THE GREAT CASH HUNT
All too often neglected, efficient working capital strategies can make a strong contribution to the bottom line.
By Steven Crane

Click HERE for the top ten list

As head of finance for the country's largest listed company, Haji Hamis bin Hasan enjoys a regal position in corporate Malaysia. But his kingdom is under siege. Profits at US$2.1 billion-a-year Telekom Malaysia Berhad (TM) have been slipping for the past four years, while Malaysia's telecommunications industry has seen double digit growth. Why? Because the ruler of the local telecommunications market has been facing real competition following Malaysia's privatization of the sector in 1996. Indeed, a small army of pretenders to the throne are making claims on Hasan's crown. A total of 23 companies - some with cash-rich foreign partners like British Telecom - have been awarded licenses to provide fixed line, cellular phone and Internet services. All of a sudden, Hasan has to worry about cash. "Increasing competition," says Hasan, "has made the efficient management of working capital critical."

Hasan's right. Few companies grind to a halt if debt levels start to soar. A good CFO can normally rally his bankers for a fresh round of financing if his business is sound. But bankers will run for cover if a company becomes illiquid. At the same time, a healthy company that neglects working capital management is neglecting its potential for growth. In TM's case, time is now of the essence. While it still holds a commanding portion of the fixed-line market, that share is slipping. The company has been slow to modernize its systems and infrastructure in the fast-growing and lucrative cellular phone market, and currently has a mere 17 percent of that market. In addition, depreciation costs, including write-offs of outmoded equipment, were expected to total 2.8 billion ringgit (US$568 million) in 2000, putting more pressure on the company's bottom line.

Hasan admits the company has been slow off the mark and can't yet compete with its smaller and nimbler high-tech rivals - especially in terms of pricing. But being big does have its advantages. Because of its size, it can improve cashflows by freeing up money trapped in the system. One of Hasan's main concerns is accounts receivable. Since the financial crisis, customers have taken longer to settle their accounts, and rival companies with cheaper rates have made collection even more difficult. "With so many competitors in the market," says Hasan, "it's easy for customers to switch to another operator leaving behind their outstanding balance with TM."

His solution was to set up an independent credit management unit reporting directly to the chief executive. It's a clever move. Many companies place responsibility for accounts receivable under the sales department where little motivation exists to collect payment. Even when sales are recorded only upon payment, it creates a conflict of interest. Sales personnel can hardly demand payment, while at the same time hoping to secure new sales from the same customer. Alternatively, putting credit collection solely under the responsibility of the finance department can result in rigid controls, driving customers into the hands of competitors.

By putting accounts receivable in neutral territory, so to speak, Telekom Malaysia achieved a days sales outstanding (DSO) of 138.4 and a cash conversion efficiency rate (CCE) of 24.5 percent in 1999. But TM still has a long way to go. According to our first Working Capital Survey, a joint project between CFO Asia and New York-based REL Consultancy Group, a management consulting firm, TM's overall ranking in Asia's telecommunications sector was 72, far below other companies in the sector. It was also too low to win a place among the top 215 companies in Asia.

First-Place Losers

The survey looked at working capital efficiency at 715 public companies with net sales of more than US$100 million (CLICK HERE TO DOWNLOAD FULL LIST). The overall rankings are based on an evenly weighted combination of cash conversion efficiency, the ability to turn sales into cash, and days working capital (DWC), which is the sum of days sales outstanding and inventory less days payable.

While the rankings provide a useful comparison of the components of working capital by industry sector, top performers in each sector are not necessarily winners in the management of working capital in Asia. "The company's product, its geographical location, the sophistication of the banking system, intercompany funding, the degree of market liberalization, and competition," cautions REL's Singapore-based operations director Michael Brame, "can help or hinder its working capital management and, consequently, affect its position in the survey."

Furthermore, for years most companies in Asia had access to cheap capital and enjoyed high growth rates. "As a result," says Brame, "companies did not put a high priority on creating a working capital strategy that encompassed short-term efficiencies with long-term business requirements such as returning value to shareholders." Jiangsu Expressway (JE), for example, a Hong Kong-listed H shares state-owned transportation company based in mainland China, achieved the top spot in the overall rankings, even though its working capital program isn't necessarily a model of best practices.

Why? Its main business is a highway toll operator along the Shanghai-Nanjing expressway in Jiangsu province - a cash cow that generated about 90 percent of its net profit before tax of 631 million renminbi (US$76 million) in 1999.

The company also receives rebates from the government, which effectively reduce its tax burden from 33 percent to 15 percent. As a result, JE is sitting on a mountain of cash - about US$98 million at the end of 2000. "With great cashflow contributing to a cash pile that's basically sitting idle," says Hong Kong-based ABN Amro analyst Adrian Fung, "it's not surprising that Jiangsu looks good in terms of working capital."

Fung has a point. Working capital management isn't just about optimizing cashflows or squeezing cash from the system through efficient credit collection or reducing inventory. Equally important is how the cash is used, be it to fund expansion, ward off takeovers or reduce debt levels. "Finance executives," says Singapore-based Rej Sermonia, managing director at treasury management consulting firm Trema, "typically are proud of having a lot of cash on hand. What they often don't realize is that they haven't employed that cash to maximize the company's value."

Nothing Up My Sleeve

Indeed, many CFOs, treasurers and financial controllers are reluctant to speak
about their working capital strategies - apparently because none exists. Of the more than 20 finance executives approached for this article, all but four declined to comment.

CFO Asia's request for an interview with Singapore Telecom's finance chief met with a typical response: "We will not be participating," wrote the company's corporate communications manager in response to our request for an interview. When pressed for an explanation, he responded: "They (the finance executives) are aware of SingTel's ranking (#8 overall) ... it's a cash generating business and we are sitting on a huge amount of cash. The challenge is how to best manage it to maximize the returns for the company and our shareholders."

