Some suggestions to interpret REL Hackett’s Working Capital data

Once again, REL Hackett has dug through annual reports of Fortune 1000 corporations to analyze and compare Days Inventory Outstanding, Days Payable Outstanding, and Days Sales Outstanding for some of the largest corporations. For Trade Financing Matters, the new US REL Working Capital Survey for 2014 is particularly interesting for how large US companies pay suppliers.

REL has seen payables performance declining over the past three years, meaning companies are paying significantly faster, in fact, the average is 32 days (note: this is in line with some of the data I hear from Supplier Networks in terms of their average payment acceleration when suppliers take early cash). Note, 32 days is not a long time even if we know getting your money is another thing. I find it can take 10 plus more days to get funds from buyers due to payment system runs only on Fridays, shared service centers in India, W-9 forms needed, missing vendor bank instructions, mail float, and many other reasons.

RELs big ahha with the data is the opportunity for improvement in working capital. They now claim it is over $1 trillion, or nearly 6 percent of the US gross domestic product. About $266 billion of this gap is in payables optimization, as top performing companies by industry pay their suppliers nearly 50 percent slower than typical companies, taking over 10 days longer to pay. Excess inventory represents the largest share of the working capital gap at $423 billion.

Basically what REL does in their analysis is take the gap between top-quartile working capital performers and typical companies (not sure how they define typical), to come up with working capital improvements.

On the surface, it makes for nice reporting and nice directional estimates. But digging further, the way I would look at this data is the following:

Credit is either Intermediated or Un-intermediated. What do I mean by that? Un-intermediated credit sits between corporations as receivables and payables and is financed at the firms weighted average cost of capital. Intermediated is done by Banks, Insurers, Factors, Borrowed against Receivables, Risk Mitigation, etc.

So what is wrong with Hackett’s Gap Methodology?

There is no question below investment grade companies Weighted Average Cost of Capital (“WACC”) is less than banks so they should try and borrow less (ie, if they are selling to an Investment Grade buyer, they would want quick terms). The weighted average cost of capital is a weighted average of the after-tax marginal costs of each source of capital (debt, equity) and is used to value a project using the net present value method.

For companies that are investment grade, think Proctor & Gamble, Walmart, Nestles, Unilever, etc. their WACC is lower than banks and for many of their suppliers. They should look at payment terms with an eye towards the Total Cost of the supply chain. Finance costs can be a key component of that and can be managed, just like transportation spend or IT spend.

So I say not so fast with the easy Gap Analysis. You need to understand the dynamics of counterparties WACC - and that is not easy feat.

On another note, many of these Fortune 1000 companies have the possibility to invest excess cash in early pay programs that pay risk-free at high yields when compared to today's low interest rates. Suppliers can be easily segmented and the annual APR rates offered by the same Buyer can vary widely to reflect terms attractive to the respective supplier group. So REL finding DPO declining should not come as a surprise.

The other interesting point is how does Finance and Procurement view payment terms? Does the finance function in Procurement use payment terms as a negotiating tool?   For example, corporations may take some of the large spend and rather than maximize the payable they work with suppliers and explicitly include the payment terms as part of their cost negotiations to get better leverage.

Suggestions for REL

It would be nice to have a deeper understanding of why DPO differs – for example, Southwest Airlines had a 26 day DPO while Alaska Airlines was 5 days. Now we all know for passenger tickets we pay credit cards, so is freight driving the difference? How?

Also, some categories just don’t jive. For example, why is Visteon, a pure auto components company in with Goodyear Tire or a home builder like Toll Brothers mixed in the household durables category with Whirlpool? It may be a bit petty, but still, I am sure these companies consider themselves as having very different supply chains.

All in all, it’s data and it’s a good start. But digging deeper is important, lest we jump to conclusions that may not make the most sense.

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Voices (2)

  1. Brian Shanahan:

    David,
    You make some very good points that are right on the money. There are now several versions of this survey from REL, PWC and E&Y and they all say roughly the same thing. While these regional surveys are numerically accurate they can be misleading. For example, there is no evidence whatsoever that the underlying processes employed by companies to manage working capital have either changed for the better or have any influence at all on the overall result. Therefore you must look at these surveys as an economic indicator. In the longer run working capital will expand as companies seek to satisfy higher market demand and working capital will retract during periods of recession. These surveys only have meaning if you can track progress at the individual company level and you understand the context of the numerical results.

  2. Siva Kuriyakkattil:

    Very thoughtful indeed David and agree with your comments

    WACC is always a difficult one to crack and not an easy concept to explain in every conversation

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