shedding light on working capital management challenges and best

Audit / Tax / Advisory / Risk / Performance Smart decisions. Lasting value.™

June 2016

A research report by Bart Kelly

Shedding light on working capital management challenges and best practicesA study of the manufacturing and distribution industry

Working capital management: A study of the manufacturing and distribution industry

2 June 2016 Crowe Horwath LLP

Every senior executive faces the working capital challenge: managing cash for today’s obligations while also investing in tomorrow’s growth. Crowe Horwath LLP conducted the Working Capital Study to help manufacturing and distribution leaders make informed decisions when addressing this challenge.

Working capital is a critical gauge of business health, measuring current assets against current liabilities. While negative working capital can create a cash-flow crisis, too much working capital means that a firm’s cash isn’t working hard enough. The Working Capital Study explores the challenges and opportunities U.S. manufacturers and distributors face as they work to maintain optimum liquidity while planning for the future.

This report highlights best practices and benchmark performances for working capital management. For example, successful working capital management often is built around lean-thinking operation and financial improvement practices. The lean objective that drives profitability through operational and financial improvement also directs the management of the business at optimum levels of working capital.

The findings from the Working Capital Study provide insights that will help executives minimize working capital while maintaining or improving quality and service to customers. This delicate balance requires cross-functional collaboration, with the following functions proving particularly important:

• Operations: Minimizing process wastes, lowering inventories

• Supply management: Improving forecasting and fulfillment with customers and suppliers

• Finance and legal: Securing favorable procurement and sales terms

• Senior executives: Analyzing and communicating the importance of working capital management

3Numbers may not total 100% due to rounding.

Working capital strategies and effectivenessThe Working Capital Study confirms that most executives realize the importance of optimizing working capital – 32 percent rate it “extremely important” to their company’s success over the next two years, and another 50 percent rate it as “very important.”

The vast majority of executives surveyed (88 percent) also believe that improved working capital management would boost their company’s profit margin.

Despite the importance and potential outcomes from working capital management, more than half of companies have not implemented a working capital strategy (Exhibit 1).

“Working capital management requires ongoing awareness and consistent, standardized practices throughout an organization,” says Bart Kelly, principal at Crowe. “That can only happen if senior leaders identify working capital management as a core objective. Developing and implementing a strategic plan to optimize working capital is the first step in demonstrating that.”

Exhibit 1: Strategic plans to optimize working capital

54% of companies have not implemented a working capital strategy

9%

24%

7%

46%

14%

Strategic plan implemented

Strategic plan developed but not yet implemented

Strategic plan in development

No strategic plan but considering development

No intent to develop strategic plan



About two-thirds of executives agree that the approach to managing certain activities (including accounts payable, accounts receivable, capital expenditures, raw materials inventory, and finished goods inventory) meaningfully affects their working capital management. For example, 68 percent report that raw materials inventory management has a measured impact on working capital management in their organizations.

The problem is that a high percentage of manufacturing and distribution executives don’t recognize the impact of these activities; in fact, some stated they see “no impact.” And still other executives don’t see the connection between daily activities in their companies and working capital. Executives may understand the

general relationship between operations and finance, but don’t have access to specific metrics to track the impact of production decisions on the bottom line. For example, a fear of being out-of-stock may spur managers to order “just-in-case” inventory – wasting working capital.

This situation is driven in part by the fact that many companies lack effective management of raw materials inventory. For example, only 60 percent of survey respondents effectively manage their raw materials inventory.

This lack of effective management is unfortunate, because improved processes and policies could reduce working capital by an average 28 percent without negativelyaffecting business performance.

Addressing working capital challengesIssues beyond a company’s control can increase the need for working capital: Executives cite economic factors, unreliable customer-demand forecasts, and industry-related factors as their top difficulties (Exhibit 2). But other challenges are directly or indirectly within executive control and provide opportunities to optimize working capital, including:

• Supply-chain lead times. Vendors can deliver supplies on a just-in-time (JIT) basis or assume ownership in strategic areas (and the working capital burden of inventory) until production begins.

