Europe Working Capital Survey 2013: the Story Behind the Numbers

According to REL’s recently-issued 15th annual
Working Capital Survey’

, working capital performance has improved by 6%
year-on-year among Europe’s 821 largest publicly traded companies.

This, company analysts explain, is an indication that companies understand the
importance of working capital in today’s difficult economy. Yet, many still
struggle to convert sales into actual cash.

Despite the improving
trend, about €762bn remains tied up in excess working capital, representing a
12% increase over the past three years, or the equivalent of 6% of the European
Union’s (EU) entire gross domestic product (GDP).

However, the data
provides reason to worry about whether the improvements are sustainable and
history has shown that companies tend to relax their focus on working capital
following a period of improvement.

Working Capital
Performance is Mixed

First, the good news: days working
capital (DWC) for Europe’s major corporate improved by 6% to 40.8 days
year-over-year (YOY) in 2012. This figure represents an improvement of 2.5
days since 2011 and means that companies today have less working capital tied
up in their business operations.

Two of the three components of DWC
– days inventory outstanding (DIO) and days sales outstanding (DSO) –
improved by 3.1% and 6.4% respectively. Conversely the third component, days
payables outstanding (DPO), deteriorated by 4%.

Although companies
have successfully reduced inventory and accounts receivable (AR), this
achievement is partially offset by the reduction in the value of accounts
payable (AP). Overall revenue for the companies included in the 2013 survey
increased 6% from the previous year and 35% across the three-year period.
This revenue increase is linked in part to a 2% increase in Europe’s GDP in

Cash conversion efficiency, measured as operating cash flow
divided by revenue, has now deteriorated for the past three years in a row,
from 13.4% in 2009 to 10.6% in 2012. Companies are taking longer to convert
sales into cash, principally due to pressure on margins. Consequently, their
efforts to improve working capital management (WCM) are not sufficient to
counteract the squeeze on cash generation.

Part of the problem is
the wide availability of inexpensive debt. This route to cash is initially
straightforward compared with other sources of cash. Debt among the companies
increased 6% year-over-year in 2012 to €147bin, and is up 11% over the past
three years. Such high debt levels invite concern that a potential increase in
interest rates could adversely affect debt-leveraged portfolios. The ability
of companies to pay down debt with cash from operations also declined 3% over
the period. Recently the market for corporate bonds has slowed significantly,
increasing the importance of finding alternative sources of cash to meet
business needs.

At the same time, business costs continue to rise.
The cost of goods sold (COGS); selling, general and administrative expenses
(SG&A); and operating expenses all increased by 8% YOY. This explains why
profitability, measured as earnings before interest and tax (EBIT) margin
percentage, decreased by 9%.

Significant Opportunities for

The slight uptick in DWC performance is offset
by the sizable opportunities that remain to improve overall working capital
efficiency. Altogether, companies in the survey have €762bn in potential
working capital opportunities (a figure equal to 6% of the €12.9 trillion in
European GDP).

The biggest of these opportunities is in AR. Despite
the strides that companies have made to enhance their receivables
performance, approximately €272bn is tied up in this area, representing 36%
of the total working capital opportunity. The €257bn languishing in inventory
and €232m in payables represent other potentially lucrative improvement

The findings point to a substantial DSO performance
gap between upper quartile and median performers in the survey YOY,
representing a €40m cash flow impact for a typical €10bn company.

Upper-quartile companies are defined as having the lowest DIO and DSO, or
the highest DPO. These companies, in other words, are better able to manage
debt, monitor cash flow and maintain a leaner operation than median
performers. The survey findings reveal that top performers operate with less
than half the working capital of median performers, hold less than half the
inventory, pay suppliers two weeks later on average, and collect from
customers more than two weeks sooner.

In the aggregate, working
capital performance has turned a corner in the survey, improving year-on-year
since the great recession. From this, REL analysts theorise that companies
appear more conscious of the importance of working capital efficiency. However,
their actions do not go far enough, given the substantial opportunities for
DWC improvement that remain. Overall, the findings suggest that companies do
consider working capital and cash to be important but the gains made are not
making up for the slowdown in cash conversion and margin pressure.

Concerns over Sustainability of Improvements

survey findings indicate that the sustainability of working capital
improvements remains a major issue. Only one company improved all three
constituent elements of DWC over the period. Looking back at the past five
years’ findings affirms this lack of sustainability – just 9% to 12% of the
companies in the survey achieved year-to-year DWC improvements over three
consecutive years.

Equally sobering is that only about a quarter of
the survey (225 companies) maintained DWC performance without it falling by
more than 5% over the three-year period. The remainder experienced at least
one year in the past three years where this deterioration exceeded 5%. These
findings suggest that once companies enhance their working capital efficiency,
focus is turned elsewhere and previous gains are lost or reduced.

Concerns over sustainability are affirmed by the substantial decline in free
cash flow, which fell by 18%. Free cash flow represents the capital that a
company is able to generate after laying out the money required to maintain or
expand its asset base. This capital is conserved via efficient working
capital practices, and can be used to fund acquisitions, develop new products
and reduce debt, thereby enhancing shareholder value.

Component Performance in 2012

Not all the
individual components of working capital efficiency improved in 2012. While
DSO and DIO did improve, DPO lost ground.

Receivables: DSO is at
its lowest point in the last 10 years, falling to 47 days in the 2012 survey
against 50 days in 2011. The 2012 results represent considerable momentum in
the right direction since the 10-year high of 55 days was established in
2005. Nevertheless, this improvement is attributable to the widening gap
between top performers and the rest of the companies in the survey. Working
capital opportunity for DSO is higher than other DWC components because of
this broadening performance gulf. Upper-quartile companies that have benefited
from DSO improvements have set the bar high for all others.

Inventory: DIO for the survey decreased from 38 days in 2011 to 37 days in
2012. This approaches the level of DIO seen during the first year of the
recession, when DIO reached a 10-year low of 36 days. Since 2009, when DIO
crested at 39 days, it has been on a downward path; in part a reaction to the
need to recover from the post-recession peak. Companies focused more on
inventory and took advantage of quick wins. Additionally, some organisations
reacted to the uncertain European economic situation by putting the brakes on
production. As the economy improves, production should accelerate. Companies
must therefore maintain their focus on sustainable DIO improvements,
extending their activities beyond quick fixes.

Payables: DPO fell to
43 days in 2012 from 45 days in 2011. This is the fourth consecutive year
that DPO has declined, although the 41 days reached in 2008 represents the
10-year low. Nevertheless, the 2012 figure marks a significant decline from
the 10-year high of 46 days reached in 2005. The figures suggest pressure on
supplier payment terms, however. Traditionally, a quick working capital win
is to extend supplier payment terms or delay and/or not pay. It appears that
this option is no longer as readily available due in part to improving
collection practices and perhaps the influence of preparing for the EU
Directive on Late Payments that went into effect in March 2013. The rule
requires enterprises to pay their invoices within 60 days, unless they
expressly agree otherwise and if it “is not grossly unfair to the

Strategic Implications

Despite the marginal improvement in DWC in 2012, the survey indicates that
substantial capital that can otherwise be conserved or invested in growth
opportunities by many organisations is being lost because of inferior working
capital practices. Working capital is the least expensive form of cash
available to a business. To maintain superior working capital efficiency,
companies need to strategically elevate and sustain working capital
standards. The benefits are profound, as there is a link between working
capital performance and shareholder value. Improving working capital
performance will release cash to the business. This factor alone should
encourage organisations to maintain their focus on working capital in good
times and bad.

To download the full research paper, which features
graphical representations of the data and charts detailing the best and worst
performers by industry, please click


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