Years of low interest rates, lack of viable investment opportunities, and financial turmoil, have led large U.S. public companies to hold sizable amounts of working capital on their balance sheets. According to a recent Wall Street Journal article, this is beginning to change: “There is roughly $6 trillion in working capital locked up across U.S. and European companies … Finance chiefs at companies including Conagra Brands Inc., NRG Energy Inc., and Diageo PLC are among those reducing the amount of cash used to run their operations.” The article is available here.
The article further notes that efficiently managing a company’s working capital can significantly improve profitability and cash flow: “Working capital improvements contributed to an 81% increase in Conagra’s net cash flow from operating activities to $1.1 billion in fiscal 2017…”
A key metric that measures how efficiently a company manages its working capital is the cash conversion cycle, which measures how long it takes from the time cash is paid to vendors, to the time cash is collected from customers.
Cash Conversion Cycle = Days Inventory + Days Receivable – Days Payable
Companies can unlock value when they minimize their cash conversion cycle; however, it’s not always easy to do. The cash conversion cycle can be improved by collecting receivables faster, carrying less inventory or extending the time it takes to pay vendors. Reducing a company’s cash conversion cycle by efficiently managing working capital not only leads to improved operating cash flow and increased profitability, but also increases a company’s enterprise value. Focusing on working capital can and should be considered a driver of enterprise value.
For our private clients, it’s important to note that improvements in the working capital of Fortune 100 companies often comes at the expense of their vendors. For example, extending payment terms and shortening inventory lead times can improve one party’s cash conversion cycle, but strain the other. Private company owners should take notice of this and take precautionary measures to avoid damaging vendor relationships.
Reducing inventory, shortening collection times, extending the time to pay vendors and increasing lines of credit can all be effective means to efficiently manage working capital. Reducing the amount of time cash is tied up in working capital has proven to be an effective strategy to increase profitability and company value.
Contact the Valuation Team at Lurie for more ideas on ways you can optimize your company’s working capital management.
 Tatyana Shumsky and Nina Trentmann, “Putting the Squeeze on Working Capital,” The Wall Street Journal, August 22, 2017.