LOST IN THE MACHINE
As Asia's economy surges, working capital is growing at the same rate as sales. That's not good.
By Arthur Clennam

It's a problem most CFOs wouldn't mind having. Ravi Sud, the CFO of Hero Honda, the New Delhi-based maker of motorcycles, is gearing up for a bust-up year. Primed by 8 percent growth in India's economy and the utility of motorcycles for negotiating India's hyperactive highways, the bikes are going out of the shops like mad. Sales of Sud's motorcycles increased more than threefold to US$914 million in 2003 over the year before. But the burst in revenues has caused his days working capital to creep from negative two - a sterling result - into the positive for the first time in years. "Of course, we have to keep an eye on working cap growth at a time when we're moving our products fast," says Sud. "It's a top priority for my finance team."

If one conclusion can be drawn from CFO Asia's fourth annual look at management of capital consumption in Asia, it's that squeezing valuable cash from the working capital cycle is not easy. And only a few, like Sud, make it a top priority. The ranking, based on the research of REL Consultancy, a London-based advisory firm, shows a marked decline of performance in each of those areas in which discipline is best tracked, such as the number of days it takes to collect on bills, the speed at which suppliers are paid, and, in general, how efficient companies are at converting working cap to ready money. (The full CFO Asia/REL ranking, sector by sector and country by country, is here (xls format) and here (pdf format).)

Read it and weep. Days working capital for all the companies in the 21 sectors published here ballooned to 83 days from 42 on average. In other words, it takes Asia, Inc. twice as long to convert its working cap into cash than it did a year before. Days sales outstanding (DSO) also got worse, growing to a painful 72 days from 47. It would be nice to claim that all of this was an embarrassment of riches, and that all parties were struggling with the same problems of growth that confront Ravi Sud. But not all sectors can boast of the kind of growth year experienced by Asia's automotive sector.

Telecommunications, for example, saw a fall-off in sales of 68 percent over the year-earlier period. But the decline hardly concentrated the minds of telecom CFOs. Instead, they responded to very real pressures by ignoring working cap as a high priority. Days working capital in the sector increased sixfold to 55. The industry, particularly in China, saw intensified competition and heightened scrutiny of subscriber lists by analysts. This added an impetus to loosen terms in a grab for customers.

It may be that Asia's heady boom-bust cycle leads to inattentive working capital management. "On a worldwide basis," says Simon Brew, chief executive for REL's regional unit based in Sydney, "there are three capital consumption models. The first is the US, where a fast cycle plays out in the domestic market. In the EU it's longer, but a broad profile of parity has emerged throughout the market, from Italy, say, to Germany." He adds: "But Asia has a much longer cycle time converting working capital into cash."

The reasons, according to Brew, are ingrained in the region, which is geographically much larger, and more diverse in culture. Compromises on payment terms are made with suppliers in South Korea, for example, that would never fly in Singapore or India. Electronic payment infrastructures are hardly universal here, while they are far more common in the US and Europe.

"Asia seems to be a special case," adds Michael Brame, who heads REL's office in Singapore. "The boom mentality encourages them to stimulate sales and allow terms to slip, when times are good." He adds: "But companies in sectors hit by a temporary downturn get caught up in a competitive trap, spinning new sales to survive." Brame says that if countries in Asia matched the United Kingdom's growth rate of 2.4 percent, then current working cap management would be unsustainable. They would need the cash clogged in the system in order to survive.

But that's just it. No one in Asia ever envisions a period in which growth - God forbid - slowed to 2.4 percent. "In Thailand," says Sataporn Jinachitra, president of the Export-Import Bank of Thailand, "there's a complete lack of understanding of how to organize working capital." He says that, instead of relying on cash from efficient management of working capital, companies turn to banks and "ask for a credit line in two or three days. They say they're short of cash and need immediate assistance." He adds: "Planning with the goal of improving cashflow simply isn't in their thinking."

Field of Dreams

The truth is that Asia is the repository of the world's sales dreams, and its companies lose a tremendous amount in ready cash because sales can be a goal in themselves. In our ranking last year, we reported the amount of money, dubbed 'opportunity', that Asian companies would have at their disposal if they managed working capital better. Last year's amount was a princely sum: US$23 billion. This year it has doubled to an astronomical US$46 billion. The most felicitous way to describe opportunity is to call it all the money you would have if you managed working capital at a benchmark rate compared to an average for your peer group and your market. Consider for a moment what US$46 billion in available cash really means. The sum represents 8 percent of the projected US$555 billion total GDP estimated for the ten countries that comprise the ASEAN trading partnership this year. A cool US$46 billion could have funded half of US President George W Bush's adventure in Iraq, which currently has a pricetag of US$80 billion and rising.

