WHEEL OF FORTUNE
The mundane art of working capital management is becoming a driver of value in uncertain times.
By Karen Winton and Enid Tsui

An incredible fortune - almost US$23 billion - is begging to be accessed by finance chiefs in 45 companies in Asia. They could be using the money for acquisitions or factory expansions, they could be using it for debt repayment, or anything else they fancy. They could be, but they can't because, unfortunately, the money is all locked away in places they don't seem to be able to touch. And these places are not like time deposit accounts, they are overdue accounts receivable, over-generous inventory levels and overly prompt bill payments. CFOs could unleash this entire fortune from working capital by conscientiously improving their management of receivables, payables and inventory levels. So close, yet so far.

Working capital management never makes it to the front page of the business news section. It is, to the few laymen who have heard of the term, something buried deep in annual reports, and therefore boring. To most CFOs, it's mainly grunt work, and it could involve alienating customers, suppliers and even the people in the sales department. But there is no doubt that it is a financially rewarding exercise since unlocking assets tied up in working capital could immediately enhance operating cash flow, which, if used wisely, could then lead to an improved bottom line.

Some companies that have started to squeeze cash out of their working capital have seen concrete results. In the first half of its fiscal year 2003, Hong Kong toy maker VTech Holdings cited reduced inventory levels as a major contributor in its return to a net cash position (US$23 million) and a 14-fold increase in net profit (US$50 million) - despite an 11 percent decrease in sales. In 2002, Hong Kong holding company Jardine Strategic added US$64 million to its operating cash flow simply by reducing rental deposits. Likewise, Philippine liquor producer La Tondena Distillers' significant improvement in its receivables collection (from 78 days to 29 days), coupled with a cut in inventories, enabled it to release 2.3 billion pesos (US$42 million) from its working capital.

Unglamorous as it may sound, working capital management is probably one of the more worthwhile tasks a CFO could do to navigate his or her company through the ill effects of the war on Iraq. Economists are unanimous that whether or not the war is resolved quickly, it will have chilling repercussions for months to come. Business activity will slow, revenues will falter, and financial investments will yield negligible returns. In short, traditional sources of liquidity will dry up. These are the days when the old clichZ¹ is worth mentioning again: cash is king, and those who can generate cash quickly will at least have a greater level of comfort and room to maneuver amid the rough patches ahead than those who can't.

With this in mind, CFO Asia, in partnership with London-based REL Consultancy Group, presents its third annual working capital survey. The survey looked at working capital efficiency at 687 public companies with at least three years of publicly available records. The overall ranking is based on an evenly weighted combination of cash conversion efficiency, or the ability to turn sales into cash, and days working capital, which is the sum of days sales outstanding (DSO) and days inventory outstanding (DIO) less days payable outstanding (DSO). (See table, "Top 5 Companies by Industry").

A more analytical look at the figures reveals a bothersome scenario. By calculating the difference between what the companies in the top quartile of the ranking have in their balance sheets in terms of receivables, payables and inventory, and what they would have if they reduced their DSO, DIO and DPO to their industry averages, REL found that the sum of available capital amounted to US$39.8 billion, of which US$22.6 billion belongs to 45 companies alone. (See chart, Missed Opportunities "Missed Opportunities").

Collect Call

If generating cash is the goal, the most obvious way of mining for it is through the super-efficient collection of receivables. "Working capital is about managing our accounts receivables," says CFO Chua Sock-Koong, CFO of Singapore Telecommunications, which ranks fourth overall and first in its industry. "The focus here is to collect, and the worst-case scenario is if you make lots of sales, but you can't collect." In its financial year ending March 2002, the US$4 billion-a-year company had a cash conversion efficiency of 58.1 percent, and a days working capital of negative 11.43 percent. This means Chua is able to collect from her clients sooner than she pays her company's suppliers.

This is hardly surprising. With millions of fixed line and mobile services clients in a financially well-off city-state, SingTel, Chua admits, enjoys predictability in its collections. On the other hand, its payables are in the form of capital expenditures, which are planned annually. Being a virtual monopoly, SingTel can obviously bargain hard on payment terms with its vendors. "We look at structurally appropriate vendor credit and do it as part of overall procurement," she says. "We try to get all the purchasing leverage we can get."

