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Focus on working capital poses corporate challenge

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by Nick Dunbar

Updated: March 19, 2019

Achieving growth while reducing working capital is becoming a holy grail for companies. With control of the key metrics, treasury teams are playing an important role. Nicholas Dunbar reports.

As investors focus increasingly on working capital as a performance metric, large companies are struggling to reduce it as they try to squeeze efficiencies from global supply chains and return more cash to shareholders. With items such as receivables, payables and inventory being the key inputs to working capital, treasury departments are playing a central role in this process, analysis of disclosures shows.

Volvo and United Technologies were two companies that reported increases in working capital for the first half of the year. For the Swedish truck maker, increased orders meant reducing the flow of shareholder cash by 30% as it built inventory to satisfy demand. A tight supply chain meant that Volvo was forced to hand over cash to suppliers rather than increase payables outstanding.

Jan Gurander, Volvo

“We are growing right now, that means that we tie up more in capital in terms of receivables”, chief financial officer Jan Gurander told analysts on a 20 July earnings call. “Inventory situation, also an effect of the fact that we are growing, but also an effect of the supply chain disturbances. So we have along the value chain a little bit more in inventory that we should have”.

Industrial parts conglomerate United Technologies, which more than doubled its working capital to $8.5 billion between 2015 and 2018, also blames growing pains for the trend. But at 7% of net sales, the amount is small compared to other firms. Even so, the company is now dangling the prospect of supply chain efficiencies in years to come.

“The area which we still have work to do, which is the long-term opportunity for our cash flow metric, is inventory”, CFO Akhil Johri told investors on a 25 July earnings call. “We’ve seen continued growth in inventory to support the ramp that is there. The supply chain stability that would come in that area over the next few years as production rates start to stabilise”.

Darius Adamczyk, Honeywell

One company that can claim to have squared the working capital circle is electronics components maker Honeywell. At the end of 2016, the company had an outsized 17.4% of net sales tied up in working capital, and incoming chief executive Darius Adamczyk was under pressure to improve cash flow performance. At a February 2018 investor day, he spoke of an “all hands on deck” focus to reduce working capital.

The efforts are starting to pay off. The company announced that it increased free cash flow in the first half of 2018 by 42%, primarily by reducing working capital, at the same time as sales growth exceeded estimates. As Adamczyk told investors on 15 July:

“The kind of focus we’ve had within the company on working capital, on terms, on executing on our inventory, receivables, all those things are really kind of coming together and being reflected”.

How did Honeywell achieve this? The answer can be found from disclosures of receivables, inventory and payables in its financial reports. While inventory went up this year, receivables went down and payables went up by even more, resulting in a $311 million working capital reduction.

Examining these disclosures carefully, it would be an exaggeration to say that Honeywell is managing to get cash out of its customers faster – most of the receivables improvement was the result of an accounting change. However, it is true that Honeywell is taking longer to pay its suppliers, doubling its days payable outstanding to 165 days. The fact that Honeywell has achieved this without disrupting its supply chain is a testament to the work its treasury team has done.

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