This year, we've decided to rank Asia's most notorious wasters of 'opportunities' in two different ways. The first (on page 44) shows Asia's biggest offenders in terms of opportunity as a percentage of sales. The top slot goes to Moulin International in Hong Kong, a candidate for intensive care.

Moulin, with US$151 million in sales, is the world's third-largest eyewear manufacturer. But it has seen its role as an original equipment manufacturer (OEM) decline as competition increases from lower-cost producers in Southeast Asia, and it is trying to switch its marketing strategy to becoming a producer of brand-name eyewear. In a crunch to compete with the lower-cost producers, Moulin has allowed days sales outstanding to fall to 355 days. REL reckons that the amount of cash that Moulin could have on hand if it hadn't been caught in this bind - and managed its working capital better - is US$147 million, or almost as much as all the sales it made last year.

Toby Tan, financial controller of Moulin, says that CFO Asia and REL's computation for DSO is too stringent. Moulin's method for calculating DSO includes trade receivables only. Excluding other receivables and including only trade would reduce its figure for DSO to 151 rather than 355, making its days working capital 217 rather than 422. Using his method, Tan sees opportunity amounting to US$75.7, or 49 percent of Moulin's sales, rather than US$147.3 million. Tan says that 217 days working capital, in any case, is still too high, but explains that the company is amid a change in business plan and a shift to "global integrated manufacturing distribution. We're in a transition and a growth stage." Like the CFOs in our cover story ("Brand and Deliver"), Tan sees Moulin taking bold steps to build a brand from Asia.

Moulin's case, a mid-size firm with grand ambitions, may be unusual. But there are many companies, often much larger, often household names, that have huge, unexploited opportunities in the form of cash clogged up in inefficient working capital management. These opportunities don't represent a sizable portion of sales, but actual dollar amounts indicate that they could be extracting a lot more cash out of their inefficient working capital systems. Ranked by sheer dollar size, Samsung Electronics, the South Korean electronics giant, is the reigning champion at US$2.1 billion. That represents only 4.2 percent of its US$50 billion in total sales, however, meaning that because Samsung has such large sales volume, its working cap problem can be obscured by success. "But look at that figure," says Brew. "Imagine what mileage Samsung could get out of having even some of that cash on hand." Another Asian Goliath, US$9.6 billion in sales Hutchison Whampoa, has US$937 million, or 9.7 percent of sales, tied up in days working capital.

One culprit with both of these giants is their speedy payment to vendors versus the much longer time it takes for them to get paid. In the cruel world of working capital management, best practice is to wring payment on receivables immediately, but avoid paying vendors for as long as possible. With cash on hand that does not yet have to be paid out, the money can be put to good use. Both Samsung and Hutchison have reversed this cash alchemy, by paying bills much faster than they receive payment for goods and services.

If either of its CFOs are looking for a motive to improve working cap management, it is that sell-side analysts are spending more time looking at the numbers these days. "Analysts increasingly are looking at working capital performance," says Simon Jones, the head of Asian corporate sales for JPMorgan treasury services. He adds: "Eight years ago, companies were funding mostly with bank debt, but now they've turned to the international capital markets. Their efficiency in converting working capital to cash is scrutinized: the better they are at it, the lower their funding costs.""

Inventory Heroes

This lesson has not been lost on Sud. He joined Hero Honda in 1998 after having been in the working capital trenches at a previous job with a tractor-maker called Eicher Motor, where the problem with receivables, compounded by fickle rains affecting crops in the early 1990s nearly pushed the business into a loss.

After joining Hero, Sud reorganized his working capital management. He attacked receivables by reworking the terms with which Hero Honda contracted with its dealers. "We devised a system," he says, "in which those who were most efficient were rewarded; those who fell behind were punished." Starting with delivery of motorcycles to a showroom, dealers have 15 days of grace. Within the next 15 days, they must pay, and those that pay ahead of time get a concession on price. Those that slip beyond 30 days are fined interest. The plan started in July 2002 and Sud said that all dealers had to buy in, or face a cut-off. In real-money terms, days sales outstanding were reduced threefold to 1.26 billion rupees from 3.7 billion rupees.

He reinforced the receivables policy by setting strict guidelines on payables. At the time he revamped the system, the company was paying its vendors on average 37 days. Sud extended it to 45 days by last November, a goal he's satisfied with. "In this country," he says, "there are not many companies that pay in 45 days. The vendors suffer tremendously. Most, I'd say, have to wait 60 days or more. So I plotted myself out to 45 days without anyone protesting. But I also made it a tight goal: we pay in 45, never in 46." This kind of consistency has won Hero Honda friends - and better terms - with suppliers. Some 67 percent of Hero's payables are automated, which helps keep Sud within his timelines.