This, however, is no excuse for complacency in collections. Although prosperous, the Singaporean economy has just been through a recession and is still hurting. As such, Chua continues to refine her collections process through a credit rating system that tracks past collections and immediately detects "high risk" accounts. "We have a disciplined credit management policy in place so we have very healthy accounts receivable," says Chua. "As a result, the cash flow from our operations is very strong." In the first quarter of 2003, Chua estimates that SingTel's DSO would fall to 40 days from 54 days.

Of course, SingTel's formidable position in Singapore as a phone services provider makes it the exception rather than the rule. For many manufacturing companies in Asia, the reality is that customers are either too few and far larger than they are, as in the case of original equipment manufacturers, or too many and too dispersed to monitor, as in the case of consumer product makers or industrial materials suppliers.

Good Chemistry

Sinopec Shanghai Petrochemical, which makes plastic, synthetic fiber, chemicals, refined oil and other products, falls in the latter category, and chief accountant Han Zhihao knows the value of tight cash controls better than most of his peers. The Shanghai and Hong Kong-listed company, which ranks eighth of all 27 mainland companies in the survey, saw its 2001 sales fall by 5 percent to RMB 20.2 billion (US$2.5 billion). Net profit plunged a drastic 86 percent to RMB116 million. Interim results for 2002 showed a slight improvement in net profit, but growth in turnover remained slow.

That's partly because the industry was in a bind. In 2001, Shanghai Petrochemical (which ranks 11th in the chemicals industry) spent about 58 percent of its total cost of sales on crude oil, the main raw material for its products. Although the price of crude oil fell an average 8 percent that year, the company's customers, which sell their own finished products overseas, were faced with a depressed market and thus pressured Shanghai Petrochemcial to push down its prices. The company relented and cut the average price of its major products by 12.5 percent.

Last year, the same pattern emerged - oil prices went up while demand for products remained low. As of June 30, 2002, the company had total accounts receivable worth RMB1.47 billion, and a days sales outstanding of 28 days. This is far better than the Asian chemicals industry average of 62 days (or even the US average of 51 days), but it's actually eight days worse than Shanghai Petrochemicals' previous year's DSO, which was only equivalent to 20.6, according to REL. This worsening trend was a wake-up call to Han. "It is a major part of our department's duty to grasp the cash flow situation of the company and to ensure that capital within the organization is kept liquid," he says.

As such, Shanghai Petrochemical is clamping down on costs as well as working capital. The process is not an easy one. For one, the petroleum and chemical industry is very dependent on the price of oil, but Shanghai Petrochemical and its peers in China are not allowed to buy oil futures, which offer protection from oil price volatility and are common in developed countries. As a result, Chinese companies have to buy direct from oil companies and are billed at the end of the month. Hua Xin, the director of finance, says: "The company can pay according to the day average international market price on the actual billing date or the average price of that month." It is usually given 30 days to settle the bill by a letter of credit.

Historically, the company has not been strict with its own customers. "Our sales team naturally hopes to give customers more relaxed payment terms," says Han. "It does contradict the thinking of the finance department." Now, the finance department administers a tougher collection regime. A potential client's creditworthiness is carefully studied before a sales agreement is signed. Clients are asked to settle their bills in one of three ways: with cash, with bank bills or by asking for deferment. The latter is triggered when payment is not settled within 30 days from the day of sale, and requires approval by senior management. Han says that most clients pay by bank bills, payable within a month. Customers who pay with bank bills that cannot be cashed within a month have to bear the cost of interest. The result: Han claims Shanghai Petrochemical has hardly any unrecovered sales receivables today.

