Engineer control robotic mechanical arm with tablet

A $230 billion cash opportunity for industrial products companies

By implementing a focused cash management strategy, industrial products companies can make more cash available and improve shareholder value.

In brief

  • Supply chain disruptions have given industrial products companies a significant imbalance of payments headaches that have gotten worse since the pandemic.
  • Companies can release significant cash and improve competitiveness with strategic process improvements, better use of technology and a cash-focused culture.

Diversified industrial products companies are facing a pandemic-induced hangover of over $230b in cash tied up in working capital, according to an industry-wide analysis by EY-Parthenon Working Capital Advisory Services.[¹] While cash conversion efficiency is likely to be a continuing issue for the sector, companies can implement realistic measures to release significant cash from the balance sheet to boost agility, competitiveness and shareholder value.

Despite being one of the sectors hit hardest by COVID-19, diversified industrials have seen revenue rebound worldwide as the economy has emerged from the downturn. However, their cash position has not recovered at the same rate.

Working capital
$230b
cash estimated to be tied in working capital at industrial products companies across the globe.

Historically, diversified industrials companies have had one of the lengthiest cash conversion cycles (CCC) of any industry because they are capital intensive and depend on physical inventories and global supply chains. In aggregate, the industry CCC, which measures a company’s efficiency in turning its resource inputs into cash, has consistently exceeded 60 days. The number spiked to an all-time high of 83 days in the second quarter of 2020, 38% above the historical norm, according to Capital IQ data (see Figure 1).[²]

How to meet old and new cash challenges

Certainly, companies cannot readily fix the structural causes for slow cash conversion or the ongoing supply chain crisis, but they can significantly improve cash conversion efficiency by taking strategic steps to compensate for the negative impacts. For example, companies can improve operational efficiency by implementing automation and adjustments to trade relationships and payment and collections processes. Tracking metrics and supporting change management can help make the improvements permanent and sustainable.

In recent years, many companies in the industry have responded to competitive pressures with acquisitions or mergers, resulting in integration inefficiencies that have also had a negative impact on the sector’s overall cash conversion position.

The challenge for industrials during the pandemic has been a sharp rise in aggregate days sales outstanding and days inventory outstanding without a corresponding extension in accounts payable terms. For example, companies that sell expensive equipment or finished goods and normally have large amounts of cash committed in the delivery pipeline have been especially impacted by delays caused by the ongoing supply chain crisis.

With a creative approach, including borrowing ideas from other sectors, industrial products companies can push against sector constraints to make improvements and stand out among peers. Based on years of experience working closely with industry clients, we have identified ways companies can adjust available levers and institute a cash-focused culture to improve cash performance.

Accounts receivable

Besides focusing on collections, industrial products companies can augment the quote-to-invoice process in high-volume, high-variability environments. Potential improvement levers include:

  • Standardizing terms and making greater use of down-payment arrangements to pay up-front costs
  • Simplifying the contract booking process 
  • Updating billing systems and using smart contracts to improve milestone billing timeliness and accuracy 
  • Reducing invoice frequency and timing to lower internal and customer processing costs

Companies could also consider applying proper quality acceptance and execution sign-off procedures to ease back-end collection delays. Appropriate bond and lien rights, and the processes for executing them, are critical for manufacturing companies that sell or install expensive equipment.

And finally, a robust dispute management process and escalation protocols could be implemented for timely identification and resolution. Dispute processes can be flexible to account for variable products, services and dispute-reason codes, and business units can designate appropriate contacts to expedite resolution.

EY at work

An EY team helped a global manufacturer of payment processing systems implement a robust collections strategy, including customer prioritization enabled by advanced analytics, collections “hot lists” and a dispute management framework. Once executed, the strategy reduced the time spent on disputes and accelerated collections.

Accounts payable

In our experience, industrial products companies that have a well-structured procure-to-pay program can address various challenges to successfully realize cash benefits.

Also, because single-source suppliers could account for a significant percentage of direct spending by industrial products companies, this could limit the company’s leverage to negotiate extended terms. Companies armed with better insights into industry payment standards can address these constraints and uncover additional cash opportunities. A focused, vendor-risk assessment can help identify ways to improve negotiation leverage and limit disruption while extending payment terms.

