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Time to get capital efficiency back on the agenda

Europe’s biggest companies by revenue are stockpiling €742bn in cash. In our latest annual survey of the working capital performance of Europe’s 1,000 largest public companies excluding the financial sector, it is clear that recession has already hit hard.

The companies featured posted like-for-like deterioration in year-on-year sales of some 10 percent, while their working capital performance deteriorated by 6.2 percent. The average number of days it took for companies to convert working capital into revenue increased by three days during the recession, moving from 44 to 47 days’ worth of sales – a five-year high.

The results imply that companies anticipated a heavy recession in their 2008 results, as an overall reduction of working capital was observed. But their 2009 results show a significant deterioration. Looking at the underlying components that make up their number of days of working capital, the figures for number of days of sales outstanding deteriorated by nearly eight percent, down to 2.8. The figure for days’ inventory on hand (DIO) – year-end inventory divided by one day of average revenue, in which a decrease is an improvement and an increase a deterioration – deteriorated by five percent to 3.5 percent.

Only their number of days payables outstanding (year-end trade payables divided by one day of average revenue – for the purposes of the survey, payables exclude accrued expenses. An increase is an improvement, a decrease a deterioration) improved. This was because companies took longer to pay bills and suppliers, resulting in an increase of nearly seven percent.

Net working capital as a percentage of revenue returned to 12.8 percent, though this follows the usual pattern of bouncing back the previous year’s gains. Another key factor is industry cycles, which can significantly influence individual company performance. We observed the effect on working capital efficiency of dramatic swings in the oil, gas and consumable fuel industries in 2008 and 2009.

Short-termism still dominates with very few companies managing to sustain a longer-term improvement trend – sometimes referred to as a cash culture – hoarding money instead of using it efficiently to build, expand and grow. In fact, 59 percent of the companies featured did improve their days’ working capital in 2009 but, based on the previous results, only about 40 percent can be expected to sustain this improvement in 2010.

Only 56 companies – just six percent – achieved upper quartile performance within their own industry and managed to improve in all three working capital elements over a five-year period to 2009. As many as 39 are in the lower quartile for their industry and have actually deteriorated in all three areas over the same period.

Meanwhile, we found that just two companies within the survey – French automotive components maker Valeo and Dutch cable manufacturer Draka Holding – improved their number of days’ working capital every year for the past five years and are in the upper 50 percent in all three elements of working capital.

For comparability, all financial figures throughout are expressed as euros, including those for UK companies.

Days sales outstanding (DSO) Year-end trade receivables net of allowance for doubtful accounts, divided by one day of average revenue. A decrease in DSO represents an improvement, an increase a deterioration.

Days inventory outstanding (DIO) Inventory divided by one day of average revenue. A decrease in DIO represents an improvement, an increase a deterioration.

Days payables outstanding (DPO) Year-end trade accounts payable divided by one day of average revenue. An increase in DPO represents an improvement, a decrease a deterioration.

Days working capital (DWC) Year-end net working capital (trade accounts receivable + inventory – trade accounts payable) divided by one day of average revenue. The lower the number of days, the better. A negative change in DWC is an improvement.
* Methodology provided by REL

To download the full survey click here

Gavin Swindell is managing director for Europe at REL, a working capital research and consultant group that is part of the Hackett Group

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