Cash & Liquidity ManagementCash ManagementWorking Capital Index highlights problem of trapped liquidity

Working Capital Index highlights problem of trapped liquidity

Working Capital Index will help organizations to effectively benchmark their working capital performance with accessible and reliable industry data

According to JP Morgan, as much as US$460bn of liquidity is trapped across the supply chains of the S&P 1500 companies. JP Morgan has just launched the JP Morgan Working Capital Index to enable companies to benchmark their working capital performance against industry peers.

The index captures the working capital metrics of the S&P 1500 companies for CFOs and treasurers. The working capital metrics of the S&P 1500 companies from 2011 through to 2018 will help in critically benchmarking success and understanding industry trends.

By analyzing cash conversion cycles, or the number of days it takes to convert inventory purchases into cash flows from sales, the index found substantial cash held up between corporates and their suppliers.

Optimizing working capital is a top priority for many companies and CFOs and treasurers need to ensure that sufficient cash is available to mitigate risks and support the firm’s strategic decisions.

The Index will provide insights into working capital trends that help finance practitioners plan and track the progress of various working capital initiatives within their organizations.

Cash Conversion Cycles (CCC)

The report based on the Working Capital Index also captures trends based on the cash levels and Cash Conversion Cycles (CCC) of the S&P 1500 companies.

Some of the key CCC findings shared in the report include:

  • The top 3 industries showing deterioration in CCC in the last 8 years are Aerospace & defense (19.3), Semiconductors (18.7) and Media (17.4)
  • Industries showing the biggest improvement in CCC in the last 8 years are Utilities (14.7), Consumer staples (11.8) and Logistics (3.3)
  • 53% of companies saw an improvement in CCC in 2018, 67% of which improved their DPO
  • Top 3 industries showing decrease in cash levels in last 8 years are Semiconductor (9.9%), Airlines (7.5%) and Healthcare (4.4%)
  • Average CCC difference between the top and bottom performers across industries is 85 days
  • Small companies take 25 days longer than big companies to convert inventory into sales cash flows

Benchmark performance, guide action plans and monitor progress

With significant money on the table and all eyes on working capital, a structured approach needs to considered to leverage industry insights and best practices.

It is observed that industries have undergone a significant transition over the last decade driven by external market forces. Access to capital remains tight for the foreseeable future and attention is moving towards working capital optimization to supplement existing sources of capital. There remains significant capital trapped within the supply chains of S&P 1500 companies, with a potential to release an estimated $460 billion through working capital optimization programs.

Companies have traditionally focused on the profit and revenue side of business, with a lack of discipline on balance sheet management. However, CFOs and treasurers are now committed to improving internal sources of liquidity, making working capital optimization an important priority.

While external forces will always push businesses to search for quick wins, sustainable working capital improvements require a more structured approach and cannot be left to chance. Quick fixes like payment term extension that are not in sync with industry standards may potentially harm supplier relationships.

The differences in working capital performances both across and within industries are driven by various internal and external factors and it’s important for companies to understand the drivers and formulate the best strategy to manage them effectively. Finance and treasury practitioners can leverage the Working Capital Index and underlying industry insights as a starting point to benchmark performance, guide action plans and monitor progress.

Significant potential to improve

The report concludes with: “There remains significant potential to improve working capital efficiencies across the S&P 1500 companies. Based on our calculations, assuming every firm in this study improves its working capital and moves into the next performance quartile across the DSO, the DPO and the DIO metrics, an estimated $460 billion in working capital can be released across all industries.”

Political uncertainty, interest rate hikes and complex logistics have hit capital performance hard in 2019 – and while an obvious solution forward is to free up working capital, there are a few key obstacles organizations will need to overcome first.

As borrowing rates soar and new trade barriers begin to emerge, it’s getting harder and harder for treasurers to unlock cash. Corporates need to find liquidity and boost working capital without taking on costly debt.

The report can be downloaded here.

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