Available steps for the accounts payable process include:

  • Driving payment-term extensions and payment-frequency optimization according to supplier-risk segmentation
  • Aligning invoice due-date triggers to invoice or product-receipt dates
  • Implementing process improvements and controls to improve payment discipline and adherence to agreed invoicing terms, leveraging automation capabilities 
  • Using alternative financing programs that allow more favorable payment terms with selected suppliers

EY at work

A global industrial products company experiencing fluctuations in its cash position was able to compensate by establishing flexible payment terms that helped make cash available to deploy for its capital allocation strategy. An EY team helped the company implement flexible payment terms based on benchmark data and market insights, including an early-payment discount based on supplier market rates. This approach, which can be supported by predictive analytic solutions, prevents changes in supplier treatment based on fluctuations in a company’s capital allocation strategy.

Inventory

Industrial products companies’ supply chains involve interdependencies across the globe. The transition from product-driven to outcome-driven services to fuel growth adds an extra layer of challenges. Leading IP companies are leveraging machine learning to identify common parts for SKU rationalization, automating multi-echelon planning, and using innovative technologies such as the “digital twin” to visualize and enhance manufacturing processes. 

  • Beyond digitization, the foundation of inventory management remains: 
  • Developing an inventory strategy based on segmentation and establishing SKU-level entitlement  
  • Focusing on dynamic stock visibility and enabling global inventory mobility
  • Establishing a strategic stock approval process (e.g., last time buy decision) using a data-driven approach

A key success factor for leading industrial products companies is building skills in inventory management as part of the overall supply chain operating model.

EY at work

A global, advanced manufacturing company specializing in hardware and managed services solutions wanted to reduce service parts inventory and write-offs. Due to decentralized global inventory management and disparate enterprise resource planning systems, the company lacked field inventory visibility and governance. An EY team assisted the company with installing a global inventory mobilization program and data consolidation tool that helped streamline the decision process for inventory rebalancing. The new, comprehensive governance model now enables one source of truth for 80% of global inventory. This shortens the time needed to select and move parts across continents, resulting in a projected 10% inventory reduction while mitigating write-offs.

Cash leadership

The key to unlocking the full potential for a business is establishing a forum, such as a cash leadership office (CLO), that brings together key decision-makers to holistically assess revenue, cost and cash requirements. A successful CLO uses executive and operational dashboards to track performance and enable execution teams to thrive with real-time information. This generally requires a sustained effort across processes, digitization, metrics and incentives. But, in our experience, companies have seen a return on investment through significant improvement in free cash flow.

Finally, cash leadership does not end with accounts receivable, accounts payable and inventory optimization. Companies should consider:

  • Using non-trade working capital to improve indirect tax positions
  • Reviewing the necessity and expense timing of real estate portfolio holdings 
  • Improving capital allocation controls 
  • Adjusting the timing of non-trade revenue (e.g., royalties)
  • Managing accrued liabilities and other payables

EY at work

One large diversified industrial company released over $1.5b in working capital by implementing a cash leadership office. The company designated a new officer position, CLO lead, and a dedicated CLO team staffed with senior leaders. By working with operational stakeholders to set entitlement levels for trade working capital and prioritize projects, the team was able to champion improvements to cash flow forecasting, the capex management process, and value-added tax optimization.

Borys Trofimov of Ernst & Young LLP contributed to this article.

Summary

While industrial products companies face structural and pandemic-imposed challenges that undermine working capital efficiency, organizations that focus attention and leadership can achieve measurable improvements. By taking a coordinated, multi-step approach that includes strategic process adjustments, supported by automation, monitoring, and a cash-culture focus, manufacturers can make more operating cash available for new investments or future challenges.

Related articles

Five ways to use the current crisis to improve supply chain management

Corporate leaders can use the current supply chain crisis to reimagine their future supply chain.

Peter Kingma + 1

How a sustainable cash culture can drive growth

Freeing up cash on the balance sheet may be hard, but companies such as Johnson Controls are finding ways to establish a sustainable cash culture.

Peter Kingma + 2

    How EY can help

    EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients.