Working capital management – 10 steps forward, 11 steps back
Happy New Year and welcome to Q1. Time to undo all the good work you did last quarter – and a little bit more. Let’s hope the shareholders aren’t paying attention.
REL consultancy published some research last year that showed that businesses that play the year end game, on average improve their working capital by 10% in the last quarter of the year only to see it deteriorate by 11% in the following quarter. The report describes the various tactics that the businesses employ to inflate performance figures from inventory manipulation to sales incentives and discounts – all effective in the short term but detrimental to the business in the long term.
If the excessive zeal of Q4 were only undone, it would be a short sighted strategy but the fact is that losses in Q1 exceed the gains in Q4. That’s not just short sighted – that’s incompetence.
Executives in any business have a fiduciary responsibility to act in the best interests of the shareholders yet it seems increasingly common that they act in the best interests of themselves first and the long term interests of investors seems a secondary concern. This is what happens at the end of a typical Q4. In order to attain optimum financial results the focus falls on working capital. Suppliers go unpaid and discounts are offered to customers who agree to close a deal in time for the year end reporting. If all goes well, targets are met and bonuses are paid. All of which will be undone in Q1 as suppliers eventually get paid and new business dries up.
The accountants are being rumbled. The scandalous activities of some businesses, performed in the name of working capital management, is increasingly in the spotlight. And so it should be. Only this weekend the Sunday Telegraph in the UK named and shamed those large and powerful British businesses that have extended their payment terms to an astonishing 200 days. Leaving aside the disgraceful treatment that these firms dish out to already struggling suppliers, what do they think they are doing? Do they really believe that the extra costs they impose on their supply chain isn’t filtering through in terms of increased prices? Do they not see the supply chain risks that they are exposing themselves to?
I have some advice for shareholders and investors in these sorts of businesses. Call the board to account and demand that they explain why it is that their short term targets are being met at the expense of the long term interests of the businesses. Ask them to explain how they can be sure that extending payment terms to suppliers does not have a negative impact in terms of supply chain risk and increased costs. And ask them if the return they could get by securing discounts for prompt payment are not greater than the return they get from their myopic working capital management strategies. If you don’t get satisfactory answers – fire them!
That is all.
Pete Loughlin can be found on twitter @peteloughlin