Is Working Capital Keeping Your CFO Up Nights?

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1 Is Working Capital Keeping Your CFO Up Nights? Nat Goodman CPA, MBA, CAPP, APM Goodman & Associates Naperville, Illinois

2 Nat Goodman Goodman & Associates Served in numerous corporate leadership posi3ons including Comptroller Sears Roebuck de Mexico Shared service manager of various func3ons including AP, payroll & credit card units Consulted on five con3nents Licensed CPA in Texas and an AICPA member Presented over 900 seminars worldwide Published several AP manuals & research reports Goodman & Associates trains, consults plus writes on P2P, working capital & AP cer3fica3on G & A

3 Valuing the Cash Conversion Cycle Buyer- Seller financial rela3onships frequently result in a tug of war Buyers try to extend terms, some3mes ac3ng disingenuously or simply paying late Sellers seek more exac3ng terms compliance without sufficient sensi3vity to the buyer Winners & losers needlessly emerge affec3ng short run performance 800 pound gorillas frequently prevail G & A

4 Working Capital fuels organiza3onal opera3ons Tradi3onally Working Capital was expressed as an absolute amount: current assets less current liabili3es However, the $ amount of working capital sheds very lixle light on the quality of a company's liquidity posi3on Assets that generally can only be sold azer a long exhaus3ve search are known as illiquid Inventory is not always accurately valued at cost or market whichever is lower thereby distor3ng the metric G & A

5 Cash Conversion Cycle (CCC) as an Indicator of Liquidity Liquidity refers to how quickly & cheaply an asset can be converted into cash Simply put, you can t pay your bills with working capital, you have to pay in cash Therefore, CCC is upmost as an indicator of liquidity: normally expressed in days- Days Working Capital or DWC or how fast assets are converted to cash G & A

6 Days Working Capital (CCC)= DIO+DSO- DPO DIO represents days inventory outstanding (29) DSO represents days sales outstanding (38) DPO represents days payable outstanding (31) Example: = 36 days Working capital metrics highlights the dynamics of a supply chain. It brings the supply chain & financial supply chain from the warehouse/ produc3on floor/sales floor into the boardroom G & A

7 Days Working Capital=DIO+DSO- DPO Expresses the days a company takes in order to convert resource inputs into actual cash AXempts to measure 3me each net input $ is 3ed up in produc3on & sales before it is converted into cash via sale to customers Working capital management focus rises with a rise in interest/yield rates or in a credit crunch/illiquidity Dispari3es on how differently each trading partner values their working capital may result in opportuni3es G & A

8 DWC: Days Working Capital = (AR inventory - AP) / (net sales / 365) Measures days working capital 3ed up in the opera3ng cycle. The lower DWC, the healthier A nega3ve DWC is even bexer Poor DWC is generally a sign of poor management of DPO, DSO, DIO G & A

9 Increasing Days Working Capital is Important But There are Challenges AR managers need to balance collec3ons with sales with customer rela3ons AP managers need to gauge vendor rela3ons plus credit ra3ngs with protec3ng the cash posi3on & the paying capability AR & AP managers should look for discount/ accelera3on opportuni3es when economically sound Increasing working capital or accelera3ng the cash cycle is a goal but should be not secured at the expense of overall performance G & A

10 DIO: Days Inventory Outstanding = Inventory / (net sales / 365) Measures inventory 3ed up across its supply chain A decrease in DIO is an improvement Can be segmented: raw materials, work in process & finished goods Poor DIO suggests weakness in F2F process Too lixle inventory can lose sales/reduce service levels Single DC may lower inventory but take longer to deliver product to customers while mul3ple DCs may deliver faster, but result in more inventory Offshore manufacturing saves on labor costs but increases lead 3me & inventory Watch ownership transfer differs with FOBs & LOCs G & A

11 DPO: Days Payable Outstanding Reflects terms contracted & level of compliance/ stretch An increase in DPO is usually an opera3onal improvement except in insolvency or taken to the point of aliena3ng suppliers or eroding credit ra3ng Must be weighed against not earning discounts for prompt payment or nego3a3ng bexer prices Poor DPO is ozen a signal ineffec3ve P2P process management G & A

12 DSO: Days Sales Outstanding Decrease represents an improvement Poor DSO may signal lags in Customer- to- Cash C2C par3cularly credit & collec3ons weakness Lengthened payment terms as an incen3ve can impair DSO but may increase sales Some interna3onal sales can extend DSO due to the retarded customer payment prac3ces G & A

13 Best Possible Days Sales Outstanding (BPDSO) Value achieved if all customers paid exactly to agreed upon payment terms This measure is ozen called the theore3cal days sales outstanding (DSO) Opera3onal improvements enable a lower BPDSO Example: 80% of sales 30 day terms; 20% credit card or 2 day payment (30x.8+ 2x.2)= 24.4 BPDSO G & A

14 AR & AP Manager s Role in DSO & DPO Understand cash flow mechanics & how it contributes to overall performance Know your trading partners & seek win- win opportuni3es Take shared responsibility for reduced DSO/increased DPO Overemphasis on DPO & DSO metric could drive behavior adversely affec3ng overall performance Employ E- technology & Supply Chain Finance (SCF) Assist financial chiefs in working capital strategies, forecas3ng, iden3fica3on of opportuni3es, performance metrics & supply chain finance trade offs G & A

15 Case Studies Days Working Capital G & A

16 Days Working Capital US 1000 Companies DSO DIO DPO DWC WC/Sales 9.9% 10.5% 10.9% ROCE 13.0% 12.6% 12.6% Source permission from REL Hackee Associates G & A

17 Miscellaneous 2008 Permission REL HackeX Group Report 2009 DWC DSO DIO DPO Toll Brothers Amazon.com (34) G & A

18 Auto Components 2008 Auto Components DWC DSO DIO DPO General Motors (3) Ford Motor Co Median Source permission from REL Hackee Associates 2009 Report G & A

19 Food/Staples Retailing 2008 DWC DSO DIO DPO Costco Wholesale (1) Walgreen Co Median Source permission from REL Hackee Associates Report 2009 G & A

20 Food Products 2008 DWC DSO DIO DPO Kellogg Co McCormick & Co Median Source permission from REL Hackee Associates Report 2009 G & A

21 Hotel Restaurants Leisure 2008 Source permission from REL Hackee Associates DWC DSO DIO DPO Brinker Interna3onal (7) Yum! Brands (4) Median Source permission from REL Hackee Associates Report 2009 G & A

22 Mul3- Line Retailers 2008 DWC DSO DIO DPO Family Dollar Stores Nordstrom Median Source permission from REL Hackee Associates Report 2009 G & A

23 Personal Products 2008 DWC DSO DIO DPO Herbalife Ltd Elizabeth Arden Median Source permission from REL Hackee Associates Report 2009 G & A

24 Specialty Retail 2008 DWC DSO DIO DPO Zale Tiffany Median Source permission from REL Hackee Associates Report 2009 G & A

25 Apparel, Tex3les & Luxury 2008 DWC DSO DIO DPO Coach Columbia Sportswear Median Source permission from REL Hackee Associates Report 2009 G & A

26 Summary Op3mizes receivables, payable & inventory consistent with revenues, margin & expense Results in less expensive short- term financing Synchronizes supply/service chain with the financial supply chain Impacts free cash flow which increases Growth/ROI