The Importance of Working Capital Management
by Robert Smid, Partner and Head of Working Capital Team, and Niall Cooter, Senior Manager, Working Capital Team, PwC
European companies could release a total of €997bn of cash from working capital if they match upper quartile performance in their sector; €370m for each company
On 15 September 2008, Lehman Brothers filed for chapter 11 bankruptcy protection. This event started an unparalleled global financial crisis that has caused businesses, lenders, insurers and governments to reevaluate their situations, taking steps to protect themselves for now and the years to come.
Since this time, there have been reports of ‘green shoots’. Equally, there have been double dip recessions in many parts of the world and even an unprecedented triple dip recession for some. These factors are directly affecting the availability of debt finance and businesses’ ability to secure it. If they are to survive and grow, they need to be more innovative in their approach to their financing activities. For many, a deep delve into their working capital is likely to be the cheapest and easiest way to release cash. In this uncertain economy, one thing that is clear is that the current turbulent economic conditions are likely to remain for some time and with the limited availability of debt finance, the need to maintain low levels of working capital is becoming ever more important. What was seen by some as an unusual, temporary period of hardship may actually be the ‘new normal’ and is likely to remain so for several years to come.
Over the last few years we have seen ongoing growth in the Far East and other emerging markets. This phenomenon has started to drive a change to a more global supply chain model as more and more products are manufactured in these territories. The result is increased transit and buffer stocks due to the long and variable delivery lead times and shorter payment terms, especially when buying from China. Consequently, there is increased pressure on working capital in the West and working capital is rising fast up the corporate agenda. During this period we have seen some businesses try to ride out the storm, relying on the goodwill of suppliers and lenders, whilst others have taken the opportunity to take decisive action to reduce working capital. But how many of these companies have viewed these actions as a long-term solution?
Those businesses that have taken short term measures to shore up their balance sheets must now explore ways of providing sustainable changes to business practices that will make them leaner and fitter to weather this ongoing period of uncertainty.
Our key findings
Our 2013 study analysed the performance of almost 16,000 companies across the world, 2,700 in Europe. From this analysis we were able to draw three key conclusions:
1. The trend is not consistent in all regions
European countries along with those in Africa, experienced reduced levels of working capital (an improving trend), whilst American and Asian companies saw their working capital increase. Overall, working capital levels have deteriorated year on year by almost 2% globally, a trend that is reflected across all industry sectors. While in Europe, working capital improved in all country clusters except Germany, Austria and Switzerland (0% change) and Nordics and Finland (7% deterioration), an overall improvement of 2%. There are three key factors that have influenced the direction of working capital in recent times.
1. The availability of debt financing in each country.
2. Uncertainty around credit risk, driven in part by a lack of confidence in credit insurance schemes.
3. Increased levels of purchasing from the emerging economies in the Far East and Latin America. Businesses with a high dependency on these regions experienced shorter supplier terms and increased inventory levels due to the geographically extended supply chain.
2. There is a correlation between GDP growth and working capital performance
Countries experiencing the highest increases in GDP also saw the greatest increases in their working capital. This could indicate that in a growth market, banks are more willing to finance these higher levels of working capital. As a result, companies in these regions were under less pressure to maintain low levels of working capital.
Southern European territories (Spain, Portugal, Italy, and Greece for example) as well as the Benelux countries, experienced reducing GDP, but showed some of the largest improvements in working capital. However, the greatest deterioration in working capital is seen in the Nordics and Finland where there was 1% growth in GDP. The Central and Eastern European Markets along with the UK and Ireland were the notable exceptions to this trend, showing both improving working capital and GDP growth.
3. There is significant opportunity for improvement
Based upon the survey, if all companies achieved upper quartile performance, €1tr of cash could be released from the balance sheets of European companies, equivalent to 10% of turnover.