• Inaccurate sales, inventory, and operations planning (SIOP). Shorter product life cycles and increased demand volatility challenge manufacturers everywhere. Yet SIOP at many firms

remains a largely static process that is not updated frequently – meaning that sales plans, production schedules, inventory volumes, research and development project pipelines, and customer lead times often are out of date. Straightforward approaches to implement a better SIOP can deliver more efficient operations, supply chains, and product development.

• Delinquent receivables. Lax invoicing and receivables policies create cash flow problems. Improved management reduces the strain on working capital. Frequent use of any of these methods can improve management of working capital. Frequent use of all four can result in world-class working capital management — but only 5 percent of companies have achieved that status.


11%38%33%1% 17%Economic factors

31%5% 17% 18%30%Unreliable customer-demand forecasts

12%34%38%4% 12%Industry-related factors

29%16% 22% 12%20%Seasonality of business

Inability to transfer transaction data to business analytics

9%16%31%14% 29%

Challenges within executive control

12%19%46%7% 17%Long supply-chain lead times

10%16%31%12% 31%Delinquent receivables

7%20%8% 20% 45%Inaccurate SIOP

10%13%28%21% 29%Access to financing

7%15%30%14% 33%Unfavorable supplier contracts

8%14%32%16% 30%Aging or obsolete inventory

7%14%41%13% 26%Expeditious payables

7%14%31%13% 35%Unfavorable customer contracts

7%14%35%14% 31%Lack of visibility/transparency to working-capital performance

9%11%39%12% 29%Poor ERP system drivers or adherence

8%8%21%60% 4%Other

7%13%28%29%24%Poor creditmanagement/diligence

Issues beyond company control

= 1 Not difficult = 2 = 3 = 4 = 5 Extremely difficult

Exhibit 2: Difficulties affecting working capital management

Numbers may not total 100% due to rounding.



Exhibit 3: Annual inventory turn rate

14%

28%

27%

11%

5%

13%

3%

3 turns or fewer

4-6 turns

7-12 turns

13-18 turns

19-24 turns

More than 24 turns

Don’t know

69% of executives report they turn inventory monthly at best

Improve inventory levels, improve salesThe faster a company can turn over its inventory, the faster it frees up cash for other purposes. But two-thirds of

companies turn their inventory monthly at best, and 14 percent have three turns or fewer (Exhibit 3).

Companies frequently fail to implement the following four best practices for working capital although doing so could vastly improve an organization’s working capital management:

1. Formalizing collaboration with suppliers: 15 percent “frequent” vs. 23 percent “infrequent”

2. Building timely and detailed dashboards of working capital performance: 12 percent “frequent” vs. 28 percent “infrequent”

3. Creating business analytics of working-capital factors: 12 percent “frequent” vs. 23 percent “infrequent”

4. Formally collaborating with customers: 10 percent “frequent” vs. 29 percent “infrequent”


Exhibit 4: Factors responsible for obsolete inventory

17%Poor economy

27%Poor scheduling processes

15%Poor production processes

14%Poor supplier- management processes

28%Volatile market factors

14%Lack of visibility into work-in-process inventory levels

11%Lack of production visibility

8%Lack of visibility into finished-goods inventory levels

7%Other

11%No problem with obsolete inventory or inventory write-offs

12%Poor logistics processes

12%Lack of visibility into material and components inventory levels

What’s more, 25.5 percent of a typical company’s total inventory is more than 180 days old. This poses a major risk: The longer inventory sits, the more likely those goods are to become obsolete.

Not surprisingly, almost two-thirds of companies hold obsolete inventory or inventory write-offs worth 1 percent

or more of annual sales. And one in 10 companies holds obsolete inventory worth 4 percent or more of annual sales. Much of this obsolete inventory and write-off damage is self-inflicted — it’s the result of unsolved problems such as poor scheduling, production, and supplier management (Exhibit 4).

Much of obsolete inventory and write-off damage is the result of unsolved planning and production problems.



