Annual Working Capital Survey

KPMG cash and working capital management survey report 2011

kpmg.co.uk

In 2011 KPMG in the UK commissioned MD Media to conduct research into cash and working capital management. The survey comprised interviews with 300 finance executives in the United States, Canada and continental Europe.

About the authors

Andrew Ashby Associate Partner KPMG in the UK Roger Bayly Associate Partner KPMG in the UK

Andrew has more than 12 years of professional services experience in the areas of sales, marketing, SG&A cost reduction and cash and working capital management. He graduated in Economics and Corporate Finance from Brunel University and started his career as an equity analyst with Kleinwort Benson. Andrew joined KPMG to lead the corporate cash and working capital practice. He specializes in helping companies improve cash flow from operations. Prior to KPMG he was the US and then European President of a specialist consulting company focusing on cash and working capital management. Andrew works with companies to help them identify opportunities for improving their visibility and control of cash flow around the business and supporting them with programs to release cash locked up in working capital, tax, capex and other assets. Andrew has been involved in over 40 working capital programs either as the project leader or advisor. Many projects have been global requiring effective program management and co-ordination of multiple teams in different regions. The majority of projects have been focused on the implementation of sustainable improvements in working capital, achieved by driving behavioral change across businesses.

Roger joined KPMG in 1998. He specializes in operational restructuring and turnaround of businesses in the consumer and industrial markets sector. Roger works with management teams to create and execute operational restructuring programs. He has worked with numerous companies, from multi-billion dollar global businesses to 50 million single site operations. Roger has led projects aimed at all areas of the Profit and Loss and cash flow including new product development; supply chain reorganization; site consolidations and outsourcing; rationalization of back office functions, property moves and operational improvement initiatives. Recently, Roger has led a major operational restructuring for a FTSE 100 scale industrials business aimed at taking out 15 percent of the cost base and improving cash performance. Roger started his career as an engineering apprentice with Jaguar Cars. He graduated in Engineering at Cambridge University and worked on a range of Jaguar and Ford programs.

Our contributers
Michael Keppel Chief Restructuring Officer Phoenix Pharmahandel John Mullins Professor of management practice and entrepreneurship London Business School Jeff Van Der Eems CFO and Coo United Biscuits Francios Masquelier Head of Corporate Finance RTL Steve Lucas Finance Director National Grid Ken Daly Global Financial Controller National Grid Sten Daugaard CFO Lego

Contents
Section 1: Executive summary Section 2: Lack of incentives Section 3: Slipping down the agenda Section 4: Struggling with implementation Section 5: The road ahead Section 6: Challenging assumptions 1 8 10 12 13 14

Conclusion 17 Demographics 18

1 | Annual Working Capital Survey

Executive summary
Cash and working capital management remain a high priority for leading businesses but there are worrying signs that improvements in performance achieved during the downturn may be eroded as a result of failure to institute effective core management as part of business as usual.

Growth

in emerging markets is also affecting commodity prices, forcing raw materials costs higher as demand rises
Past experience tells us the priority given to cash and working capital management tends to have an inverse relationship with economic performance. In periods of contraction or sluggish growth, cash and working capital issues rise to the top of the boardroom agenda. When prosperity returns, the focus shifts elsewhere. But the past is not necessarily an accurate predictor of the future. The recent downturn was triggered by the global financial crisis and throughout the recession, constrained access to capital was one of the major factors forcing companies to assess the cashgenerating ability of their operations. And today even though the recovery is now underway - the cheap finance that fuelled the preceding boom is nothing more than a rapidly fading memory. Given this new reality, you might assume a sustained shift in corporate behavior, with effective cash and working capital management remaining a key priority for businesses an integral part of the corporate five a day - even when demand and revenues begin to gather pace. However, the results of our survey this year, suggest that even in the current era of relatively expensive finance and patchy growth, a sustained commitment to cash management, both in bad times and good, is not yet embedded.

At first glance, the findings of the survey are moderately encouraging. Cash management remains high on the agenda, with 83% of respondents naming it a top five priority, However, that does represent a slight reduction from the 86% figure returned in last years poll. Perhaps more significantly, the percentage of respondents assigning highest priority to working capital management fell from 84 to 75. Both findings suggest that the onset of recovery has triggered a shift in focus, with cash and working capital management moving, albeit slowly , away from the centre corporate radar screen. The danger is that this trend will ultimately result in the improvements achieved during the downturn being eroded just at the time when corporate demands on financial resources are on the increase. Recoveries see more cash consumed, cash grow requirements faster than sales. All of this begs some critical questions. Should cash and working capital management by prioritized in good times and bad? And if thats the case, why does it seem such a struggle to sustain a commitment to running a tight ship when the economic cycle turns up? These questions were very much to the fore when KPMG embarked on its third annual survey of cash and working capital management.

radar, with nearly all respondents rating it as a high priority. But the survey also reveals significant challenges. Finance executives are struggling to improve working capital performance, for a variety of reasons, including corporate complacency and lack of clarity from leadership at the top. This is worrying. According to most forecasts, the economies in key developed countries will recover, but not to the robust growth levels of previous times and even large companies cant expect the double-digit top-line expansion that they once enjoyed. This is no time for boards to take their eyes off the working capital ball.

Taking the Initiative

And nor do they have to. Our survey contains interviews with three finance executives who have successfully implemented working capital management initiatives while also demonstrating that some of the perceived obstacles can be overcome. For instance, its often said that managers in highly regulated industries are too hidebound by the rules and statutes surrounding their businesses to make effective changes in the long term. However, at energy company National Grid, measures to improve the visibility of working capital management have played an important role in helping the company to expand. Rather than tying the companys hands, regulation acted as a spur to coming up with imaginative revenue collection strategies in a market where simply cutting customers off is not an option. Lego has demonstrated that there neednt be a dichotomy between driving sales and a commitment to working capital management. By focusing on the

Challenges and Opportunities

Focusing a companys attention on cash, while putting the squeeze on working capital is always a challenge. But it is even harder during the good times when, inevitably, resources are thrown into expanding the top line, leaving little energy or focus for addressing process inefficiencies that needlessly tie up cash. Cash management is clearly on finances

Annual Working Capital Survey | 2

customer through high quality, safe and attractive products, the company has sustained a community of happy retailers who, crucially, pay their bills on time. Meanwhile, our interview with the CFO at United Biscuits demonstrates that not only can working capital management projects be sustained over a protracted period, they are at their most effective when not tied to a limited time frame. As the firms CFO says: the focus on working capital never ends. And it shouldnt.

The following are the highlights of the findings of our cash and working capital survey:

Key data
Cash continues to be a top priority for companies: 83% of respondents say its among their firms top five priorities. While thats down slightly from 2009s 86%, theres been a big increase in the number of CFOs citing it as their number one strategic priority -- 38% in this year compared with 28% previously. Finances ongoing focus and increased prioritization has helped drive a noteworthy improvement in the accuracy of cash flow forecasting, continuing the upward trend of the previous two years -- 48% of respondents say their companies hit their targets in 2010, compared with 28% in 2009 and 14% in 2008. But in the case of working capital management at a company-wide level, we have seen a retrenchment over the past 12 months. In 2009, 84% of respondents placed working capital management as a high or highest priority. This has fallen to 75% in the most recent survey, reinforcing the view that companies have started to shift their focus now that the signs of a recovery have become clearer. Looking at working capital performance over the last 12 months, 66% of respondents reported flat or increasing working capital. This is disappointing given that while companies might insist its a priority, their actions speak louder than words.

49% of companies state that they are finding it harder to drive improvement in working capital. This may be the result of running out of ideas, reduced focus or resistance from the business to further change. As in 2009, companies are not exploring all areas of cash and working capital management, namely indirect tax, pension funding options and capex cash controls are still getting limited attention. What is mystifying is the continued low number of companies linking incentive compensation to cash flow: 61% of companies still do not link management incentives to cash flow, despite 83% of respondents claiming it to be among their top five strategic priorities. Given that this is only an increase of 3% over 2009, its clear that companies are struggling with both how and why effective cash management should be a part of compensation structures. Respondents are anticipating commodity prices to be among the main factors feeding into working capital deterioration. In addition, they predict continued pressure from customers to stretch payment terms. Looking forward, we see a shift in expectations. 86% of companies expect flat or deteriorating performance in the next twelve months. This is up from 61% in 2009 and begs the question why companies would be reducing their focus on working capital when they expect performance to worsen? Have we returned to the days of freely available cheap capital?

The Bigger Picture

These are uncertain times for Western companies. With the economic growth of advanced countries expected to remain stagnant, the best chance for growth is to come in the emerging markets, a fact acknowledged by many of our business leaders. That shift in marketing focus has implications for working capital management. Companies seeking to take advantage of rapid growth in emerging markets should be considering whether their receivables, payables and inventory processes are fit for purpose in these territories. Growth in emerging markets is also affecting commodity prices, forcing raw materials costs higher as demand rises. This too has cash management implications. All this points to an important message. Effective cash management shouldnt be sidelined as the world economy recovers.