Han and Hua stress that working capital forms a major part of their work and that they are constantly on the lookout for new initiatives to match the timing of receivables and payables. On payables, Shanghai Petrochemical's DPO stood at around 20 days in 2001, less than half the Asian industry average of 45 days. "Our company's reputation used to mean a lot to us," says Han. "We may have had clients who gave all sorts of excuses when they didn't pay on time, but we were always quick with our own payment. We've now learned to balance the two." If Shanghai Petrochemical took as long as the industry average to pay its bills, it would have had an extra RMB1 billion to play with, according to REL's estimate.

Sharp Focus

Like Chua and Han, Peter Day, executive general manager for finance at Australia-based packaging company Amcor, prioritizes receivables collection in his effort to improve working capital management at the A$11 billion (US$6.6 billion) a year company.

Day is in the middle of a program to shorten the DSO of Amcor, already hard enough work given that the company has six businesses, each with its own CFO, worldwide. He has, however, made working capital management a passion and will next attack the DPO and DIO performance of the whole enterprise. "I wanted us to focus on the management of receivables, something that we had a common view on," says Day. "It was easier for me to kick start the focus on working capital by using receivables as the starting point. If we can do something as a group on receivables and do it well, then we will feel confident about doing things collaboratively in the other areas of working capital."

Day didn't have to look far to see that Amcor's working capital management was not in good shape. Last year, it acquired a packaging business called Schmalbach-Lubeca. That company's DPO is roughly 60, its DSO around 20, and DIO about 80, giving it a days working capital of 40. Amcor, on the other hand, had DSO and DPO of 65, and a DIO of 70. "I believe that Amcor is not comparing as well as it should with other companies in the packaging sector," says Day, "and that's where it has an opportunity to improve."

So far, so good. Day has met and talked with some of his accounts receivable department staff, and found that the benchmark they used to measure working capital efficiency was, in fact, inefficient. Amcor previously measured it by tracking average working capital to sales. The lower the ratio, the better for Day. While this is always true, it didn't indicate whether this was because of improvements in receivables, inventory or payables.

From a manufacturing standpoint, Day illustrates, inventory sits at the furthest end of a scale of difficulty, with payables at the other end. Receivables, however, embrace the interfaces with sales and manufacturing - one problem in receivables is often about product quality, for example, or a customer dispute - and as such sit firmly in the middle. Being pragmatic given the size of his operations, Day says he expects no immediate results. "Anyone can have a campaign to reduce receivables or stretch payables or do just-in-time inventory," adds Day, "but we don't see this as a 12-month exercise. We see it as a three-year exercise. It's something that has to be built in rather than built up."

Collections Culture

Michael Brame, director of operations at REL in Singapore, acknowledges that there are no easy answers to working capital management,particularly receivables among Asian companies because they rely on a collections apparatus linked to the sales function, a sort of unholy alliance.

Brame claims that this cultural difference harks back to the Asian family business model where the customer relationships were owned by the founder. "In modern Asia, what that translates into is a customer-facing person, and that person is the salesman who is responsible for making sure that the customer pays according to his obligations on the due date," he says. Without generalizing, Brame says separate sales and collections departments could do wonders to receivables. "There should be a discreet collections function whose job is to contact customers and ask them to pay to terms."

This, of course, is not a hard and fast rule. As Paul Coleman, CEO of Systems Union, the UK-based global developer and marketer of SunSystems' business and financial management software, found out, having a strict commissions policy could sometimes do the trick. "Our commission plans now are all on a cash basis, globally. That is going to have a dramatic effect on our receivables, which were poor in the US and Europe last year to the point where I stopped all commissions until they came down to an acceptable level," says Coleman. This "clawback" situation left the sales force in a position where, if no debts were collected within 60 days, their commission was clawed back. "All I can say is it is most surprising how quickly the cash came in," says Coleman.

In the end, it's probably fair to say that the relationship in many companies between the finance people and the sales and marketing people should be strengthened if receivables management - and working capital - is to be improved. For the strategic benefits of improved receivables to be used in gaining an opportunity to access capital, the CFO's involvement is imperative, but it's obvious that managing them is not solely a financial exercise. "Ultimately, the process is a collective," says Day.

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Additional research by Vero Escarmelle of Enterprise.com.