Eye on Working Capital Performance: Median Companies Are Falling Behind
After a rare 2021 “Triple Crown” that saw improvement in all three working capital metrics, 2022 was a year of course correction.
When The Hackett Group last analyzed working capital performance, at the midpoint of 2022, we saw early signs of deterioration in days payables outstanding (DPO) performance. We noted that this trend might signal an inflection point in companies’ ability to continue improving their balance sheet by further extending payment terms with suppliers.
For more than a decade, lengthening payment cycles was companies’ easiest option for improving working capital performance, and many organizations came to rely heavily on it. Indeed, our prediction that this approach might no longer be working as well proved true in the second half of 2022. As our newly released “2023 Working Capital Survey” reveals, DPO deteriorated sharply throughout last year, and the percentage of total excess working capital attributable to accounts payable increased by a stunning 33 percent.
Additionally, all three key components of working capital, as well as the overall cash conversion cycle (CCC)—the high-level proxy for working capital performance—moved with greater magnitude in 2022 than they typically do. Excluding the pandemic years and the 2009 financial crisis, our working capital studies usually record modest movements of between 2 percent and -2 percent. Last year, all four metrics moved by 3 percent or more, in one direction or the other.
These are among the key findings from The Hackett Group’s annual study of the working capital performance of the 1,000 largest listed companies in the United States outside of the financial services sector. We calculate working capital metrics using the latest publicly available annual financial statements, based on data sourced from FactSet.
Key Working Capital Metrics
DPO deterioration—down 8%. The largest U.S. companies appear to have hit the ceiling of their ability to extend payments to suppliers. Days payables outstanding deteriorated by 4.7 days, to an average DPO of 57.2 days. Industries with large Tier 1 suppliers that are dependent on scarcer commodities—including consumer durable goods, recreational products, and oil and gas—are among the sectors that saw the greatest deterioration in DPO.
DSO improvement—down 5%. In 2022, days sales outstanding (DSO) decreased by 1.9 days, to 38.7 days on average. This is an accelerated improvement from the 2 percent decrease in 2021. Strong demand and tight supply put some companies in a favorable position to enforce timely payments according to terms. Companies with a strong business-to-consumer component—including those in consumer durables, recreational products, airlines, and the oil and gas sector—benefited from the economic rebound and “revenge” consumer spending. Other industries benefited from the expansion of subscription models that alter the customer/supplier dynamic and positively impact receivables performance.
DIO improvement—down 3%. Improvements in days inventory outstanding (DIO) also gained momentum. DIO decreased by 1.6 days, to 54.9 days on average. This 3 percent improvement topped 2021’s 2 percent improvement, as strong customer demand depleted inventory levels and lessons learned during the pandemic led to more strategic approaches to inventory management. Top performers are using technology to optimize inventory amid sustained and shifting customer demand.
CCC deterioration—up 3%. The composite measure of working capital performance deteriorated by 1.2 days, to 36.4 days, despite the improvements in DSO and DIO. The significant deterioration in DPO eclipsed the better receivables and inventory numbers, as payables proved to be the year’s main driver of overall working capital performance. This stands in contrast to 2021’s 6 percent improvement in the cash conversion cycle.
Our analysis also found that most companies struggle to maintain improvements in the cash conversion cycle. Of the 1,000 companies we studied, only 53 (5%) were able to improve their CCC every year for the past three years. Just 13 (1%) improved their CCC in each of the past five years, and only 4 companies (less than 1%) improved their CCC in each of the past seven years.
Drivers of Working Capital Performance
This year’s industry leaders and laggards are similar to those in our 2021 study, which reflects continuing challenges and opportunities in the current environment. In 2022, top performers in CCC improvement were airlines; telecommunications; hotels, restaurants, and recreation; and oil and gas—in part due to the rapid rebound in demand for travel and recreation.
Several industries, including motor vehicles, saw CCC deteriorate despite revenue increases. (See Figure 1.) The household and personal care sector saw degradation of all three working capital metrics. And a 14 percent DPO deterioration contributed to an overall drop in CCC performance for computer hardware and peripherals.
The study also examined changes in several key liquidity and operational metrics that influence working capital performance—see Figure 2.
Where to Focus Now
Despite improved accounts receivable (i.e., DSO) performance in 2022, excess working capital grew substantially. According to our analysis, the top 1,000 companies now have nearly $1.9 trillion tied up in working capital. That is an increase of 12 percent, following 28 percent growth in the previous year. Most stunning was a 33 percent increase in payables opportunity, to $665 billion, which is now nearly equal to the $666 billion of excess inventory that we found.
The gap between top-quartile performers and median companies continued to widen in 2022, but not because the top performers improved significantly, as was the case in past years. Rather, median companies’ working capital performance—specifically, DIO and DPO—degraded significantly in 2022. Typically, the ratio of top companies’ working capital performance to that of median businesses averages about 2.95. In 2022, it widened by 10 percent, to 3.30. Top performers collect from customers 42 percent (19 days) faster, hold 59 percent (41 days) less inventory, and take 52 percent (25 days) longer to pay suppliers.
For companies facing higher interest rates, persistent inflation, continuing market unpredictability, and many other major challenges, cash flow management should be a top priority. Businesses need to strengthen working capital management to provide liquidity for strategic investments. Our study underscores the significant opportunity to tap working capital and strengthen the organization’s cash position. The widening gap between median and top performers should be a real wake-up call.
Our research indicates that many companies learned from recent experiences to improve performance in some areas, particularly around inventory and receivables. That said, today’s challenges are different and still evolving. The impact of current developments will take time to fully materialize, and the strategies companies have relied on in the past may have limited effectiveness going forward.
We expect the trend of worsening payables performance to continue throughout 2023, especially as the restructuring of several major regional banks may result in less availability of supply-chain finance assets. In addition, the new accounting disclosure rules introduced by the Financial Accounting Standards Board (FASB) requiring companies to disclose information about their supply-chain finance programs have softened the demand for such tools.
While DPO still presents opportunity, organizations will need to focus attention across all three elements of working capital and establish the necessary processes and technology to optimize them. Specific areas of focus will vary by company and situation, but these are some prudent steps that may be relevant across industries:
In accounts receivable:
- Review credit and collections processes continuously to ensure agility in capturing changing payment behaviors for consumers and businesses, minimizing bad debt exposure.
- Review credit risk management processes, and tighten policies if uncertainty (inflation, recession, and geopolitical risks) remains present.
- Review pricing, payment terms, and contractual milestones. Also, consider bringing receivables management to the forefront of the contracting process.
In inventory:
- Review end-to-end supply-chain processes to ensure you can recognize and act on changing demand signals.
- Conduct frequent risk and contingency planning.
- Ensure tight integration of commercial and market intelligence processes with planning and manufacturing operations.
- Identify and incorporate changing consumer behaviors and demand patterns into supply-chain planning and product portfolio management.
In accounts payable:
- Monitor and revisit sourcing, location, and working capital strategies—particularly in light of the Build Back Better plan.
- Assess and consider the relevance of supply-chain finance initiatives in light of recent GAAP rule changes and the current banking environment.
Finally, we cannot emphasize enough the importance of visibility and agility in managing through unpredictability and improving working capital performance. Simply put, it is impossible to recognize and respond to changing conditions at scale and speed without the assistance of technology. Companies that have invested in technology—as well as the supporting infrastructure, processes, and skills to use it—are able to forecast more accurately and more efficiently adapt to change.
Learn more
A more detailed summary of the research findings, with industry analysis and working capital improvement recommendations, is available on a complimentary basis with registration at: https://go.poweredbyhackett.com/23wcscc2306