3 | Annual Working Capital Survey

Main triggers for increasing focus on working capital

We had such a good experience in 2007 and 2008, that I kick myself and ask why we werent doing it in 2005 and 2006.
Thus spoke a chief financial official as he looked back at a recent project to overhaul working capital management at his firm. Having unleashed cash trapped in receivables, payables and various parts of the supply chain, the company was left with a healthier balance sheet and a range of sharper, more cost-effective processes. But theres no resting easy. During downturns, companies slam on the brakes. Faced with the prospect of falling demand and lower revenues they immediately look for the internal levers that will enable them to free up much needed cash. Its a different story when the economic cycle begins to swing upwards. In a research study covering 500 of the largest global companies over three economic crises, KPMG found clear evidence that working capital performance tends follows a cycle - improving during hard times and deteriorating in recovery years. And the research confirms what many finance chiefs have long suspected while putting in place sound working capital management practices can be a Herculean feat in itself, sustaining them throughout all the highs and lows of business cycles is another. What is the main trigger for your company to increase its focus on working capital? Performance against peers

4% 17%

12%

Rising cost of debt Reduced access to debt

15% 13% 15% 14%

Percentage of respondents

Pressure from stakeholders (banks, board, analysts, credit rating agencies) To fund acquisitions To return cash to shareholders To pay down debt Other

10%

And yet achieving sustainability is well worth the hard work. Effective working capital management plays an important part in engendering the cultural discipline that enables businesses to keep a lid on costs and pursue efficiencies wherever and whenever they can. These tightly run organizations are constantly thinking about the most effective means of managing their levels of working capital

in their own unique circumstances. Thus, effective cash and working capital management should be a consistent element of business as usual - part of the corporate five a day - not something that kicks in only when cash becomes tight.

Annual Working Capital Survey | 4

A powerful management tool

Working capital management is one of the most powerful management tools a CFO has.
The problem is that outside the financial function it is a much underused tool. And without buy in from senior managers across the wider organization, achieving sustainability is easier said than done. Its really a leadership issue, said Michael Keppel, chief restructuring officer of Phoenix Pharmahandel, a 28.6 billion US dollar German drug wholesaler. Working on the premise good working capital management is both a by-product and barometer of flexibility and good management, KPMG embarked on its analysis of how CFOs are dealing with the issue in their own companies. As in previous years, the research was based on a survey of senior finance executives in the North American and across Europe, working for businesses with annual revenues starting from $250 million. (See sidebar 4 on page xx for the surveys methodology and full results.) We carried out 300 phone interviews in total, all taking place at a time when the outlook for many companies was mixed as economies around the world began to clamber out of the worst financial crisis experienced since the Great Depression of the 1930s. Such periods of transition throw up crucial challenges for CEOs seeking to raise the cash management bar.

5 | Annual Working Capital Survey

The good news, the bad news

Call it a small silver lining -- during the recent economic downturn, many finance executives found that they didnt have to work as hard as they have had to in the past to get the rest of their organization focused on cash. CFOs suddenly werent the only cash champions as deteriorating business conditions forced all parts of organizations to rely on cash and working capital management to help drive their businesses. However, once their companies navigate through the downturn, what happens next? To find out, new research from KPMG takes a look at the impact of global economic downturns on working capital management. The findings confirm what many CFOs have long suspected -- working capital performance stalls as business picks up. KPMG researchers analysed the 500 largest global companies (by revenue), between 1987 and 2009, before, during and after an economic crises (defined as the four recent periods when annual global GDP growth over multiple years was less than 2% and when annual revenue growth of the sample companies was below 5%). The good news is that over the past 20 years, working capital performance has gradually improved across the board (in receivables, payables and inventory) for the companies in the study. According to the results, average days working capital (DWC)* strongly improved during a crisis, by a minimum 13% in three crisis periods (1990 to 1993, 1996 to 1999 and 2001 to 2005). But what happens in the subsequent two years of recovery? Looking at the accounts receivable component of working capital, the research found a V-shaped trend in DSO performance in a crisis cycle. DSO decreased significantly during a downturn, but companies werent able to sustain the improvements during the upturn. The same trend was also found in inventory, and the reverse trend was the case for payables.
* Days Working Capital (DWC) = Days Sales Outstanding + Days Inventory Outstanding Days Payables Outstanding

The good news is that over the past 20 years, working capital performance has gradually improved across the boar

Annual Working Capital Survey | 6

As the survey reveals, managing cash is clearly on finances radar, with nearly all respondents 83% rating it as a high, if not their highest priority. Although this represented a drop of 3% from the number doing so last year, 38% of respondents gave it as their firms number one priority compared to 28% in 2009. Clearly companies are taking cash management seriously.

Top of mind? Cash management as a strategic priority

Which of the following best describes where cash management ranks as a strategic priority for your business?

11% 6% 38%

Number one priority Among the firms top 2 to 5 strategic priorities A second tier strategic priority Of concern, but not a astrategic priority

Cash continues to be a top priority for companies:

of respondents say its among their firms top five priorities. While thats down slightly from 2009s 86%, theres been a big increase in the number of CFOs citing it as their number one strategic priority - 38% in in the latest survey compared with 2 8% in 2009.

