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Working capital drives cash flow, and more cash means more flexibility in making business decisions. However, during periods of volatility and trading disruptions, as was the case in both waves of Covid-19, the ability to effectively manage working capital becomes even more difficult.
In its recently launched Working Capital Report 2021, McGrathNicol sought to quantify the effect of Covid-19 by analyzing the working capital performance of 137 ASX-listed companies across seven sectors.
“The businesses we targeted needed more working capital to be able to do business in 2021,” explained Sean Wiles, partner at consultancy McGrathNicol and co-author of the report.
“We experienced a 3.1-day increase in net working capital cycles, which translated into an additional $5.5 billion in cash closed at our sample companies,” he said.
The report showed that companies collected cash from their customers more slowly and held more inventory. They partially offset this impact by paying suppliers more slowly. “Holding payments to suppliers is not an uncommon lever for businesses to have, and is typically in their power, but as you’d expect, it’s difficult to sustain for too long,” noted Jason Ireland, also an advisory partner at McGrathNicol and a co-author. news.
“An interesting side note to this was that in four sectors – agriculture, construction and engineering, mining and resources and transport and logistics – average payment terms to suppliers were 60 days or more,” he added.
Of the sectors covered by McGrathNicol, the food and beverage sector saw the largest deterioration in working capital performance of any sector in 2021. The net working capital cycle extended by just over two weeks and “locked in” an additional $400 million in cash. “It was actually one of the biggest changes in working capital that we’ve seen in the nine years of doing this analysis and writing the report,” Wiles said.
An interesting finding was that food and beverage companies transferred more working capital per month than their retail customers and their transport suppliers, showing where the working capital burden lies in this particular supply chain.
Who leads the way?
McGrathNicol also looked at the “best” and “worst” working capital managers, noting that five of the seven sectors saw a spread of more than 100 days in the length of the working capital cycle. In three of these sectors, it was more than 200 days, namely agriculture, retail and food and beverage.
“This is a key figure because it shows that there is a wide range of outcomes at a company level and highlights that significant competitive advantage can be achieved by implementing best practices,” Ireland explained.
“Interestingly, across each of the elements of working capital, the spread widened during the second half of the year, signaling the challenges facing businesses as business conditions changed following the first wave of Covid-19,” he added.
As Australia emerges from the latest Covid-19 restrictions, most sectors are likely to have growth opportunities. How businesses manage their working capital will be a big factor in determining whether or not they take advantage of these opportunities.
“Growth requires inventory, and we think inventory will be difficult to secure. We began to see the first signs of this in the second half of 2021, particularly in sectors such as building products and construction and engineering, where there was inventory reduction,” explained Wiles.
“Australia is recovering from the second wave of Covid-19 later than other Western economies. Demand from Europe and North America is straining supply chains that have not yet fully recovered. They also pay more, which increases costs throughout the supply chain, not just the well-publicised rise in transport prices,” Ireland added.
McGrathNicol’s report also included international benchmarking data which showed that Australian businesses typically hold almost 1.5 times more inventory than their US, European and Asian counterparts. However, with supply chain pressures building, they may not have the same luxury in 2022.
“Management teams will likely need to look at other sources of inventory, including offshore and alternative suppliers. The days of having all your eggs in one basket are gone for now,” Ireland said.
Wiles added: “Essentially, there will need to be a dedicated and disciplined focus on working capital in the new year. Senior management and the board will need to be given an appropriate level of airtime, just as strategy and security are key pillars of any successful business. Management teams that implement best practice processes and track performance at all levels of the working capital cycle will win.”
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