It is no secret that cash is in tight supply. Consider, for example, commercial paper. Early in 2009, interest rates on commercial paper — used by many companies to fund such relatively short-term needs as payroll — were as much as 6 percent above three-month Treasury bill rates, compared with a spread of only about 0.4 percent in the 2001–02 recession. The illiquid economy is sending a pointed message to companies: “Plan to meet cash requirements from operations, and don’t count on the credit windows being open, no matter who you are.”
Other ways of raising cash are similarly difficult. Assets that previously could have been converted have little value today, when all prices are depressed. It sounds dire — and it mostly is. But there is some good news. Companies that are not in financial services are sitting on as much as US$950 billion of excess working capital on their balance sheets, untapped and wasted, according to a Booz & Company analysis of North American stock exchange–listed businesses with annual revenue of more than $1 billion. All this potentially available cash is tied up in a vast array of receivables, payables, and inventory that is being neglected or that could be better handled.
Even when credit is readily available, unused working capital should not be ignored. There’s little reason to pay for money on the open market, no matter how inexpensive it is, when capital could be obtained at little cost internally. And when capital is scarce, making better use of working capital is not merely a matter of improved practice. Companies are threatening their own survival by neglecting the cash in plain sight at home.
For example, a leading consumer products maker had a cash position of about $290 million at the end of 2008. A closer look at the accounts suggests that a few deliberate measures — speeding accounts receivable from 69 to 55 days, constraining accounts payable from 48 to 56 days, and reducing inventory turns from 99 to 68 days — could improve this company’s cash position by $670 million, an increase of more than 130 percent. Those actions would move the company to the top quartile in its industry.
The analysis of hundreds of other companies shows similar results. (An analysis for any public U.S. company with sales of more than $1 billion can be found through Booz & Company’s Working Capital Profiler. For companies not listed, the assessment can be performed by filling in data manually.) This type of assessment offers the first critical step in streamlining operations and thereby navigating the difficult periods when capital is scarce. Comparisons within industries, also available at this site, are already yielding some surprising insights. For example, the consumer products company highlighted above is highly regarded for its management capabilities, but it fell behind the industry average in all three parameters related to working capital improvement.
Once an opportunity has been identified, the next step is to capture this value and convert it to cash. Typically, organizations deploy functional specialists to drive working capital improvement initiatives. Sales is asked to tackle accounts receivable, procurement is given responsibility for accounts payable, and operations is told to speed up inventory turns. Unfortunately, these efforts often fail in the aggregate. They reinforce the silos that already exist and overlook the interdependencies among functions that have led to poor working capital performance in the first place.
For instance, to improve its payables policy, a company might increase minimum purchase requirements or change inventory transfer points, forcing suppliers to raise prices and making the overall situation worse. Alternatively, focusing on inventory reduction without regard to customer service commitments can lead to invoice disputes, which can overburden staff and thus reduce accounts receivable performance. In general, piecemeal initiatives aimed at improving working capital tend to “squeeze the balloon,” adding pressure to the system, rather than “release the air,” freeing up excess cash from the system as a whole.