83%

45%
Percentage of respondents

But there is scope for improvement. Take the quality of cashflow forecasting. Building on a trend observed last year, an increasing number of companies are using some sort of short-term forecasting. Thats clearly a good thing and progress has certainly been made with 48% of companies hitting their targets, against 28% in 2009 and a mere 14% in 2008. But the corollary is that more than half of the organizations we spoke to missed their forecasts. As with the previous years survey, a third of companies exceeded their forecast to varying degrees. Admittedly, exceeding a forecast is a better position to be in than the opposite. But it comes with an opportunity cost. Companies may be tying up cash that could be used more profitably elsewhere or paying for financial facilities that arent needed.

Could do better Level of satisfaction with the quality of cash flow forecasts
Finances ongoing focus and increased prioritization has helped drive a noteworthy improvement in the accuracy of cash flow forecasting, continuing the upward trend of the previous two years Are you satisfied with the quality of your cash flow forecasts?

48%
of respondents say their companies hit their targets in 2010, compared with 28% in 2009 and 14% in 2008.

Yes No
20%

80%

Percentage of respondents

7 | Annual Working Capital Survey

Hit and miss Actual cash flow vs cash flow forecasts

Over the past 12 months, please estimate how actual cash flow compared to your cash flow forecast?

3%

2%

1% 6%

1%

Missed by more than 30% Missed by 30% Missed by 20% Missed by 10% On Target Exceeded by 10% Exceeded by 20% Exceeded by 30% Exceeded by more than 30%

8% 11%

20%

48%
Percentage of respondents

Future tense Cash flow forecasting and how far companies are looking ahead
Which of the following best describes the type of cash flow forecasting that your company uses?

1% 8%

1%

We dont use cash flow forecasting Daily treasury cash forecasting eg 2 to 4 weeks Rolling short-term receipts and payments eg daily or weekly for next 13 weeks Rolling funds flow eg monthly for next 12 months Funds flow eg monthly to the year end

23%

40%

27%
Percentage of respondents

Other

Annual Working Capital Survey | 8

Lack of incentives
More worryingly, the figures suggest a great many finance executives have not managed to bed down the deep behavioral changes that would see a continuous focus on cash within their organizations.

This is illustrated by the response to our questions on incentives. One way of creating a cash aware culture is to link working capital and cash performance with employee incentive schemes. But few companies just 39% - were doing this, even though the vast majority of organization had identified cash flow as a key priority. This suggests a potential gap between a headline commitment to effective cash and working capital management and the practical measures that could be employed to deliver on the stated goal. Perhaps more fundamentally, the finding raises the question of how serious companies are about a long-term strategic focus on cash management. (See sidebar 2 on page 8.)

A lack of incentive Cash flow targets as part of incentives packages and percentages of packages
Are cash flow targets part of the management teams incentives package at your organisation, and if so, about what percentage of the package is linked to those targets? No

What is mystifying is the continued low number of companies linking incentive compensation to cash flow:

11% 9% 5% 6% 8% 61%

Yes, 21% or more linked Yes, 16 - 20% linked Yes, 11 - 15% linked Yes, 6 - 10% linked Yes, 0 - 5% linked

of companies still do not link management incentives to cash flow, despite 83% of respondents claiming it to be among their top five strategic priorities. Given that this is only an increase of 3% over 2009, its clear that companies are struggling with both how and why effective cash management should be a part of compensation structures.

61%

Percentage of respondents

9 | Annual Working Capital Survey

Everyones job
When it comes to sharpening the focus on cash and working capital management throughout a company, one way to do that is often overlooked: incentivisation. John Mullins, professor of management practice and entrepreneurship at London Business School, makes the point that, at many large companies, few, if any annual incentive plans have a working capital component there are revenue incentives, profit incentives and sometimes general cash incentives, but working capital improvement tends to be left out of the mix. It needs to be understood that managing working capital is everyones job, not just the treasurers. Many aspects of managing units of a business have working capital aspects. KMPG third annual survey underscores the absence, with only 39% of respondents using any kind of cash targets in incentives packages, a miniscule improvement on the previous years survey results. Why the reluctance? Fear of the danger of introducing counter-productive incentives is perhaps a partial explanation, even in the companies that are thinking about the issue. Says Jeff van der Eems, CFO and COO of UKbased United Biscuits: After endless debate, probably over three years, weve finally put cash as part of the bonus target. But its cash, not working capital specific. We dont want people to do the wrong thing some guys may be tempted to do something silly with a supplier, like not pay him for a couple of months. You want to incentivise people the right way, but you dont want to encourage the wrong way either. It can be risky, agrees Francios Masquelier, head of corporate finance and treasury at RTL, a $7 .2 billion Luxembourg-based radio and television broadcaster that operates in 10 European countries. However, we need to make this a better part of strategy, he says. There is much scope for improvement on this at RTL. The various management teams should have different targets there needs to be a common ratio, but targets themselves should be more individualised. But incentives arent a panacea that on their own will make managers more cash-conscious, say some finance executives. Incentives are great, but only push one button -- money, asserts Michael Keppel, who joined the family-owned German drug wholesaler, Phoenix Pharmahandel, as its chief restructuring officer shortly after a company-wide turnaround plan was put in place in 2009. You need to apply incentives, but a good system of processes has to be in place. For Mullins, it is about setting appropriate numbers. Well-chosen incentives do not ask for more, but for the right amount. It is about getting the targets right across the operation. Such an approach should ideally permeate an organisation beyond senior management, to all levels of the business where, after all, the everyday work of maintaining efficiency takes place.

