Little has changed in companies' working capitalmanagement over the past year—which means that companies have ahuge opportunity for improvement. This is the key take-away fromthis year's “2014U.S. Working Capital Survey” from REL, a division of TheHackett Group.

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In this year's iteration of the annual study, REL and CFO Magazine analyzed the 2013 financialstatements of the 1,000 largest public companies that haveU.S.-based headquarters and are not in the financial servicessector (the “REL 1000”). They separated the companies into industrygroupings, then organized them into quartiles within each industryin terms of days inventory on hand (DIO), days sales outstanding(DSO), and days payables outstanding (DPO). For every companyoutside the top quartile in one of these metrics, REL and CFOcalculated how much additional cash the organization would haveavailable if it improved efficiency enough in its inventory,accounts receivable, or accounts payable processes to bring theassociated metric in line with the level achieved by the topquartile of businesses in its industry.

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This analysis revealed that the total opportunity for improvingworking capital among the 1,000 companies in the study is $1.020trillion—which separates into a total accounts receivable (A/R)opportunity of $331 billion, a total accounts payable (A/P)opportunity of $266 billion, and a total inventory opportunity of$423 billion.

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The study also found that cash on hand increased 12 percentamong the REL 1000 from 2012 to 2013, although as a percentage ofrevenue, cash on hand remained static at 8 percent. Debt alsoincreased, up 8 percent year-over-year and 26 percent over athree-year period. “What we are seeing is that companies are stillusing the low interest rates, as they have been for the past coupleof years, to have access to cash flow,” says Analisa DeHaro, anassociate principal in REL's working capital practice. “They'vebeen utilizing the low interest rates to different extentsdepending on whether they're top performers or in the lower tiers.Now we're looking at how companies are going to fund their capitalimprovements when interest rates start to rise.”

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Balancing Working Capital Tradeoffs

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Eventually, when rates increase, companies will have to fundcapital expenditures using cash generated through operations.According to the REL/CFO study, the top performers are alreadydoing that by optimizing their working capital management.

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“We work with a lot of companies that are looking at thetradeoffs between the different elements of working capital andalso costs,” DeHaro says. “They're figuring out which drivers theycan actually impact and identifying areas of opportunity. Over thelast several years, a lot of companies have been looking to extendpayment terms on the supplier side. They've been going throughrounds of payment-terms extensions. And now many companies arelooking at other ways to improve cash flow.”

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Obviously, as companies extend their payment terms on the A/Pside, that affects the receivables of their suppliers. “Companiesthat are being impacted with their own DSO are looking at how theycan mitigate that through their own payables,” DeHaro says. “Andsimilarly, if they're looking at expanding inventory, they'refiguring out how to make tradeoffs with payables that can mitigatethe costs.”

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The net result of these calculations, according to the REL/CFOstudy, is that days working capital—which is trade receivables plusinventory, minus accounts payable, divided by one day's worth ofrevenue—remained essentially flat in 2013; it fell by 0.3 days,from 34.2 in 2012 to 33.9 in 2013 (see Figure 1, on page 2). But that doesn't mean companies' working capitalpractices are identical to a year ago.

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In fact, the study provides evidence that improvements in onearea of working capital management can lead to denigration ofworking capital performance in other areas. REL and CFO measuredthe gap in working capital metrics between the organizationsidentified as top performers and the median company in the REL1000. In the payables arena, the median company made big strides.DPO for the median organization was 57 percent lower in 2012 thanDPO for top performers, but in 2013 this gap fell to just 43percent. That's the good news. The bad news is that thisimprovement had serious consequences for the median company'sinventory levels. The difference in days inventory on hand betweenthe median organization and top performers increased from 45percent in 2012 to 59 percent in 2013.

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REL views this shift as evidence that organizations which aren'ttop performers are increasing their payables performance bysqueezing suppliers or delaying payments, rather than byimplementing best practices. Ultimately, companies that areconsistent top performers optimize working capital management on anongoing basis by implementing processes that routinely balancetradeoffs between receivables, payables, and inventory.