“Manufacturers and distributors invest significant cash into their inventories — raw material and components, work-in-process inventory, finished goods — but often hold too much inventory due to fears of unexpected customer demand (buffer inventory) or inefficient production and supplier processes (overstock), or they hold the wrong inventories,” says Kelly. “Improved inventory management can reduce the need for working capital, minimize obsolete inventories, and even boost revenues.”

Indeed, three-quarters of executives say that annual sales would increase if they had the right inventories (Exhibit 5). There’s a toolbox full of best practices available to better manage inventories, but no single technique is used by a majority of companies, and 4 percent of firms don’t use any of them (Exhibit 6). This is surprising. Even techniques once embraced only by companies using lean thinking for improvement – pull systems, kanbans, quick changeovers – are increasingly common today. Other practices such as lead-time indicators, reorder inventory levels, supplier penalties, and rewards are just manufacturing common sense.

Exhibit 5: Effect of right inventories on annual sales

75% of executives say that annual sales would increase if they had the right inventories.

No changeMore than 10% increase

Don’t know

1-5% increase

6-10% increase

44%

19%

7%5%

26%


Surprisingly, no single technique is used by a majority of companies, and 4 percent report they don’t use any of them.

Exhibit 6: Inventory management practices

44%Detailed inventory analysis (plan for every part)

41%Segmented stock and reorder inventory levels

35%Vendor-managed or -owned inventories

34%Lead-time indicators

45%Lean material-management techniques (pull, flow, kanbans)

32%Radio frequency identi- fication (RFID) and comp- uterized inventory tracking

31%Production smoothing and level loading

29%Just-in-time or milk-run supplier deliveries

20%Periodic stock-keeping unit (SKU) rationalization and portfolio management

17%Supplier penalties or rewards for on-time performance

31%Quick changeover of equipment

4%No practices to manage inventories

1%Other



Managing the cash-to-cash cycleCompanies generally balance their incoming cash flow from customers with cash going out to suppliers at about the same rate (Exhibit 7).

This cycle accentuates the need to optimize fluctuations and increases in inventory requirements.

Accounts receivable

Accounts payable

30 days or less 14% 16%

31-60 days 52% 51%

61-90 days 25% 25%

91-120 days 6% 5%

121-150 days 1% 0%

151-180 days 1% 1%

181-365 days 0% 0%

More than 365 days 1% 1%

Exhibit 7: Average age of accounts

Accounts receivable terms with customers

Accounts payable terms with suppliers

Very advantageous for company 12% Very advantageous for company 11%

Advantageous for company 35% Advantageous for company 41%

No advantage for company or customers

33%No advantage for company

or suppliers37%

Advantageous for customers 18% Advantageous for suppliers 9%

Very advantageous for customers 1% Very advantageous for suppliers 3%

Exhibit 8: Description of account terms

Many executives report that they hold advantages in contract terms with both customers (accounts receivables) and suppliers (accounts payable) (Exhibit 8).

But companies could still do more to improve their terms and cash positions, evidenced by the 16.1 percent of accounts receivable more than 180 days old.


“Financial executives need to go beyond the first layer of the reports they receive on their receivables and payables to confirm that balances and activity meet contract terms and corporate expectations,” says Doug Schrock, managing principal of

manufacturing and distribution services at Crowe. “For example, we often see companies exceeding their commitments to suppliers, creating an unnecessary draw on working capital.”

Manage and monitor capital expendituresMost manufacturers and distributors invested more than 2 percent of sales in capital equipment over the past 12 months, and plan to do so again in the next 12 months. About a third of companies invested 6 percent or more of sales in capital equipment.

Capital expenditures represent a sizeable component of working capital for industrial organizations. Yet a majority of companies earn a 20 percent or less return on invested capital (ROIC) (Exhibit 9).

Exhibit 9: Return on invested capital

More than 30%

10-20%

21-30%

58%

18%7%

16%

Less than 10%

76% of companies earn a 20 percent or less return on invested capital.

