In July, the Hackett Group released its annual “WorkingCapital Survey,” an analysis of trends in working capitalmanagement among large U.S. businesses. The Hackett Group examinedthe 2015 financial statements of the nation's 1,000 largest publiccompanies outside the financial services sector and calculated eachorganization's days sales outstanding (DSO), days payablesoutstanding (DPO), and days inventory on hand (DIO).

This year's report suggests that many companies have beenfilling their cash coffers by taking advantage of the historicallylow cost of debt, rather than by launching initiatives designed toimprove working capital performance. In fact, at the highest level,working capital performance among the companies included in theanalysis is at its lowest point since the 2008 financialcrisis.

Treasury & Risk sat down with Craig Bailey,a senior director with the Hackett Group, to get a better sense ofwhat companies have been doing in their working capital management—and what they could and should bedoing better.

T&R: At the 30,000-foot level,what are the key take-aways from the Hackett Group's “2016 USWorking Capital Survey”?

Craig Bailey: Well, the performance ofworking capital among large U.S. companies deteriorated in 2015,for the first time in three years. However, a lot of that movementcame from the energy sector, which has obviously been facingchallenges over the past 12 months. If we strip out oil and gas,and look at all the other companies in this analysis, we see thatworking capital performance overall—at the level of the cashconversion cycle—stayed pretty static in 2015. But there have beenshifts between inventory, receivables, and payables.

T&R: What does your analysis showat the level of DSO, DPO, and DIO?

CB: Receivables have generally stayedpretty flat for quite a while now. The improvement last year wasless than 1 percent. That ties in with what we're seeing with ourclients as well. Accounts receivable is usually one of the easierareas of working capital for a business to improve. So ever sincethe financial crisis, we've seen companies putting some effort intocollections processes and other internal A/R processes. There wasno real change there last year.

Inpayables, there's been a pretty steady improvement in performancesince the financial crisis. And there was another increase in 2015,so no real change in that trend. We're seeing a lot of businessesmoving to extend terms. Net-60 is becoming almost standard in theUnited States, and some companies are pushing that out to 90 or 120days. I've even come across some organizations pushing terms outeven further.

However, on the other side, we've seen that inventoriesdeteriorated last year. Not massively; if we strip out oil and gas,inventories deteriorated by only 4 percent. But we're seeing thisamong some of our consulting clients as well. Lots of companies arelooking at cost-cutting. Some that haven't done it yet are nowlooking at offshoring. Other businesses that have moved operationsto low-cost countries are finding costs rising in popularoffshoring destinations, so they're now looking at movingoperations even farther afield. Which may reduce costs, but alsoextends lead times and extends the supply chain.

T&R: Where should a company startin improving inventory management?

CB: Typically the first step is formanagement to break down inventory into groupings. Maybe they'llbreak inventory down into raw materials, interim work, finishedgoods, and spare parts—whatever groupings make sense for theirbusiness. They should look at all of these individual groupings ofinventory in isolation, both in terms of dollar value and days ininventory as well. We find that sometimes organizations are lookingat the dollar value of a certain type of inventory; then when we goin, we find that another area has a very high number of days, whichis where the company's focus should be. So that's the first thing:Break inventory out into meaningful groupings and look at bothdollars and days of each grouping.

Thenthey should look at the drivers of each grouping of inventory, andwhich of those drivers they can actually influence. There may be acertain number of days that can be defined easily in terms ofmanufacturing lead times or customer staging requirements, andthese are generally non-negotiable. But where are the other driverscoming from? To what extent are they within the organization'scontrol? And which drivers—such as transportation lead times,potentially—are within the company's control, but with tradeoffsattached to them and some cost implications? From there, a companycan look at each of these drivers and determine which it can, andshould, tackle, and it can move forward with making thoseimprovements.

Success in improving inventory management revolves around takingthat step approach, from a total inventory number to understandingthe groupings of inventory; understanding the drivers of thosegroupings; understanding which drivers are most influenceable, whatthe tradeoffs and risks are; and then identifying action plans totackle each of those drivers accordingly.

