Businesses across Europe have been pushing out their payment terms but have seen an overall deterioration in their working capital management, according to the latest annual survey from consultancy REL. The cash conversion cycle (CCC) in 2016 lengthened by 3.6% to 40.4 days, up from 39.0 in 2015.
Days payable outstanding (DPO) increased by 10.1% from 65.4 days to 72.0. However, the working capital benefit of that improvement was offset by a 5.9% deterioration in days sales outstanding (DSO) from 46.5 to 49.3 while inventory positions worsened 9.1% from 57.9 days’ inventory outstanding (DIO) to 63.1.
The DPO performance was the best improvement in at least 10 years, according to REL. DSO, however, returned to a similar level seen in 2010, ending a three-year run of flatlining.
The survey is based on the published accounts of the largest 1,000 listed non-financial companies with headquarters in Europe.
“Payables are being pushed out and, from a working capital point of view, that’s clearly beneficial for these organisations,” Paul Moody (pictured), associate principal at REL told SCFBriefing. “But at the same time, customers are also suppliers so we’re seeing the DSO getting pushed out as well.”
“Everyone is looking at payment terms”
Moody says that the DPO numbers could also be an indication that more organisations are adopting supply chain finance solutions to ease the financial strain for their suppliers. “We know from our conversations with corporates that it’s a very popular topic at the moment.”
He adds that the REL survey is biased towards larger companies, which may partly explain why the improvement in DPO in the survey is considerably greater than the worsening of DSO. “Everyone [in the survey] is looking at their payment terms and looking for opportunities to leverage more cash,” Moody says.
The survey suggests that companies have been through a still-difficult economic environment: revenues at the companies surveyed fell by 1.2%, debt rose by 5.9% while cash on hand increased by just 2.2%. Cost-cutting measures appear to have been effective, however, with a 3.1% improvement in cost of goods sold (COGS) and gross margins up by 5.4%. EBIT margins (earnings before interest and tax) improved 10%. European GDP improved just 1.9% over this period.
The increase in inventories could be a result of sales volumes being less than had been anticipated, but Moody believes that it could also be a sign that companies are still looking for cheaper but more distant sources of supply. “If you’re now manufacturing in China but still selling to customers in Europe, then the inventory impact is an extra four weeks on the ship.”
Dividends up despite financial strains
Surprisingly, given the tight economic circumstances and the pressures on debt and working capital, the survey saw dividend payouts increase by 25% – the biggest increase in dividends in a decade. “That’s probably a signal that companies have easier access to cash so they tend to take on more debt but they are still paying and increasing their dividends,” says Moody. “We know that the cost of that debt continues to be very low. We also know from talking to clients that they don’t express concerns about getting access to money; their concerns are in some cases more about what to do with released cash. One of the routes is to pay it back out to shareholders.
“Often, misaligned goals have meant that procurement has gone down the pricing route and finance probably didn’t get their wish for payment terms extension. I think we see that balancing out a little bit, now, so the tendency to extend payment terms or look at SCF solutions has increased.” – Paul Moody, REL
The numbers don’t appear to indicate that there is much interest in deploying cash in dynamic discounting programmes, paying suppliers early to reduce purchase costs. “Germany, Austria and Switzerland are typically big users of discount terms,” says Moody, “but in those areas it is decreasing. People are beginning to look to extend the payment terms as opposed to taking the discounts.” He believes that the financial community is talking increasing interest in balance sheets rather than in other lines in the accounts where price discounts have an impact.
Moreover, the ongoing tussle between procurement on the one hand and finance or treasury on the other creates a strategic tension within the organisation. “On the DPO side, there’s long been an active discussion between the procurement community and the finance community about what is the best thing to do,” Moody says. “Often, misaligned goals have meant that procurement has gone down the pricing route and finance probably didn’t get their wish for payment terms extension. I think we see that balancing out a little bit, now. The finance influence is stronger so the tendency to extend payment terms or look at SCF solutions has increased.”
Consistent performance is lacking
Only the minority of companies manage to consistently improve their CCC performance, REL’s survey has found, with just 11% improving CCC every year for the last three years. Only 4% managed to improve every year for five years, and only 1% of companies achieved that seven years in a row.
Companies that do achieve sustained working capital performance increases also tend to do better in other areas, Moody says: “Their revenue is stronger, cash-on-hand is much stronger, cash as a percentage of revenue is better. All the metrics are better for that 1% of companies.”
REL calculates the working capital ‘opportunity’ available to European companies is €1.046 trillion. The calculation is based on the overall improvement if every company were to achieve what is currently upper-quartile performance for their industry. That overall figure breaks down into three almost equal parts: a €354bn opportunity to improve payables, a €343bn opportunity to improve receivables and a €350bn opportunity within inventories.
The DPO figure may suggest that there are still huge opportunities to improve payables and to introduce supply chain finance programmes for suppliers. “It’s always a question of how far can you go and are your processes good enough to take hold of that opportunity?” says Moody. “One of the factors slowing it down is that companies are not able to process invoices fast enough to take advantage of it.”