Maximizing working capital efficiency has always been a core job of the CFO. Traditionally, keeping cash on hand longer by extending payment terms has been their go-to strategy. The results of The Hackett Group’s working capital studies show that year over year, for the past 10 years, companies have consistently pushed out days payable outstanding (DPO), or the average time a company takes to pay bills.
However, this easy win has come to an end, according to Istvan Bodo, director of Hackett, a Miami-based consultancy firm. At the end of 2021 DPO started to slow down and in the first two quarters Hackettt saw a “significant and surprising” deterioration of DPO, he said. With a host of economic and supply driven factors working in their favor, sellers are clearly getting more leverage, he said. “With all the supply chain challenges created by COVID and other global risk factors, it looks like the tables have turned and we are at an inflection point.”
DPO fell by 1.1%, to 55.9 days from 56.5 days in the first quarter of 2022 from the year-earlier period. As DPO deteriorated, working capital efficiency declined. In 2022, days sales outstanding (DSO), a measure of the average number of days it takes to collect a payment, and days inventory outstanding (DIO) remained flat —
meaning receivables were not coming in faster and the time that inventory remained on the books and in warehouses stayed the same. DIO, is a gauge of the average days that a company holds inventory before turning it into sale, and shorter DIO is better, from a liquidity standpoint. A deteriorating DPO saw the cash conversion cycle increase by 2%.
Receivable and inventory levers
What can be done to improve working capital efficiency in 2023 against a backdrop of persistently high inflation, rising interest rates, as well as, at least for many companies, expectations of lower revenues and lingering high input costs?
With DPO tightening, in 2023 CFOs will have to turn to the lesser low hanging fruit when it comes to their operations and focus on DIO and DSO to improve working capital efficiency. However, certain industries
or organizations are still struggling with inventory and supply chain logistic challenges, said Bodo, and this will likely continue into next year.
What they need to do better, he said, is leverage data and look at their inventory parameters under alternative supply conditions. “It’s essential to keep agile when managing inventory,” he says, “and many companies are rethinking their global sourcing strategies so they either don’t fall short, or to avoid unnecessary holding costs.”
Mark Schoolcraft, CFO at Midwestern Industrial Supply, a dust control and soil stabilization firm based in Canton, Ohio, is taking added measures to maximize working capital efficiency, primarily focusing on days sales outstanding and getting paid faster. “We look very hard at our working capital and focus on credit and collections, he says. “It’s really old school, but for us it’s about having a very good accounts receivable process.”
Receivables are something that can get away from you if you don’t pay attention, he adds. “To manage your cash, you just have to follow business fundamentals and make sure you’re on top of your receivables…. and also keep on top of how your customers are doing.”
For Taswer Khan, CFO for Günter Middle East, a privately owned company based in Germany, and specializing in the manufacture of refrigeration and heat exchange products with a strong global presence, managing credit and keeping close relationships with their customers is the key to ensuring working capital efficiency, particularly in times of a global economic downturn.
“In 2023, we do expect a recession, he says, but nobody really knows how deep it will be,” Khan said. For Güunter, larger projects will likely give way to smaller ones which sometimes pose greater risks and this will result in a change in the company’s approach to credit and potentially move to an advanced payment policy. “The more we go into a recession, the more we’ll attempt to reduce our credit exposure,” Khan said. For customers that aren’t insured, the company might have to reduce credit limits, and in some cases cancel credit altogether and require payment before delivery, he said.
Khan also expects to work more closely with their customers in 2023 to manage DSO. “In my view working with customers, especially in close relationships helps a lot. No businesses default overnight. There are a lot of early warning signs before a business completely disappears,” he said.