GO WITH THE FLOW
For the top tier of performers in this year’s ranking, the challenge is keeping working capital cool as markets get hot.
By Niles Lo

Full CFO Asia / REL Ranking link

Being the CFO of a company that stock analysts regard as a proxy for the growth of a nation’s economy has its pleasures. “It’s been a rather glamorous 18 months, with sales just huge,” says John Slack, CFO of PT Astra International, the US$4 billion in sales Indonesian automaker. Indonesia is on the growth path again, and a new breed of consumer is hungry for a first vehicle – motorcycles – as well as Astra’s more premium brands of Hondas and Toyotas. And one of the most beautiful parts of the proposition is that working capital management seems to be taking care of itself.

“Depending on the business, and counting trade receivables only, we have between eight and 19 days working capital,” which, Slack reckons is manageable given the company’s stellar growth. One of the reasons that working capital has not expanded at the rate of the business is inventory, or rather the dearth of it. “We’re in a market that responds very strongly to new products,” says Slack, “and the presales of products are very high. We have advanced orders from four to six months, with deposits paid, and this helps our cash position.” Best of all, as soon as a vehicle is off the assembly line, it’s out to the dealer. “We have low inventory costs and the product lines are very easy to move.”

He adds: “That’s the fundamental thing. It’s consumer driven, and demand has forced us to produce more, which is good and bad.” The good is that working capital doesn’t grow as fast as the company grows. The bad is that if Astra doesn’t produce its motorcycles and cars fast enough, it loses market share. This is where Slack’s analytical skills – and perhaps a little of market clairvoyance – pay off. Building too much capacity would be a mistake, because economists expect the Indonesian market to cool eventually, and competition will eventually ease the now-monumental thirst for Astra vehicles. That would lead to waste, including high inventory costs and working capital woes. But to build too little would also be a mistake. Right now Slack is happy enough with Astra’s balance on this fine line, but he’s ever vigilant.

More an embarrassment of riches than a nagging problem, Slack’s situation is shared with the companies that occupy the top tier of CFO Asia’s and REL Consultancy’s fifth annual ranking of working capital in the region. In choice sectors within a handful of economies – most notably Indonesia, India, South Korea, and Taiwan – the top performers are all improving their working capital management, despite periods of intense growth. To show this phenomenon, we’ve offered a different slice of the numbers than in previous years, showing percentage changes in key figures, including days working capital (DWC), over the previous two years. We’ve then ranked the bunch by performance on days working capital, showing the top and bottom players in a given sector. Beneath that, for benchmarking purposes, we’ve given an average for the sector.

The historical information is instructive. Astra, for example, decreased its DWC by 14 percent between 2001 and 2002 and then 23 percent in the following year. (Astra’s figure on the ranking is a DWC of 20 days. The figures that Slack gives above are a more recent reckoning.) The top player in that sector, Sanyang Industry Company, a US$627 million auto manufacturer from Taiwan, held its reduction of DWC by 17 percent steady over two years, resulting in three days DWC. Siemens India, a US$376 million maker of electronic components, can boast of a negative 15 DWC and an improvement of 35 percent over the previous year. Likewise, Hindustan Lever, the US$2.4 billion household products maker, enjoys a negative 19 DWC driven by an improvement of 26 percent over the previous year. The US$924 million diversified industrial company Sterlite Industries (India) has an enviable negative three DWC based on an improvement of 135 percent from the prior year.

Given the improvements in so many sectors, it would be natural to assume that Asia’s overall averages for working capital performance would be improving. Sadly, this is not so. In 2003, net working capital of Asian companies deteriorated slightly on 2002, with a 1.6 percent increase in DWC. This still brings the total fall to 8.6 percent over the past two years, because of an improvement in 2001, but, of course, indicates a slowing of what looked to be a positive trend. The reason behind this, according Peter Rabjohns, an analyst with REL in Singapore, is that Asia-wide, companies have managed to bring in receivables at a better rate, but this improvement has been offset by a 2.6 percent increase in days inventory outstanding and a 5.3 percent decline in days payables outstanding.

Even if the overall performance deteriorated slightly in 2003 on 2002, it is interesting to notice that out of a total of 47 sectors, two-thirds of them have shown improved DWC, while a third deteriorated. Among the biggest improvers were manufacturers of computer-related hardware, consumer and household services, and containers and packaging. Heavy industries, such as mining, oil, and telecom companies did better. Among the sectors that took a dive were airlines, electric utilities, media, and home construction. Even some of the sectors that comprise the outstanding companies mentioned above have declined on an overall basis, including household products and electronic components.