Well-chosen incentives do not ask for more, but for the right amount. It is about getting the targets right across the operation.
says John Mullins

Annual Working Capital Survey | 10

Slipping down the agenda

Questions about the longer term commitment to cash management are underlined by some evidence of retrenchment.

In 2009

of companies placed working capital management as a high or highest priority. But this has fallen to 75% this year. It remains very important priority but even a fall of a few percentage points suggests that with the recession over in technical terms at least boardroom priorities may be changing.

84%

The list of priorities Working capital management as a strategic priority

What level of priority do you place on managing working capital?

1% 6% 18% 26%
Highest priority High priority Neither high or low priority Low priority Lowest priority

49%
Percentage of respondents

Performance is disappointing. 66% of survey respondents reported flat or increasing working capital over the last twelve months and this is set to worsen. Looking ahead:

Ebbs and flows Working performance over last 12 months

What has happened to your companys working capital over the last twelve months?

of companies expect flat or deteriorating performance in the next 12 months, up from 61% in 2009, a projection underpinned by the impact of rising commodity prices and sustained pressure from customers to stretch payment terms.

86%

3% 8% 10% 11% 6% 9% 9%
Percentage of respondents

2%

Stayed about the same Decreased by more than 30% Decreased by 21 to 30% Decreased by 11 to 20%

32%

Decreased by 6 to 10% Decreased by 1 to 5% Increased by 1 to 5% Increased by 6 to 10%

5%

5%

Increased by 11 to 20% Increased by 21 to 30% Increased by more than 30%

11 | Annual Working Capital Survey

The crystal ball

On the Horizon
When finance executives were asked to identify the factors they expect could affect their cash and working capital management strategies over the next 12 months, more than 80% of respondents predict some impact from rising commodity prices. With the worst of the economic downturn over, CFOs now understand the wisdom of expecting the unexpected. That said, KPMGs latest annual survey asked finance executives to identify the factors they expect could affect their cash and working capital management strategies over the next 12 months. countries over the next three to five years. But with that growth come risks, Deutsche Bank economists note, such as the build up of bubbles in some markets, rising inflation in others. While some macro-level trends will affect some sectors more than others, its clear to finance executives that working capital management strategies require highly flexible, adaptable payables, receivables and inventory policies. Thats been the case for Mannheim, Germany-based wholesaler Phoenix Pharmahandel. Michael Keppel, chief restructuring officer at the pharmaceutical wholesaler, says, months, more than 80% of respondents predict some impact from rising commodity prices. He sees other factors requiring companies like Phoenix to have a really clear picture of demand, and getting a much deeper understanding of their value chains. As a wholesaler, were really at the intersection of change, he says. That includes having to adapt to the sweeping consolidation thats under way among the big pharmaceutical suppliers. While Phoenix has long been highly decentralized to accommodate local health care laws, the newly consolidated suppliers now want to negotiate on a national level, requiring the Mannheim company to draw up standardized policies, ranging from delivery terms to reporting requirements. The market is changing, says Keppel.

80%
of respondents predict some impact from rising commodity prices

Such concerns are likely to prove justified: although commodity prices slumped on the back of the economic downturn, they have since recovered. According to data released in September 2010, the cost of crude materials (inputs for manufactured goods) in America rose 2.7% from June to July and 2.3% from July to August, with the Dow Jones-UBS commodity index up 12% since the beginning of July. Commodity prices are likely to continue strengthening as demand outstrips supply (especially for agricultural commodities) and on growing demand for commodities in emerging economies, particularly China. Thats not the only way emerging markets will affect working capital performance. As growth becomes harder to achieve in their developed markets at home, corporate focus will continue shifting to higher growth emerging markets, beyond the now outdated BRIC segmentation of Brazil, Russia, India and China. According to Deutsche Bank economists, annual economic growth will be roughly 4% higher in emerging market economies than industrial

The challenge that we see here is driven by demographic developments. You have fewer age-related illnesses. Were already seeing less volume, higher priced treatments for illnesses like cancer. Changing markets
When finance executives were asked to identify the factors they expect could affect their cash and working capital management strategies over the next 12

If you just continue as you have been, your working capital will blow up.
There is a danger that companies overlook the cash flow impacts of greater exposure to emerging markets. Many western companies have supply chains and manufacturing set up to serve local markets. This may no longer be efficient or effective if the business is forecasting a growing proportion of sales being derived from emerging markets in the future.