T&R: Clearly some companies aregetting it right. Your 2016 Working Capital Survey dividesrespondents into quartiles based on their performance in DSO, DPO,and DIO. And the difference between the top-quartile companies andthe median company is pretty remarkable, for each of those metrics.In terms of inventory management, the median company keepsinventory on hand for almost twice as long as the top-quartilecompany. [See Figure 1, below.]

CB: Yes, the top quartile oforganizations are doing a lot better than the median company ineach area of working capital performance. Although even amongcompanies that are currently focused on improving working capital,many struggle with sustainability. A lot of organizations run theseprojects as one-off initiatives, and they lose momentum over time.Among companies that have improved their cash conversion cycle inrecent years, only 10 percent have seen improvements every year forthe past three years. Only 2 percent have improved every year forthe past five years. And fewer than 1 percent of the companies welooked at have improved working capital every year for the pastseven years.

Companies really struggle to make their quick wins sustainableby embedding working capital performance improvement practices sothat they become normal ways of working for employees.

T&R: So, what should anorganization do to make a working capital management projectsustainable?

CB: The company needs to look at how toactually change normal ways of working. Often we'll seeorganizations put in a quarter-end or year-end initiative to try toimprove collections, cut back inventories, or extend payment terms.But the project will be very short-term.

Twoof the common things we look at in trying to make these types ofprojects more sustainable are: First, what are the targets; whatare we measuring in the business? And second, who isaccountable—not in terms of apportioning blame, but in terms of whois responsible for performing the root-cause analysis to understandtrends and then find corrective actions? That's a key thing we seein projects that aren't sustainable—a lack of accountability.

So my key recommendation is to move away from quarter-end oryear-end targets, to ongoing rolling targets with very clear ownersand very clear reporting.

T&R: Another challenge I see withsustainability of a working capital initiative is that onecompany's payable is another company's receivable. So improvementin one company probably corresponds to deterioration in the other.You found that, in the largest U.S. companies, receivablesperformance has stayed pretty flat, while payables performance hasimproved. Does this mean they're squeezing smaller companies, orwhere else in the supply chain does that improvement in payablesshow up?

CB: I think it's a couple of things.You're right, there might be an element of squeezing smallercompanies. I also think supply chain financing could be having aneffect there, and we are certainly seeing an increase in supplychain financing. There are more and more providers coming into themarket, and it's something our clients are increasingly askingabout.

T&R: That makes sense. What aboutdebt? The debt load for companies in your study increased by almost10 percent last year, and has more than doubled since 2008. Do yousee a connection between increasing corporate debt and a lack ofimprovement in working capital management?

CB: We do. Among the 1,000 companies we looked at, 432 have increasedtheir debt levels by more than 100 percent since 2008. Over thesame period, these companies' cash conversion cycle alsoincreased—by 332 percent on average. In contrast, among companiesthat paid down their debt, the cash conversion cycle fell by anaverage of 40 percent.

T&R: Those are pretty strikingnumbers. With interest rates so low and debt so cheap, though, howcan a treasury or finance manager convince senior managementthat a working capital performance initiative isworth the effort?

CB: The first step is to explore anyopportunities that could come from improving working capital. Howmuch capital could you free up, and what could that capital be usedfor? It's easy to say, 'The cost of cash is cheap, so why worry?'But when executives start to see hundreds of millions of dollars ofopportunity, they get ideas of what that could be used for. So thefirst step is to get a feel for the size of the opportunity and theadvantage it offers the business.

The next step would be to look at what other benefits could comefrom the project. Often, working capital management initiatives arenot exclusively about working capital. Companies can achieveadditional process improvements, and possibly also cost savings,depending on which initiatives they're putting in place.

T&R: Do you anticipate thatworking capital management will become more front-and-center forcompanies once interest rates are rising?

CB: We do. We are anticipating that as interest rates go up, there willbe more of a discussion internally around ways to improveoperations and to release cash from operations before looking forfunding elsewhere. As the cost of cash increases, companies willbecome a little less complacent and will look for thoseopportunities internally.

Many companies have become very, very reliant on debt, and inthe long term that is not sustainable. Now is the time forcompanies to be getting ahead in terms of their working capitalmanagement practices. They should be getting ahead of it now,anticipating changes in the future and looking to improve theirworking capital position while they still have time to do itproactively rather than reactively.