Releasing Cash Through Improved Working Capital
Citi’s Financial Strategy Group (FSG) has released a new report ‘Putting Working Capital to Work: Releasing Capital by Accelerating the Cash Conversion Cycle’, which examines why companies should focus on working capital during the economic downturn.
As production and orders slow down, cash is released through the working capital cycle. Presently this is happening but perhaps not as rapidly as many corporates had hoped. Therefore, working capital management and accelerating cash conversion cycles (CCCs) have become priorities for corporates. (CCC is the time it takes from when an order is given to a supplier or a sale is made to a customer, through the manufacturing and sales process, to the time cash is collected from a customer or paid to a supplier.)
Yet most firms have seen their cash conversion cycle lengthened over the past year. Among US firms in working capital intensive industries, the median cash conversion cycle increased in both the fourth quarter of 2008 as well as the first quarter of 2009, amounting to an annual median increase of seven days, or 9%. This reflects the difficulty of improving cash conversion cycles during severe economic downturns where firms recognise the need to support important suppliers and customers who may need working capital relief to survive.
Citi surveyed 22 working capital-intensive industries, covering 828 of the largest global firms. The report’s main findings are:
In an interview with gtnews, Shams Butt, managing director for FSG EMEA at Citi and co-author of the report, commented: “It is important to improve working capital management, which in turn can help ROIC. We have also seen that in this environment where liquidity is at a premium, companies that have better working capital management schemes can improve their liquidity which is equity market positive.”
He was clear that improving the cash conversion cycle was not a panacea for all business problems but had to go hand-in-hand with other aspects. “If a firm improves its cash conversion cycle, it is not necessarily a more profitable company, or a company that sees increased sales or capital expenditure, automatically – rather that these things are related. Improvements in working capital efficiency and correlated improvements in sales, income or capital expenditure and investment are integral to a company that has all cylinders working at the same pace. Working capital is one of the cylinders that a firm needs to be working full tilt, certainly in this environment.”
By adopting best practices, Citi estimates the working capital improvement potential to be up to 30% for the typical large multinational firm, which translates into 2-3% earnings per share (EPS) improvement.
The research also helped to de-bunk seven working capital ‘myths’, said Butt. These were:
“Working capital shouldn’t be managed as a project somewhere in the back of a company – it is key to the financial strategy of a company, certainly at a time like this,” said Butt.