The most common practices to manage accounts receivable are:

• Early detection and alerts of late payments: 56 percent• Front-end credit review: 54 percent• Responsive escalation process: 41 percent• Accounts receivable segmentation analysis: 37 percent• Stratified terms by customer type: 18 percent• Use of outside collections-service providers: 16 percent• Incremental penalties: 16 percent• Enhanced post-mortem review: 16 percent



During the Great Recession, many companies shelved their capital expenditure plans. Even as the economy rebounded, capital expenditure hesitation remained. Younger manufacturing executives now may be purchasing long-term assets for the first

times in their careers, and even seasoned executives may be rusty in evaluating capital expenditures. This is reflected in the limited effort expended by most firms in managing (Exhibit 10) and monitoring (Exhibit 11) capital expenditures.

Exhibit 10: Practices to manage capital expenditures

33%Project portfolio segregation (such as by risk or by need)

36%Tracking all proposals and capital expenditure projects in a single portfolio

33%Standardized capital expenditure proposal input data

48%Standardized capital project proposal process

46%Capital-management team or committee

24%Capital expenditure project-stage-gate reviews

31%Standardized capital expenditure project tracking measures

1%Other

22%Standardized capital expenditure post-project tracking metrics (such as ROIC)

No practices to manage capital expenditures 3%


Exhibit 11: Metrics to gauge effectiveness of capital expenditures

42%

34%

43%

53%

20%

33%

34%

4%

Return on assets (ROA)

Net present value (NPV)

ROIC

Payback period

Hurdle rates

Benefit-to-cost value

Internal rate of return (IRR)

No metrics to gauge capital expenditure effectiveness

Other 0%



Collaborate with supply-chain partners to minimize working capitalManufacturers typically work with a large number of customers and suppliers and have an opportunity to optimize working capital by focusing on their core supply-chain relationships:

• 37 percent of suppliers provide 80 percent of purchased materials and components.

• 45 percent of customers account for 80 percent of product sales.

Yet only a small percentage of companies takes full advantage of these opportunities to better manage incoming and outgoing inventories (Exhibit 12). Collaboration with supply-chain partners via shared forecasts (customers) and production schedules (suppliers) improves inventory management. Enhanced collaboration also can generate other benefits, such as improved capabilities (including knowledge, best practices, and intellectual-property sharing), and capacity (facility and resource sharing).

Exhibit 12: Level of inventory collaboration and coordination

= 1 Never = 2 = 3 = 4 = 5 Continuously

With suppliers 6% 11% 36% 35% 13%

With customers 10% 13% 41% 22% 14%


A critical success factor in satisfying customers is delivery performance, and half of companies deliver to their customers in two weeks or less (from receipt of order to delivery).

“In the era of e-commerce, speed is expected,” says Kelly. “This puts tremendous pressure on the business, often resulting in ill-advised downstream practices, such as excessive inventories and overproduction. An upstream perspective — better demand forecasting and collaboration with customers — can reduce the pressure and minimize working capital tied up in inventories. It also

helps to evaluate and understand which customer sales drive the most business success.” Although a dynamic, ongoing assessment of market segmentation in terms of products, lead times, pricing, margin, and terms is critical, even for basic measures, this type of assessment rarely occurs (Exhibit 13).

Executives also must extend best practices and analysis upstream through the supply chain. Improved supplier performance — speed, cost, and delivery — has a direct impact on working capital. Only by monitoring and evaluating suppliers vs. performance criteria can vendors be expected to improve (Exhibit 14).

Exhibit 13: Frequency of formal sales segmentation and analysis

= 1 Never = 2 = 3 = 4 = 5 Continuously

Product margin 3%3% 25% 41% 29%

Product sales 3% 6% 27% 36% 28%

Customer 3% 6% 29% 35% 27%

SKU 20% 15% 23% 20% 22%

Customer location 11% 17% 35% 24% 13%



Exhibit 14: Frequency of formal supplier evaluations

Never Annually or less frequently Semi-annually Quarterly Monthly or more frequently