Exactly. The problem at many companies is that CFOs typically focus on long-term balance sheet related items - equity, capital requirements and debt. So, while working capital has a final representation on the balance sheet in the form of accounts receivable, accounts payable and inventory, it's a relatively short-term concern. In fact, Asia CFOs typically delegate responsibility for it down the line, often to controllers.

But for many companies in Asia, no one takes responsibility for working capital management. "The treasury function is usually undervalued," says Chase Manhattan's London-based senior vice-president Nicholas Havoutis. "It should be viewed as a value contributor, not a cost center. The CFO's role should be to incorporate treasury's short-term functions, which affect liquidity, with long-term strategies that use that freed cash to create value."

James Sohn agrees. In fact, freeing up cash is critical for the finance manager at South Korean medical equipment manufacturer Medison, with worldwide sales in 1999 of US$165 million. Last year, the company, which manufactures ultrasonic diagnostic instruments, suffered a major liquidity crisis. It also saw a drop in sales growth (down to 11 percent from 55 percent), and its investments in several listed software, securities, Internet and venture capital companies went sour.

With 170 billion won (US$141 million) in current liabilities due before end 2000, in September last year Sohn's short-term strategy was to sell off shares worth 300 billion won (US$249 million) in non-core businesses to pay down debt. He also coordinated a share buyback plan to ward off a potential takeover. With the crisis averted, Sohn focused on extracting cash from Medison's (ranked 470 overall) core business, with increased attention to working capital strategies.

"We've placed increased importance," says Sohn, "on more accurate forecasting analysis for inventory requirements. The new emphasis for working capital management," he says, "is based on cashflow and profitability, rather than growth of sales." Apparently, that emphasis sits well with investors. Says BY Hwang, an analyst at Seoul-based Daewoo Securities: "The company's fundamentals are sound, and with its financial position stable a rebound is just around the corner."

Advantage Taiwan

While Medison may indeed bounce back, it's unlikely it will ever top our rankings. The nature of its product prohibits any drastic improvement, for example, in reducing its days sales outstanding. Medison can hardly send credit collectors into a hospital and threaten to unplug its ultrasound equipment. Integrated circuit manufacturers, on the other hand, have no such worries.

The highest ranking companies in this sector are indeed all manufacturers of computer components, with the largest, Taiwan Semiconductor Manufacturing (TSMC), taking top spot in the industry and coming in 12th overall. For semiconductor manufacturers, notes TSMC treasurer Wendell Huang, their business model demands high capital expenditures, most of which is invested in R&D. As a result, working capital isn't a significant portion of their assets. As one of the largest manufacturers of integrated circuits in the world, with net profit after tax of NT$73 billion (US$2.2 billion) in 1999, TSMC also has other advantages in terms of reach and scale.

TSMC has about 8,000 products which are sold to more than 600 clients, two-thirds of which are located in North America, through its on-line engineering, purchasing and accounting systems. The nature of the business, explains Huang, is providing customers with highly customized products that they may require at very short notice. With an integrated system, the manufacturer and customer essentially work in harmony.

This allows the company to plan production more efficiently, which leads to the reduction of inventory, cycle times and lead times. "The strategy is to balance the resources between companies, and between cash in the system and cash generated," says Huang. "It's no surprise that the top companies in this sector are all Taiwanese - they all operate on the same model."

It's a somewhat different model at Philippine-based food manufacturer and distributor Universal Robina Corporation (URC). There, working capital strategy is directed by 34-year-old Lance Gokongwei, son and heir of 73-year-old Philippine tycoon John Gokongwei. The senior Gokongwei is founder and chairman of conglomerate JG Summit with turnover of 30 billion pesos (US$601 million) in 1999 and net profit after tax of 13 billion pesos, ranked fifth in its sector. Gokongwei junior is executive vice-president and overall head of finance at URC, a subsidiary of JG Summit. URC, however, with sales of 13.7 billion pesos (US$277 million) in 1999 and net profit of 905 million pesos (US$18 million), ranked only 467 out of the 715 companies surveyed.

Balancing Act

URC's performance, though, isn't as poor as it first appears. On the supply chain side, Gokongwei has introduced an e-procurement system and linked bonuses to meeting monthly performance targets, which are pegged to optimal inventory and supply levels. He has also increased local materials sourcing and negotiated extended credit lines for imports from its foreign suppliers, which account for about 30 percent of URC's material costs. These efficiencies reduced operating expenses by about 1 percent in 1999 to 18.3 percent of net sales.

The company has also reduced its receivables from about 50 days to 34 by making the credit and sales departments separate functions, eliminating conflicts of interest. But with the continued slowdown in the Philippine economy, Gokongwei admits that he's taken improvements in accounts receivable as far as he can. "Credit to customers is a weapon to sell," he points out, "so in a cash-strapped environment, tightening it would only affect sales."

And no matter how hard he works, Gokongwei faces other pressures. URC's low ranking is mainly due to loans extended to its affiliate companies. While URC is a lean and well-run organization, the interests of the parent are served ahead of any particular subsidiary.

In other words, working capital management in Asia still has a long way to go. Granted, the environment here is far more complex than in the West, with issues like parental relations, state monopolies and relationship-based credit systems, which are simply less important elsewhere. Says REL's Brame: "In Europe or the US, with lower growth rates and more competition, a company that doesn't pay careful attention to working capital would be out of business."

But times are changing. "Working capital improvements," says Telekom Malaysia's Hasan, "by allowing us to reduce debt and invest in infrastructure, should pay off in the next one to two years." Next year's survey may well find that the current efforts of companies like TM have created value for the future. We look forward to hearing from them.

Steven Crane is executive editor of CFO Asia based in Singapore.