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Best-Practice Decision-Making

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In terms of receivables, DeHaro says, leading companies areundertaking process improvement initiatives in all the differentcomponents of the DSO metric (see the sidebar “Headline Metrics forWorking Capital Management” on page 3). This is especially true for leading companies inindustries where customers are pushing hard for extended paymentterms. “DSO is not just terms,” she says. “It is an amalgam of bothterms and payment performance. While a company may be gettingrequests from customers for longer terms, one way it can mitigatethat is by having very clear, standardized processes and havinglots of tools in place to understand the profitability impacts ofoffering customers elongated terms.”

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Another best practice is to ratchet up credit and collections activities. “Companies need to make sure they'renot putting themselves at undue risk in extending credit to their customers,” DeHarosays. “And they need to make collections more effective. Their DSOneeds to be more heavily weighted toward the terms that they'renegotiating, rather than toward poor payment performance by theircustomers.”

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For inventory metrics, companies should focus on optimizing thelevels of inventory they hold. “They need to understand how muchthey should be holding in buffers or stock,” DeHaro says. “Theyshould evaluate their lead times with suppliers and minimum orderquantities.” And the impact of inventory issues on the company'sworking capital needs to be a routine consideration in procurementdecisions. “Companies need to consider all of these factors whenthey're deciding which suppliers to do business with,” DeHaroadds.

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For payables, top-performing companies are evaluating whichpayment terms are standard in their industry, then they're turningto approaches like dynamic discounting and supply chain finance. “In general, best practices are balancingall these options,” DeHaro says. “They won't necessarily work forall your supplier base, but they'll work for a portion of yoursupplier base, and you need to determine how they can positivelyimpact your DPO standing.”

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The other thing top performers are doing to improve payablesperformance is automating processes. “They're looking at electronicfunds transfer, electronic bill presentment, scanning, those types oftechnologies, and determining how they can impact their overallpayables process, their supplier relationships, and their cashflow,” DeHaro says. “Some are also considering p-cards. All of these things wrap into one another, withtradeoffs between cost and cash flow.”

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Integrating Working Capital into CorporateCulture

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The top companies are making working capital management a keyfocus, paying close attention to how net working capital affectstheir customer relationships and their supply chain. “We are seeingsome companies build working capital metrics into their incentivesprogram or their overall goal structure, either for their salesforce or across the entire organization,” DeHaro says. Mostcompanies in the lower tiers of working capital performance don'tgo that far, but they are paying some attention to the tradeoffsinherent in working capital management. “For some companies, thecost take-out may be the priority right now, but it's very rarethat we see a company that doesn't have any visibility into atleast one of these metrics”—meaning DSO, DPO, and/or DIO, DeHarosays.

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According to the REL/CFO study, across all organizations,DSO fell slightly from 36.4 days in 2012 to 36.3 days in 2013; DIOremained steady at 29.6 days; and DPO increased slightly from 31.8days in 2012 to 32.0 days in 2013. DeHaro attributes the stabilityof these metrics to the current interest rate environment. Sheexpects that as interest rates rise and cash becomes harder to comeby, pressure will mount for companies to move working capitalmanagement up the priority list.

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A working capital improvement initiative is a major project, butone well worth undertaking. “Working capital doesn't turn around ina month,” she says. “It's something that needs to become part ofthe corporate culture, part of the incentive program, and part ofthe company's overall goals and strategies year over year. I thinkthe reason we see the top performers outperforming the median groupso significantly may be that these organizations have made workingcapital management part of their overall standard operatingprocedure.”

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——————–

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Meg Waters is the editor in chief ofTreasury & Risk. She is the former editor in chief ofBPM Magazine and the former managing editor of BusinessFinance.

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Meg Waters

Meg Waters is the editor in chief of Treasury & Risk. She is the former editor in chief of BPM Magazine and the former managing editor of Business Finance.