EuroFinance

Grappling with lingering supply issues, industrial companies are taking longer to convert inventory into sales as average Days Inventory Outstanding (DIO), a measure of the average number of days that a company holds inventory for before turning it to sales, increased by 6% in the third quarter of 2021, highest level in the last four years.

In response, treasurers are deploying technology led strategies and data-driven insights to accelerate supply, drive production rate and manage collections in order to optimize working capital and alleviate supply chain stress.

Rising DIO

Manufacturing intensive businesses which extensively depend on a smooth supply chain have seen their operations get disrupted since the start of the year due to supply chain bottlenecks, scarcity of key raw materials, parts and electronic components like semiconductors and now the impact is visible on their working capital.

Consider Honeywell International. Inventories at the electronics components maker increased to almost $5 billion at the end of Q3, highest in the last six years while the company took six additional days to convert the inventory into sales as its DIO increased by 8.5% to 76 days, before the pandemic the metric stood at only 65 days.

Supply chain disruptions resulted in a $300 million negative impact to the company in this quarter while management expects these headwinds to oscillate between $300 million to $500million in the final quarter of 2021.

While inventories were up, a sharp rise in receivables and declining payables further exacerbated the problem as working capital increased by 10% or $559 million to $6 billion which led to a 7 day delay for the company to convert its investment in inventories to cash as Cash Conversion Cycle (CCC) increased by 14% to 59.2 days during the quarter.

The manufacturer of construction machinery and equipment, Caterpillar faced similar challenges as it took 12 additional days to convert inventory into sales, its DIO stood at 138 days, 9.3% higher than the previous quarter.

As a cushion against supply chain disruptions, the company added an additional $1 billion in inventory taking it to $13.6 billion, highest in the last six years so that it could fulfil demand in the coming quarters.

“We continue to hold a higher level of inventory, including components and other work in process, to ensure that customers will not be impacted by potential supply disruptions and to make sure we are able to respond quickly to improve demand” said Andrew Bonfield, CFO at Caterpillar. This resulted in the company taking longer to convert cash as CCC increased by 11%, or 12 days to 127 days.

General Electric also saw an increase in DIO to 114 days as compared to 111 days a quarter earlier. Management disclosed that the most significant impact of these challenges were on its healthcare segment which delayed the conversion of remaining performance obligations to revenue.

DIO at the aircraft manufacturer, Boeing increased by 7% or 36 days to 543 days in the third quarter while 22% or 97 days higher than the start of the year.

Despite being a beneficiary of the accelerated payments plan by the US Defence Department, the rise in DIO further deteriorated cash conversion at Boeing as it continued to pay its suppliers faster than the last quarter. CCC stood at 486 days at the end of Q3, 10% or 44 days higher than the previous quarter.

The manufacturing giant, 3M which produces goods for a wide range of industries also saw its DIO rise by 2 days or 3% to 91 days after reducing in the first six months of the year. The company registered elevated inventory levels at tier suppliers in its automobile and healthcare business.

Facing extensive semiconductor shortages, automobile companies were also seen holding higher levels of inventories in the second quarter, as previously reported by EuroFinance.

“The decline in our year-on-year free cash flow performance was primarily driven by higher inventory balances due to strong customer demand and more goods in transit as a result of the ongoing global supply chain challenges” said Monish Patolawala, CFO at 3M.

Munich based conglomerate, Siemens was the only company in the pack which converted inventory faster than the previous quarter as DIO dipped by 3.5%, or 2.5 days to 72 days in Q3 further helping the company to shorten its net operating cycle to 82 days, fastest in the last six years.

The company uses the IFRS accounting framework as compared to US GAAP used by other companies.

Using technology to protect working capital

Despite working capital headwinds, Siemens was able to come out on top, which the company attributed to its stringent technology based approach in driving working capital efficiencies.

Siemens points to its real-time transparency on inventory levels, paired with fully digitalized production and capacity planning in its factories. This has enabled a flexible use of its manufacturing facilities to fulfil gaps in the supply chain.

GE has also used technology to bolster its working capital position. The conglomerate discontinued its receivables factoring programmes in the second quarter of 2021 under which it received cash quickly rather than waiting for the duration of the credit terms by selling it to a third party.

Instead, it placed extensive focus on working capital management using automation & collections capabilities to drive efficiencies helping it to reduce its CCC to 75 days, 8.5% or 7 days lower than the second quarter.

“A major focus of our transformation has been strengthening our cash flow generation through better working capital management and improved linearity, ultimately to drive more consistent and sustainable cash flow.” Carolina Dybeck Happe, CFO at GE. GE subsequently decided to break up into 3 companies focusing on aviation, health care and energy.

Honeywell has also created “tiger teams” equipped with advanced digital tools to track shortages and deploy strategies to accelerate supply. The company is also developing dual-sourced platforming strategies as well as executing long-term supply agreements to procure better payment terms with its key suppliers to mitigate the impact on working capital.

Meanwhile Boeing announced its business transformation efforts in July 2020 under which it focused on supply chain health and stability of operations by reducing indirect procurement spend and streamlining transportation, logistics and warehousing to drive working capital efficiencies.