Respondents are anticipating commodity prices to be among the main factors feeding into working capital deterioration. In addition, they predict continued

pressure
from customers to stretch payment terms.

Annual Working Capital Survey | 12

Struggling with implementation

And almost half 49% of companies state they are finding it harder to drive improvements in working capital. The question, of course, is why?

49%
of companies state that they are finding it harder to drive improvement in working capital. This may be the result of running out of ideas, reduced focus or resistance from the business to further change. One explanation is that businesses arent exploring all the possibilities. Opportunities for improved cash management of capital expenditure and indirect tax receive limited attention. The poor performance could also be a sign that commitment is lacking. Perhaps businesses have made all the relatively easy quick fixes and have run out of ideas. Perhaps they are hitting internal resistance to further change. Or perhaps in line with past cycles--with tentative signs of recovery ahead, companies have, once again, started to shift their focus away from working capital.

Great expectations Expectations for working capital performance over the next 12 months
What do you expect to happen to your working capital in the next twelve months?

1% 5% 13%

1%

Stayed about the same Decreased by more than 30% Decreased by 21 to 30% Decreased by 11 to 20% Decreased by 6 to 10%

17%

49% 5%

Decreased by 1 to 5% Increased by 1 to 5% Increased by 6 to 10%

5% 0% 1%

Increased by 11 to 20% Increased by 21 to 30% Increased by more than 30%

3%
Percentage of respondents

Harder all the time Perception of change in ability to drive working capital improvement
Have you noticed any change in your ability to drive working capital improvement in the current economic environment?

6% 17% 28%

No change Harder Easier Dont know as we are trying to improve

49%
Percentage of respondents

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The road ahead

And almost half 49% of companies state they are finding it harder to drive improvements in working capital. The question, of course, is why?

Such a shift in focus could be a mistake. Economic recovery is by no means certain. According to most forecasts, the economies in key developed countries will recover, but not to the robust growth levels of previous times. For instance, The International Monetary Fund predicts growth in advanced nations to come in at just 2.5% in 2011.This compares with a global growth forecast of 4.5% in 2011 and 2012. Adding to the problems caused by sluggish growth, access to credit will remain limited, curtailing expansion strategies. Again this is an issue that particularly affects advanced countries. In this environment, businesses that pay due attention to cash management are likely to be better able to cope with any sudden shocks than their competitors.

But aside from the specific problems that businesses face at this point in the economic cycle, there is another good reason for maintaining a focus on cash management. Put simply, the tendency to de-prioritize cash and working capital issues, simply reinforces the stop-start approach to cash and working capital management that has reigned over the past two decades. The inevitable result of that is that companies will be once again be exposed when the inevitable downturn occurs. The lesson needs to be learned: effective cash and working capital management needs to be a consistent element of business as usual, not something that is simply switched on and off.

Steve Lucas, Finance Director at the National Grid, a utility with over $20bn in annual revenue emphasizes the importance of a continued commitment to cash management. The credit crunch isnt over in my view, on both sides of the Atlantic, he asserted, adding that companies such as National Grid are taking steps to stockpile cash. Typically in the old days, a company like us with significant net debt, would have had a cash balance of $793.7 million, on revenue of $19 billion a sensible amount to have on hand, he said At the end of March, we had $2.4 billion. The reason for that was that we have seen that even with very high-quality companies like ourselves, the markets are either shut or very, very difficult to access.

Room for improvement Companies that have run working capital improvement programmes in last 12 months
Has your organisation run a working capital improvement programme in the past three years?

Yes No

44%

56%

Percentage of respondents

Annual Working Capital Survey | 14

Challenging assumptions
National Grid recently intensified its focus on working capital and in doing so it addressed a number of age old assumptions, not least that heavily regulated industries have very limited room to maneuver.

The National Grid is subject to major cash flows variations through the year. We have huge seasonal swings in working capital -- they can be almost scary in size, explained Lucas. We have to store gas in the autumn, which is costing us money until we pump it into houses into the winter. We carry that working capital. Then we have a dip in the spring. Even year-on-year, the swings are formidable. For instance, in fiscal 2010, it was $684 million up from $85.7 million in 2009 and negative $238 million in 2008. Cash management is, therefore, hugely important, but National Grids options are to some extent constrained by regulation. The company is a business-tobusiness supplier in the UK and serves a range of business and household customers in the US, where the regulatory framework limits the sanctions it can impose on late and non-payers. We cant disconnect [debtors] mid-winter, says Lucas. But what a utility like National Grid can do is hone its credit control to such an extent that it quickly detects from payment patterns whether trouble is on the way. For instance, a bill of $160 dollars triggering a payment of $100 is a signifier of trouble in store and by acting on that knowledge the company can take steps to keep the customer paying. With 80% of respondents to KPMGs latest survey reporting customers delaying payments of bills had affected them to some degree and 78% expecting this to continue impacting on them, National Grid is clearly on the right track.

