth and release cash, whereas the ‘least efficient’ performers had to find additional capital to fund their growth. The difference between these two groups was, on average per company over £300m.
Although there is no 'silver bullet' to achieve good working capital performance, there are four key levers for success.
High performing companies understand all terms in place, and match these terms with the size and nature of the contract. Often, there are established “preferred term” agreements in place which are based on specifically developed models and internal and external best practices.
Leading players understand each individual working capital process, and have tested and evaluated these through challenging the individual process steps with balancing the trade off between cash, cost and service.
The most successful companies are measuring compliance to terms, processes, policies & procedures (for example on payment terms compliance is monitored through data analysis, with consequent root cause analysis to understand the key drivers for non-compliance). Consequently, the required changes to ensure compliance are analysed and valued by their potential cash impact. Working capital is monitored in detail via a key set of relevant operational and management KPIs.
Cash is at the heart of high performing businesses, with top management sponsorship, clear accountability and responsibility for Working Capital performance and management. Also, cash forms an important part of performance measurement and incentives.