Europe’s Top Public Companies Sitting on €762bn Excess Working Capital

Working capital has risen up the agenda of Europe’s largest listed companies in the last year but they are still struggling to convert sales into cash, and are sitting on €762bn in excess working capital, according to research from working capital consultancy REL.

The 15th annual working capital survey from REL, a division of The Hackett Group, examined the ability of 821 of Europe’s largest public companies to collect from customers, manage inventory and pay suppliers.

Revenue increased by 6% year-on-year (and 35% over a three year period) but there were clear signs of difficulty in converting these sales into actual cash as cash conversion efficiency (operating cash flow/revenue) deteriorated three years in a row, from 13.4% in 2009 to 10.6% in 2012. Profitability by earnings before interest and tax (EBIT) margin (EBIT/revenue) also decreased, by 9% year on year.

The survey suggests that a total of €762bn is tied up in excess working capital – equivalent to 6% cent of the European Union’s (EU) gross domestic product (GDP), which stood at €12.89 trillion in 2012. A similar survey last year estimated a higher excess working capital figure of €886bn, but analysed the performance of nearly 1,000 of Europe’s top companies against this year’s lower total of 821.

REL says that the biggest opportunity for companies lies in improving receivables, which represents approximately 36% of the total working capital opportunity. €272bn is available within receivables, €257bn in inventory and €232bn in payables.

Modest post-crash improvements

In addition, free cash flow (FCF) – an important indicator of the health of corporate cash flows – reduced by 18% YOY. FCF represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base, and is important because it allows a company to pursue opportunities like acquisitions, develop new products and reduce debt – all of which enhance shareholder value.

Cash on hand continued to increase, by US$57bn YOY or a 9% increase, and debt increased by US$147bn (6% increase YOY) – indicating that companies continue to take advantage of the low interest rates to improve their cash positions. The borrowed cash however is apparently being put into use, with Capex increasing by 9 per cent YOY and 18 per cent over a three year period. Annual dividends paid out increased by 5 per cent YOY and 29 per cent over a three year period.

“The improvements show since 2009 show that companies are more conscious of the importance of working capital in the post-crash era, but they represent little more than a token effort in the grand scheme of things,” said Daniel Windaus, a managing director, REL.

“Cash conversion performance has been declining for three years in a row, showing that efforts in working capital management have not been sufficient to counteract the squeeze on cash generation. Add to this the increase in debt levels and it’s clear companies need to be extremely alert to the possibility of interest rate increases and the impact these would have on debt leveraged portfolios.”

REL adds that there is a clear and widening gap between the top performers in the study (companies in the upper quartile of their industry) and typical companies, with the leaders operating with less than half the working capital, collecting from customers more than two weeks sooner and paying suppliers two weeks later on average, while holding less than half the inventory.

However, sustainability of working capital improvements remains a major issue across the board. Only 12% of companies improved days working capital (DWC) performance for three consecutive years. Even allowing for flat performance or slight deterioration (5%) extends this group to just 27%.

Finally, in 2012, the European Union’s GDP increased nominally by 2%. For the region’s top companies, this translated into increased revenue – up 6% for the companies surveyed by REL – but gross margins decreased by 3%, indicating companies were spending more internally to get to that revenue.

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