Having a handle on customer payment trends is a weathervane of sorts for the company, contributing to the bigger picture drive to predict major business disturbances as well as opportunities at a time when National Grid is ramping up investments in new generating plants and other infrastructure next five years. Weve been on a campaign to improve the visibility of our working capital, says Ken Daly, National Grids global financial controller. We felt we didnt have enough of a handle on it. In addition to centralizing back office processes at a shared services centre in New York State the company is also working hard to improve the accuracy of cash flow forecasts. Because of additional vigilance at we now know when the spikes will be, says Daly. Forecast accuracy has improved from around 50% to close to 100%. Accuracy from less than 50% recently to close to 100% today.

We are better at predicting the volume that energy customers use and the behavior of customers and their consumption patterns.
Counter to received wisdom, rather than obstructing efforts to improve cashflow, the regulatory frameworks that surround national grid have provided an impetus. There is no margin for error at a company like National Grid, whose prices are set by regulators. Says Lucas. There is no room for sloppy working capital management. We have to manage everything well. Any weakness goes straight to the bottom line.

Kens team is very good at understanding why a forecast is wrong -- was it the volume, the price, the number of business days? There are lots of factors, adds Lucas.

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Lego keeping a key focus on the customer to manage cash

In tough economic times, the mantra cash is king echoes around boardrooms. Sten Daugaard, CFO of $2.1 billion Danish toy maker, Lego has a different take. He says that while cash certainly is important, customers also need to stay top of mind. Legos approach has been to attempt to ensure that one is not managed at the expense of the other. Its a lesson that Lego nearly learned the hard way. In 2007 CEO Jurgen Vig Knudstorp sanctioned a move to outsource the moulding of the companys brightly colored toy bricks. The intention was to reduce costs it didnt take long for its executives to realize that a mistake had been made. Acting on that realization, the company brought production of the bricks back in house and since 2008, three new plants have been reintroduced to the system, creating 3,500 jobs. With the molding brought back in house, Lego is refocusing on quality control at its factories in Denmark, the Czech Republic, Hungary and Mexico while also improving the speed and efficiency of its fulfillment processes. Packing and distribution has been centralized in two sites near Prague and the efficiencies achieved have improved working capital performance. Flexibility is key he adds. You have to imagine that at any time we have about 370 SKUs (stock-keeping units) out in the market. If one product becomes a bigger hit with the kids than another product, consumers want more, customers want more and we need to ship more. The flexibility is underpinned by technology. The company is currently is working on a system that follow the orders of the customer; providing information on how products are selling. Coupled with a packing and distribution regime that allows Lego to get the fastest selling products into the shops within two weeks, the company has reduced the amount of working capital lying in storage. Daugaard reckons that the focus on quality and speed has served to keep customers happy, and a bi-product of that satisfaction is a willingness to pay invoices on time, even during the downturn. Though net trade receivables increased to $384.8 million in 2009 from $328.8 million the previous year, Lego reduced the amount of bad debt to $25.2 million from $35 million over this period And the headline figures are also moving in the right direction. Despite the fact that the overall global toy market stagnated in 2009, the company had the best financial performance of its 78-year history. Profit for the year before tax increased by 55.9% to $524.4 million against $325 million in 2008 on revenue up 22.4%, of $2.1 billion against $1.7 billion in 2008.

One of the things that this company realized is that the molding of the brick is actually a core expertise and the outsourcer could not do it any better,
says Daugaard

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United biscuits a continuous process

