One trillion dollars in unused liquidity
Study by Ernst & Young reveals a lot of catching up to be done in working capital management
ZURICH, JULY 16, 2009 – One thing is critical for many companies in a crisis: liquidity. However, a vast number of companies still let considerable liquidity reserves lie fallow. Reserves of up to one trillion US dollars are waiting to be tapped within the working capital of the top 2,000 groups in Europe and the US (in terms of turnover). This is the result of a study by the audit and advisory services firm Ernst & Young analyzing the annual and quarterly statements of around 1,000 companies in each of the two economic regions.
"It is an almost inconceivable amount: a thousand billion dollars' worth of untapped liquidity," says Louis Siegrist, Head of Transaction Advisory Services at Ernst & Young Switzerland, pointing out the sheer size of the sum. For the groups analyzed, this equals around six percent of their turnover. "This means that within every one billion of turnover, there is a potential to gain 60 million in liquidity. However, the majority of companies tolerate inefficiencies which prevent this from happening."
350 million euro per company
Even when allocated to the individual companies, the size of the sums unnecessarily tied up in working capital is still impressive. By pursuing a targeted and systematic approach to working capital management, American groups could each mobilize an average of up to 325 million euro, while their European counterparts could render up to 350 million euro liquid.
Both figures do represent a further slight improvement over the previous year. Sixty-three percent of American companies and 50 percent of those in Europe reported a better working capital performance. US companies did reduce their working capital by a respectable 7 percent during 2008, while European firms dropped theirs by 6 percent for the same period. However, results from the fourth quarter alone show a global deterioration in performance. Cases of funds commitment rose by 7 percent in the US, and 3 percent in Europe.
Delayed reactions
"The effects of the global downturn are reflected in this end-of-year deterioration in the form of increased fluctuations in currency, commodity and energy prices," explains Louis Siegrist. "Inventories saw a notable increase in the fourth quarter, as numerous companies happily carried on producing, only reacting to the shrinking demand after some time." The study shows inventory increases of 10 percent in the US and 4 percent in Europe, which correspondingly result in a commitment of funds.
Admittedly, Siegrist says, the groups took countermeasures to this development in the first quarter of 2009, however, "Because everyone is cutting inventories now before continuing with production and ordering, the demand curve will also remain on a downward turn for the time being." Louis Siegrist suspects that, since a drop in turnover often entails a drop in working capital, the overall "improved" performance of the company can at least in part be traced back to this effect.
This being said, Louis Siegrist does note a growing interest within the industry in reducing the working capital. "Those companies that can afford it make sure they use cash discounts. Others – particularly major groups – try to negotiate longer credit periods, and even pursue structural credit period programs," he has observed. "Strategies such as these often clash with those of market partners who look to take the strictest possible approach to managing accounts receivable".
The need for process adjustments
Siegrist says that the number of companies underestimating the importance of working capital as a liquidity reserve is still far too large. "Processes need, first and foremost, to be adjusted to prevent invoices being generated either too late or incorrectly, for example, or to avoid a higher frequency of complaints resulting in delayed payments," Louis Siegrist stresses. "Many companies barely concern themselves with their payment terms, neither on the purchasing nor the sales side. There is also often a great deal more to do in terms of optimization and affording more flexibility within the inventories".
On a more positive note, the study does show that no notable damage has been done as yet to the creditworthiness of companies and private customers. However in the meantime, Louis Siegrist sounds a note of caution: "Delayed payments and bad debt losses could be making a more frequent appearance in future, and lead to an increase in the number of write-downs."
Download "All tied up. Working capital management report 2009" (PDF 2.4 MB)
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