Cash is dead. Long live debt. The shocking truth about the US addiction to borrowing

Posted by Pete Loughlin in Financial Supply Chain Management, Supply Chain Finance 16 Jun 2015

In today’s business world, the old adage “Cash is King” is being replaced by “Debt is King,” according to the results of the 17th annual working capital survey from REL a division of The Hackett Group and CFO Magazine.

The study, which examines the working capital performance of nearly 1,000 of the largest public companies in the U.S., found that companies continue to take on alarming amounts of debt. Debt rose by over 9 percent in 2014 to nearly $4.6 trillion, with companies leveraging low interest rates to fund increased investment activities. At the same time, companies once again made almost no improvement in working capital management, doing little to generate cash internally by optimizing how they collect from customers, pay suppliers, and manage inventory.  A public excerpt of the survey results is available on a complimentary basis with registration at this link: http://www.thehackettgroup.com/solutions/working-capital-management/.

Site LogoCompanies that doubled their debt or more since 2007 saw their working capital performance worsen dramatically, REL’s research found, while companies that decreased their debt over the same period saw a significant improvement.

Cash on hand decreased for the first time in a decade in 2014, largely due to expenditures on acquisitions, according to REL’s research. But it has risen by 74 percent since 2007, and at $932 billion remains near its all-time high. Capex spending also continued its comeback, rising by 11 percent in one year.

For 2014, REL found that companies in the study could improve their cash flow by over $1 trillion, or 6 percent of the U.S. gross domestic product, by matching the performance of top companies in their industry. Inventory optimization represents the largest share of this opportunity. Top performers, who are seven times faster at converting cash into cash than typical companies, now hold less than half the inventory (22.2 days vs 50.7 days), while collecting from customers over two weeks faster (24.8 days vs 42.6 days) and paying suppliers 40 percent slower (55.4 days vs 39.5 days). CCC improved only marginally in 2014, shrinking by .7 days or 2 percent.

“U.S. companies are clearly enjoying all the benefits of the recent economic acceleration. However, their addiction to debt, and their apathy toward true cash flow management, is very disconcerting. Today, money is cheap. But there’s no question that interest rates will rise, possibly sooner rather than later. And when that happens, companies focused on optimizing their CCC will be best positioned to mitigate their risk, continue to fund investment, and outperform their peers,” said REL Associate Principal Analisa DeHaro.

For the first time this year, REL shifted from its historic calculation of Days Working Capital (DWC) to measure how effective companies are at receivables, payables, and inventory, to using Cash Conversion Cycle (CCC) as its preferred metric. CCC more accurately quantifies the time each dollar is tied up in the buying, production, and sales process before it is converted to cash through collection from customers. CCC has improved by only 3.9 percent (1 day) since 2007.

While some companies are focused on improving working capital performance, even those find it challenging to sustain improvements. Only 10 percent of the companies in the REL survey improved working capital performance for three years running, and only 2 percent improved it for five years running. Five companies showed remarkable results, improving working capital for seven years in a row: AmerisourceBergen, Diebold, EQT, Goodyear, and Masco.

Several industries, including technology hardware and biotechnology, appeared to go against the trend, significantly improving working capital performance in 2014. Industries that showed the largest decline in working capital performance in 2014 included diversified consumer goods, automobiles, and construction and engineering.

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