Working Capital Scorecard- Inventories, Receivables Need Attention

By Ramona Dzinkowski for CFO.com

Post-COVID-19, the future of working capital management has changed. Last year, supply chain complexity, inventory buffers, and loss of negotiating power all crimped many companies’ ability to reduce their working capital effectively. The height of the pandemic in 2020 also exposed weaknesses in supply chains. All those factors will increase the focus on how companies can improve working capital efficiency in 2021.

In general, this year working capital management won’t be about squeezing suppliers on terms. For the 1,000 U.S. companies in the CFO/The Hackett Group Working Capital Scorecard, days payable outstanding (DPO, the number of days companies take to pay their suppliers)  increased by 7.6% in 2020, to an all-time high of 62.2 days, up from 57.8 days in 2019. (See chart below.)

(For more on the scorecard’s results, see Thursday’s story, Working Capital: A Tumultuous Year.)

The biggest opportunities to improve working capital now are those components that lockdowns hit the hardest: inventory (days inventory outstanding) and receivables (days sales outstanding). DSO and DIO both increased in 2020, up 3.8% and 7.1%, respectively.

Organizations will be examining supply chains, understanding new patterns of demand, and, if relevant, optimizing inventory to support new online shopping patterns defined by pandemic lockdowns.

The pandemic has driven significant changes in consumer buying habits, which, going forward, will change inventory management strategies at many companies.

Consumers leaned heavily on e-commerce this past year. In 2021, companies will be looking for greater agility around inventories and distribution, says Craig Bailey,  associate principal, strategy and business transformation at The Hackett Group.

“They will necessarily be dialing production up or down to match demand, evaluating sales channels, and re-examining inventories,”  he says.

Returning to traditional demand conditions from the pandemic’s easing will pose specific challenges for optimizing inventory across all sectors. “It’s going to be very interesting to see if demand patterns return to normal. For inventory managers, there’s going to be a period of uncertainty,”  Bailey observes.

Some companies that did very well in reducing inventory stocks through online purchases might see a drop in demand as other spending outlets come back online, Bailey notes. “Inventory is still going to be a big topic, but it’s going to be more strategic, around sales channels and the stocks necessary to maintain those buying options,” he adds.

If companies in business-to-consumer markets continue to focus on the direct-to-consumer model, that could have a significant beneficial impact on their DSO numbers. “We could potentially see companies move towards a negative cash conversion cycle,” says Bailey. “Under the prepaid or subscription models, they no longer have extended terms with customers.”

For business-to-business companies, working capital efficiency this year will hinge on companies’ appetites to return payment terms to pre-COVID levels, as well as expectations around interest rates.

With record-high DPO, will buyers and suppliers revert to pre-COVID terms? “Our advice,” says Bailey, “is always to make sure that there are unambiguous criteria around when terms will revert to pre-pandemic levels.”

Meanwhile, higher inflation forecasts may have B2B companies focusing on inventory management.

“There are expectations of inflation, of increasing interest rates, and that should drive more of a focus on inventories because this is where a lot of the cash is locked up,” Bailey says.

Many organizations are looking to ensure information visibility about inventory through technology,  Bailey says. But inventory has historically been resistant to optimization, as different parts of a company, like sales or manufacturing, often have competing priorities and goals.

While COVID-19 still weighs on many companies, The Hackett Group’s experts predict a dramatic turnaround in working capital efficiency this year in several sectors.

Hotels and hospitality, for example, will rebound, says Bailey, as the world economy opens up again. “Once the revenue starts coming in, things will turn around for other related industries, particularly those [suppliers] that are holding inventories for that sector.”

The cash conversion cycles in the retail, textile, and apparel sectors will come back as these companies rebalance their inventories and figure out where demand will be. Says Bailey, “Companies are now not only dealing with new consumer demand patterns but also what their optimal sales channels should be.”

Run annually for two decades, the CFO/The Hackett Group Working Capital Scorecard calculates the working capital performance of the largest non-financial companies based in the United States. The Hackett Group pulls the data on these 1,000 companies from the latest publicly available annual financial statements.