Reading trends in this business is never easy, as the demands and conditions for working capital differ from sector to sector. But Rabjohns sees a kind of bifurcation in working capital skills around the region that would explain the decline. “This year, the gap is wider between the top tier and the bottom tier in most of the sectors,” says Rabjohns. “There’s a bigger difference between who’s better and who’s worse.” For most of the sectors, excess working capital, or ‘opportunity’, has grown in the bottom tier. REL calculates its excess figure by comparing working capital performance of a company against an average for the top quartile of a given sector. Essentially, this excess liquidity is tied up in invoices not being paid by companies’ customers, suppliers being paid too early, and inventories lying unsold on warehouse shelves. Looked at this way, at the top 1,000 Asian companies US$140 billion of cash is tied up in excess working capital, representing 38 percent of all the receivables, inventories, and payables on their books. In both Europe and the US, the amount of total receivables, inventories, and payables that can be classified as excess working cap amounts to 27 percent in each region. “This suggests that there is a larger distribution of performance within each working capital component among Asian companies,” says Rabjohns.

This means that Asia, a traditional laggard in working capital management, retains this lowly mantle due to the performance of companies like Del Monte Pacific, the US$206 million Singapore-based food producer with a 162 DWC, compared with a sector average of 54; Metropolitan Construction, the US$257 million Taiwan heavy construction company in a class by itself with 795 DWC, compared with a sector average of 79; and Cipla, the US$303 million Indian pharmaceutical manufacturer with 188 DWC, stacked against a sector average of 98. The reasons given for the wider gap between the ‘champs’ and the ‘chumps’ are the traditional candidates that dog working capital management in the region. These include a greater geographical dispersal of supply chains, ungainly or inoperable infrastructure, perhaps exemplified by India’s battered roads, and businesses built on ‘relationships’ in the Asian milieu, that allow suppliers to go easy on collecting receivables for long-standing customers.

While these drawbacks remain impediments, the greatest lesson in this year’s ranking is that, to quote Ira Gershwin, “It ain’t necessarily so”. Companies like Astra and Hindustan Lever, in markets once thought impossible, are showing significant improvements. CFOs like Slack attribute this to close attention to the
fundamentals. In the case of Astra, this includes careful management of dealer and banking relationships. Slack says that as soon as the vehicles are sold to dealers, the dealers obtain a line of credit from the banks to pay. Therefore, Astra gets its money on a pre-paid basis and transfers the problem of collecting receivables over to the dealers. If the dealers fail to meet a certain threshold, Astra stops shipping more cars. In return for taking on this risk, the dealers are able to get concessions from the banks, in the form of low interest rates on loans, lower rates on mortgages, and better conditions on collateral. In this type of arrangement, an advantage emerges in the transparency a single bank can provide. It’s easier to spot problems as they emerge and act quickly.

The salutary role of banks in working capital management is one reason that J Gopalkrishnan, the CFO of Indian cement manufacturer Grasim, says that cashflow has improved in his business. As the ranking shows, the improvements have been steady. Birla Corporation, Grasim’s owner, tops the building materials category with 11 DWC, having reduced its days working capital by 38 percent between 2003 and 2002, and 38 percent a year earlier.

He flatly states that better management is a result of banking competition that has allowed the company to move from traditional bankers, the state-owned Indian institutions, to more competitive private institutions and the foreign banks that partner with them. These banks have invested in technology, allowing a visibility over cashflow unheard of five years ago.

In India, and in the cement business, that visibility can breed distinct advantages. Gopalkrishnan says that, on a typical day Grasim has 10 billion rupees (US$229 million) in receivables outstanding, and because many of those sales are on India’s rural byways, it takes six to eight days to collect. Five years ago, he says, “we’d have 20 million rupees in a state bank on one side of India, and on the other side of the country, we’d be drawing on an overdraft of 10 crores (about the same amount) the same day.” Now, Grasim’s banks have the ability to make cash across the country visible and available when they need it. What’s more, says Gopalkrishnan, “today, I know for sure that cement and metals businesses of Birla have tied up with these banks, even in remote centers. There’s an early clear every morning, and it’s all on-line.”

The advantage, he says, is that “we can use the float early in the morning,” he says. “It helps reduce funding costs, because we don’t have to borrow while all this cash is parked somewhere that we can’t tap. We can put it in a mutual fund, where the return it earns also helps us reduce costs.”

Nick Franck, head of CFO Solutions consultancy in Singapore, is less willing to hand laurels to technology and banks. He says that improvements in top Indian companies are more likely due to better internal processes. “Banks may have been importing ‘Western’-style systems,” he says, “but the real improvements surely come from better processes within the companies.”

This suggests that companies that want to find their way into the top tier of working capital performers can’t buy their way into a solution. Like their counterparts at Astra and Birla, they will have to roll up their sleeves.

Working Capital Ranking 2005