Asia works to squeeze working capital

Finance experts have forecast that globalisation will put a greater working
capital pinch on corporates in the near future.

‘Increasing volumes of business to and from Asia during the next four to five
years will have a real impact on working capital,’ said Stephen Payne, president
of cash flow improvement experts REL.

‘As companies source more of their products in Asia, payables tend to decline
for several reasons. First, purchase costs are lower, therefore the value of
accounts payable reduces.

‘Also, because the contractual currency for sourcing in Asia is generally the
US dollar, the weakening of this currency makes the importing of products even
cheaper. This improves margins, but also reduces payables and has a negative
impact on working capital metrics.’

After a major setback in 2005, Europe’s 1,000 largest companies improved
their Days Sales Outstanding – the average time that they have to wait before
being paid – to 45.2 days in 2006 from 48.4 days in 2005, freeing up ¤46bn
(£31bn).

This was achieved largely through better bill collection and improved
inventory management, according to results of the Tenth Annual Working Capital
Survey conducted by REL and magazine.

But one key element of working capital, Days Payables Outstanding – the speed
at which companies pay their suppliers – decreased to 44.6 days for
European-headquartered companies in 2006, which put more pressure on businesses’
working capital requirements.

Among the reasons identified by the REL analysis, companies are now taking
advantage of early payment discounts to decrease cost to support EBIT.

Companies are still under pressure from their own customers when they offer
early payment discounts as well. ‘There’s still a lot of the bully element in
existence here,’ said Payne. ‘If you have a client that you rely upon for 20% of
your sales, there’s not much a company can do if they take the early payment
discount and still end up paying late.’

The European survey found that the 1,000 largest publicly-traded companies in
Europe (by sales) cut their working capital by 6.6% in 2006. These gains
followed a year in which working capital improvement stalled in Europe for the
first time since the REL Europe survey was initiated in 1998.

Typical European companies in the survey saw Days Working Capital of 45.2 in
2006. A parallel survey of total working capital performance at the 1,000
largest publicly-traded companies (by sales) in the US found no improvement in
2006, after nearly a decade of annual working capital reductions. But even with
this year’s gains, overall total working capital performance by European
companies was still 18% worse than that of their US peers.