Last, Sud tackled his inventory days. Hero Honda actually constructed its plants so that they could not stock more than 20,000 motorcycles at a time. Sud relies on an electronic inventory control package running on its SAP ERP system to track warehouse performance. The company's just-in-time system has whittled inventory down to between 8,000 and 10,000 motorbikes in general stock on average at any one time. His goal is 6,000. "Automation is essential to this system," he says. His finance department receives a daily report that automatically pops up on the computer screen every day. "We know how much money is outstanding, and how much material is in transit east, west, north, and south," says Sud, "including equipment from vendors and tools. We can see our overdues - what hasn't been paid on time."

Sud recognizes that the market sees better working capital efficiency as a good tale to tell investors. On road shows, Sud is able to note that the company is debt-free and holds no contingent liabilities, arguing that freed cash from better working capital has allowed him leeway to maintain a pristine balance sheet. Benchmarked against his peers around Asia - which show a days working capital average of 70 days - he has reason to boast.

So Where are the Banks?

With advantages like that, why don't more companies pay more attention to it? Certainly, banks operating in Asia are more than willing to help. HSBC, ABN AMRO, JPMorgan, and Citibank - have all grouped a wide range of services under the rubric of working capital management. As the tepid performance by Asian companies revealed in our ranking would suggest, these bank offerings have yet to catch fire. Still, bankers can point to a few notable successes.

"The clients are not specifically asking for service integration," says Carl Stocking, regional manager, North Asia, global trade advisory for ABN AMRO's working capital group. "They're saying, 'Here's what we're doing. How do you fit into that?'" The bank's relationship with Kansas-based Payless Shoes shows how this tasked-based approach can expand into full-blown advisory. ABN AMRO began working with Payless three years ago to sort out problems with purchase orders between its 4,900 US outlets and suppliers in Southeast Asia. But Payless was also looking for working capital improvements throughout its entire supply chain. Says Stocking: "They wanted to source shoes cheaply, and keep costs down, but maintain quality and style.'" ABN AMRO solved the purchase order dilemma by helping Payless set up an 'insourced' digital tracking system that allowed for data matching to cross-check and track documents. It has since offered a variety of services, including forex management, risk management, cash management, and supply-chain financing.

Lionel Smith, who heads JPMorgan's Asia regional consulting for treasury services in Singapore, sees lower capital costs for companies on both sides of a transaction emerging from the new wrinkles in supply-chain finance. "Financing and discounting strategies," says Smith, a former treasurer with Procter & Gamble, "are possible via electronic trading that never existed before." He adds: "There's more flexibility for everyone: buyers have more leeway for obtaining discounts, and vendors can get their money quicker and at a lower cost."

As an intermediary between a supplier and a buyer, banks can build a lending mechanism into the equation that presents new options to both parties.

Suppose you're the CFO at a small Vietnamese supplier with immediate cash needs, but you're having trouble getting decent terms on loans because of the high cost of capital in your market. With the buyer's okay, the bank can pay you immediately in return for a discount or extension of terms. Instead of making the actual payment, the bank structures the payout as a loan. If the buyer is, say, a large international company like Payless, the bank can fix the rate of interest based on the buyer's credit standing (typically, a large US buyer would have a credit rating and a lower cost of capital than the supplier).

The beauty of the arrangement is that the buyer doesn't have to pay for the order, via reimbursing the bank, until, say, 30 days later. In the interim, the cash can gain returns via cash management. For the Vietnamese company, obtaining the money up front, and at the lower funding rate, can be a life saver.

Not all parties think the banks have offered their services in the right way. Simon Brew believes that the banks have a lot to offer, but says they aren't nimble enough in responding to Asian corporate needs. "Major banks," says Brew, "are under pressure. One reason is that services for corporate clients have become heavily commoditized. A savvy treasurer or CFO will shop around, and get half a cent, say, on a transaction from one bank. He can then play the banks off against each other."

Brew says that bank services are often quite good, but that bankers haven't yet found the best way to deliver them. "They're trying to overlay a framework of services on company structure," says Brew. "Our argument would be that companies want and need the service. The problem is the organizational structure of the banks."

Indeed, new challengers are trying to take pieces of the bank business away. One is TradeCard, ubiquitous in automated trade financing transactions, which has proven popular for companies that are trying, like Payless, to get away from expensive letters of credit. But now TradeCard is offering vendor financing, too. TradeCard has enough of a 'critical mass' of transactions, according to its CEO Kurt Cavano, going between buyers and vendors that it has struck a deal with GE Capital to pool the transactions and set up a lending mechanism.

"What I want to do with all this," says Cavano, "is do for global trade what the credit card has done for shopping."

Truly, Asia's market doesn't lack willing accomplices for better working capital management. And with opportunities abounding, it's a wonder why companies don't try harder. CFOs - it's your move.

Arthur Clennam is a writer specializing in back-office operations based in Hong Kong.