Consulting firm KPMG recently released a report on the metals industry response to the economic downturn. Though these reports often include trends and information that most within the industry already know, this report contained a section on cash and working capital sufficiency that made for interesting reading. The report highlights some issues in metals based procurement that we infrequently see. For example, according to the KPMG report, companies have been able to release cash through improved working capital management and tax efficiency, leveraging options such as supply chain, VAT and tax-efficient procurement. Though the notion of freeing up cash flow via supply chain appears vague and doesn’t really suggest a strategy, my experience working with the tax group at both of my previous employers (Andersen and Deloitte Consulting) tells me these opportunities can make a big difference.
In all fairness to KPMG, the report highlights additional practices such as changing operating cash cycles and implementing new policies, procedures and staff assignments and systems, to improve working capital. Other strategies involve examining treasury, tax, property and other assets. All of this sounds good but what does it mean in practice?
According to the latest issue of Harvard Business Review in the article entitled: Need Cash? Look Inside Your Company, authors Kevin Kaiser and S. David Young walk through half a dozen mistakes companies make when managing working capital. The two mistakes most relevant to metals buying organizations include managing to the income statement and tying receivables to payables. The authors suggest that companies not use profitability performance measures and instead look to cut the lag time in receivables. The example they cite involves a metals refining firm with high levels of receivables. By moving from 145 to 45 days, the firm cut capital costs by $8m, though they did lose some sales and $3m worth of margin. The authors suggest companies ought to consider the trade-off between sales/margin and working capital.
In the second example, tying receivables to payables can create huge problems. Supplier terms and customer contracts rarely mirror one another. The article gives several examples including one from McDonald’s in which the firm pays its suppliers on 30-45 day terms yet nobody buying a Big Mac receives the same terms. The same rings true for the steel industry, according to the article. If a metals buying organization buys steel from one major mill and that mill suddenly reduces payment terms by 10 days, the buying organization would have a huge problem as it most likely could not change customer payment terms by the same amount.
How has your company shored up its working capital? Leave a comment, we’d love to hear.