Working capital improved in the first nine months of 2021, but key opportunities remain says Craig Bailey, an Associate Principal with The Hackett Group and an expert in working capital and supply chain issues. He shares seven findings from the annual report and his analysis for sourcing, procurement and supply chain teams.
The Hackett Group’s annual working capital research – The Hackett 1000 – shows that the largest public U.S. companies have run a tight ship during the crisis, employing cash and working capital management strategies to increase liquidity and cash on hand as they navigate uncertainty and demand shocks. Nevertheless, those companies collectively had nearly $1.3 trillion of excess cash tied up in working capital at the end of 2020.
Given the continued state of flux as the pandemic plays out, demand recovers and supply chain issues persist, The Hackett Group updated its annual working capital research at the end of the third quarter of 2021. This new analysis looked at changes in cash and working capital metrics during the first nine months of the year. It found evidence of improvement. But not surprisingly, it also showed significant variances by industry – with some sectors improving while others still face significant challenges.
7 Key Changes During the First Nine Months of 2021
Among the companies analyzed, revenue increased 14% in the first nine months of 2021. Of the 48 industries in the study, 38 experienced revenue growth. Top-performing sectors – such as airlines, oil and gas, and hotels and hospitality – saw revenue growth in excess of 25% during that period.
Price increases drove revenue growth in some sectors, such as lumber, steel, oil and building products. On the other hand, material shortages and changing consumer demand patterns limited revenue recovery in other sectors. Motor vehicles and auto parts, telecommunications and internet retail were among those with revenue decreases.
Working Capital Performance Improved
Cash conversion cycle (CCC) – the combined measure of working capital – fell to 29.9 days from 33.4 days, a 10% improvement.
Inventory Levels Increased
Inventory increased by 11% in the first nine months of 2021, but days inventory outstanding (DIO) remained flat as cost of goods sold (COGS) grew at the same rate through the end of the third quarter.
Key factors affecting performance include rising materials costs, product availability and changing consumer demand. For example, material shortages and supply chain issues constrained product availability and, thus, revenue, in the motor vehicles, auto parts and recreational products sectors.
Companies in electrical appliances and consumer durables built up inventory stock as supply chains replenished the network. Several sectors – including airlines, hotels and hospitality, marine shipping, and oil and gas – registered DIO improvements, largely due to external factors rather than intentional inventory rebalancing.
Companies Moved to Optimize Payment Terms
Accounts payable increased 15% in the first nine months of 2021, while days payables outstanding (DPO) increased to 57.6 days from 55.4 days, a 4% improvement – evidence that companies have extended payments to suppliers to improve their own cash flow.
Key factors affecting performance included rising material costs and increased purchasing volumes as consumer demand returned. Industries with DPO increases included those where higher accounts payable balances outpaced increases in COGS, such as textiles, apparel and footwear, beverages, homebuilding and machinery.
In the motor vehicles and internet and catalog retail sectors, revenue declines outpaced decreases in accounts payable. DPO increased in the pharmaceutical, utilities and marine shipping industries as COGS outpaced growth in accounts payable balances.
Collections Accelerated Slightly
Accounts receivable increased by 11%, while days sales outstanding (DSO) decreased from 44.4 to 43.1 days – a slight improvement – as revenue increases outpaced the increase in open accounts receivable balances. Many companies strengthened credit and risk management and explored customers’ ability to pay up front.
Overall Cash and Debt Levels Both Decreased 1%
Cash decreases are largely the result of increased operating cash flows, capital expenditures and debt repayment. Some industries – for example, pulp, paper and forest products; air freight and couriers; airlines; oil and gas; and semiconductors – recorded cash increases due to price increases and/or increased demand.
Debt decreases, which were greatest in industries such as pulp and paper and textiles, were primarily due to early payment of debt, enabled by increases in operating cash. Some sectors, particularly telecommunications, saw debt grow due to increased capital expenditures.
Implications for Sourcing and Supply Chain Functions
Optimism is returning as demand drives revenue improvement. But volatility and uncertainty aren’t going away quite yet. Sourcing and procurement processes have a direct influence on cash flow and working capital, particularly inventory and accounts payable, so it is important to maintain diligence and strategic management around these areas.
In 2022, supply disruptions will continue to impact top-line sales in some sectors and margin pressure will remain. Organizations will need to balance inventory levels with service levels. Companies should revisit current planning parameters and inventory levels to look for quick-win opportunities to release cash for strategic investments.
This is also a good time to conduct a supply chain risk assessment to identify weak links, including implications for strategic inventories in the short run and sources in the midterm to longer term. Assessments should also look at demand spikes and supply limitations to make sure cash is not invested in the wrong inventory and incorporate cost and margin criteria for making stockkeeping unit/product prioritization decisions.
On the accounts payable side, analysis of supply base risks and payment performance can reveal opportunities to further optimize payment terms. Mapping of payment terms by supplier category and region should encompass goods receipts, invoice timing and payment runs, as well as opportunities to eliminate early payments. There also may be opportunities to introduce liquidity mechanisms into the supply chain to ensure its stability and investigate dual-sourcing options to ensure supply continuity.
As companies continue to optimize their supply chains by making changes such as reducing inventory, cutting back on product offerings, and/or diversifying vendors, taking a cross-functional approach is critical. Otherwise, improvement will be stalled by conflicting demands of internal stakeholders such as manufacturing, sales and finance.
Finally, improving sourcing and supply chain agility requires good insight. Therefore, accelerating initiatives to increase supply chain visibility and improve analytical, modeling and reporting capabilities – both technology and talent – will pay dividends.
About the Research
The Hackett 1000 is an annual analysis of cost and cash performance based on publicly available annual financial statements of the 1,000 largest nonfinancial companies with headquarters in the United States. The report takes an industry-based approach to ranking companies according to selling, general and administrative (SG&A) expense, as well as the four key working capital metrics: DSO, DIO, DPO and CCC. The 2021 Q3 update includes data from more than 900 companies that were part of the 2021 Hackett 1000.