Quality and reliability 2% 24% 28% 25% 22%

Delivery to schedule 3% 22% 26% 29% 20%

Total cost 3% 25% 26% 26% 20%

Service 3% 26% 24% 26% 20%

Specification compliance 3% 29% 29% 20% 19%

Delivery lead time 3% 28% 24% 29% 16%

Regulatory compliance 9% 37% 24% 18% 12%

Upside and downside flexibility 15% 34% 29% 14% 8%

Environmental performance 21% 34% 22% 16% 7%

Ethics and governance 20% 37% 21% 16% 6%

Labor practices 25% 38% 16% 16% 5%


Approximate title

Operations or manufacturing director or comparable 22%

Other senior-level executive or VP 18%

VP operations or comparable 14%

President or CEO 11%

Plant-level manager/leader 7%

CFO 7%

Chief Information Officer (CIO) 6%

VP finance or comparable 5%

Chief Operating Officer (COO) 4%

VP information technology or comparable 3%

Chief Marketing Officer (CMO) 2%

VP supply chain or comparable 1%

Chairman 1%

Other 0%

Improving working capitalImproved working capital management requires executive time and attention, creation of a detailed strategy, and vigorous implementation of best practices in operations and across the supply chain. The data and ability to optimize working capital are available in every company, and only require senior leadership’s commitment to begin a journey toward improved financial health.

Working capital study methodology and participantsThe Working Capital Study was conducted in February and March 2016 with participants including a panel of manufacturing and distribution executives. The study received 153 valid submissions. Responses to the Working Capital Study were received from a variety of executive positions (titles), entities (public, private), company sizes (revenues and employees), and industries.



$51 million to $100 million


58%



$501 million to $1 billion

$1 billion to $5 billion

More than $5 billion

26%

16%

15%

14%

14%

8%

7%

Approximate annual revenue

Approximate employees

50,001 to 100,000

Less than 100

501 to 1,000

10,001 to 50,000

More than 100,000

58%

101 to 500

5,001 to 10,000

1,001 to 5,000

29%

16%

14%

12%

8%

7%5%

9%

Corporate structure

Private companyPublic company

Private-equity-owned company

5%

44%51%


Industries in which company participates

Machinery and industrial equipment 15%

Electrical and high tech 14%

Fabricated metal products 14%

Automotive 12%

Consumer packaged goods (except food, beverage, and tobacco) 11%

Construction materials 10%

Chemicals 9%

Food, beverage, and tobacco products 9%

Plastics and rubber 5%

Wholesale and distribution 5%

Life sciences 4%

Primary metals 3%

Textiles and apparel 3%

Wood and paper products 2%

Other 16%

crowehorwath.com/mfg

In accordance with applicable professional standards, some firm services may not be available to attest clients.

This material is for informational purposes only and should not be construed as financial or legal advice. Please seek guidance specific to your organization from qualified advisers in your jurisdiction.

© 2016 Crowe Horwath LLP, an independent member of Crowe Horwath International crowehorwath.com/disclosure MD-17000-002B

Learn moreBart Kelly is a principal with Crowe Horwath LLP and can be reached at +1 404 442 1627 or [email protected].

About the Crowe Manufacturing and Distribution Services GroupThe Crowe M&D services group is one of our largest groups, serving more than 2,000 M&D clients coast to coast. Our clients range from Fortune 500 to midmarket companies with overseas operations, as well as foreign-based companies operating in the United States. With more than 600 industry-experienced professionals serving M&D clients, our equal-sharing partnership model provides clients with the right team of people and solutions without organizational barriers.

About usCrowe Horwath LLP is one of the largest public accounting, consulting, and technology firms in the United States. Connecting deep industry and specialized knowledge with innovative technology, our dedicated professionals create value for our clients with integrity and objectivity. We accomplish this by listening to our clients – about their businesses, trends in their industries, and the challenges they face. We forge each relationship with the intention of delivering exceptional client service while upholding our core values and our industry’s strong professional standards. Crowe invests in tomorrow because we know smart decisions build lasting value for our clients, people, and profession.

http://www.crowehorwath.com

http://www.crowehorwath.com/disclosure

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