Senior executives often work on the premise that initiatives to improve working capital performance have a beginning and an end.
That is certainly not the view Jeff van der Eems, CFO and chief operating officer of $2bn food company, United Biscuits. When he joined the company in 2005 he found that initiatives on working capital had largely been confined to discussion rather than implementation. Two factors triggered action within the business. One was the recession. As the economies if advanced industrialized economies turned down there were real questions over the viability of Uniteds suppliers and customers. There was an awful lot of pressure on suppliers and -whether they were going to stay in business, said van der Eems. There was a great pressure [on us] to make sure that we were securing our cash, says van der Emms. The second factor was leverage. We had more than seven times EBITDA (earnings before interest, tax, depreciation and amortization) and big interest bills. That made cash tight, and we knew we had to go after working capital, he said. We also knew we had an opportunity. Benchmarking had shown that in two areas in particular -days payable outstanding and days sales outstanding were average or at higher levels than at other food companies. United needed to improve performance, but the challenge was finding a point at which to begin in the context of a large organization. Its really hard to go after working capital because its about the thousands of little activities that are not done in finance but out in the business itself, says van der Eems. In the past cash management projects had been launched in isolation of each other. This time round in 2007 - the company set up cross-functional teams, with manufacturing, procurement sales and finance all represented. That was a critical step forward, as was a farreaching measurement exercise to assess all of the ideas put forward. Those ideas that balanced the lowest risks with the highest potential rewards were given a green light. As van der Eems recalls, the company targeted payables, receivables and the raw materials stock, rather than finished good stock. We didnt want to touch finished goods because thats a bit more complicated and involves your customer service and forecasting, van der Emms explains. The exercise just gets a little bit too big then. On the procurement side an increased use of e-auctions was one successful measure bringing greater transparency and consistency to working with suppliers. Another success was the centralization of machines churning out Jaffa Cakes and the like was another As for payables, United Biscuits has eschewed the approach taken by other companies of squeezing suppliers. It is tempting but were not that kind of business. say van der Eems The project released more than $63.5 million in its first 18 months, but Van der Eems isnt about to glamorise something that he acknowledged can be a painful exercise.

You have to go brick by brick. And if youre going to be successful, you have to measure it all very, very carefully,
he says. Whats more, finance cant do this on its own. Finance will always lead it, finance will always connect the dots, but the people who actually are transacting it and who know whether it is feasible, this is a win-win, we can do it, will be the people on the front end, in procurement, or on the receivables side, the sales people. Crucially, United Biscuits drive to improve performance is continuing. You never stop, right? You finish one project and then have to go back to the one you finished before, van der Eems concludes.

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Conclusion
While cash and working capital remain high on the priority list, there are signs that attention is waning. With many companies having just completed their budgeting process for the year ahead, now is a good time to consider how the profit and loss forecast will convert into cash, and whether the assumptions used are a realistic reflection of the changing business environment. As the examples of Lego, United Biscuits and National Grid illustrated, managing cash and working capital does not conflict with driving profitable growth. They should be complementary and ensure healthy challenge in decision making. The goal should be make cash and working capital part of business as usual, so the people in the business understand the implications of their actions and can balance these with the priorities of the business to achieve the best outcome. Its important to remember that managing cash is an upturn is just as important as during a downturn, especially when credit remains restricted and costly.

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The nuts and bolts

KMPGs third annual cash and working capital management survey, comprised phone interviews with 300 finance executives (CFOs financial directors, vice-presidents, controllers and treasurers) in the United States and Canada (23% of respondents), the UK (17%) and continental Europe (60%). The interviews were conducted on both sides of the Atlantic in June 2010 by London-based Media MD on behalf of KPMG. The respondents were asked a series of questions examining past initiatives, while assessing their current cash and working capital management as well as future trends. They represented companies with the latest annual revenue of $397 million $1.58 billion (40%), $1.6 billion - $15.7 billion (49%), $15.8 billion and more (11%). They also came from a mix of non-financial sectors, including manufacturing, automotive, business services, chemicals, energy/utilities, food and beverage, information technology, health care, media and entertainment, travel and leisure, pharmaceuticals, biotechnology, real estate, retail trade, telecommunications, and transportation/warehousing.

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Survey results
Chart headlines and standfirsts

Which of the following best describes your job title?

7% 30% 42%

CFO, FD, VP Controller Treasurer Other

21%
Percentage of respondents

Where are you located?

Turkey

6% 23%

6% 7% 7%

Switzerland Spain Russia & cis Netherlands Germany France UK Rest of Europe US and Canada

10% 7% 10%

7% 17%

Percentage of respondents

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What were your firms worldwide revenues in its most recent fiscal year?

5% 12%

6%

250M to 500M

19%

500M to 1B 1B to 5B 5B to 10B 10B to 20B 20B Plus

21% 37%
Percentage of respondents

What is your organisations primary business?

2% 6% 2% 3% 7% 6%

1%
Automotive/automotive supply

5% 12% 4% 10% 5%

Business/professional services Chemicals Energy/utilities Food/beverage/consumer Packaged goods Hardware/software/networking Health care

31% 3%
Percentage of respondents

3%

Industrial/general manufacturing Media/entertainment/travel/leisure Pharmaceuticals/biotechnology Real estate Retail trade Telecommunications Transportation/warehousing Wholesale

Contact us Andrew Ashby Associate Partner in the UK T: +44 20 769 43231 E: andrew.ashby@kpmg.co.uk Roger Bayly Partner in the UK T: +44 20 7694 6424 E: roger.bayly@kpmg.co.uk

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. 2011 KPMG International Cooperative (KPMG International), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. Printed in the United Kingdom.

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