An Analysis of Working Capital Management Results Across Industries

Topics: Cash conversion cycle, Inventory, Balance sheet Pages: 9 (3868 words) Published: October 8, 2014

An Analysis of Working Capital Management Results Across Industries Greg Filbeck, Schweser Study Program Thomas M. Krueger, University of Wisconsin-La Crosse

The importance of efficient working capital management (WCM) is indisputable. Working capital is the difference between resources in cash or readily convertible into cash (Current Assets) and organizational commitments for which cash will soon be required (Current Liabilities). The objective of working capital management is to maintain the optimum balance of each of the working capital components. Business viability relies on the ability to effectively manage receivables, inventory, and payables. Firms are able to reduce financing costs and/or increase the funds available for expansion by minimizing the amount of funds tied up in current assets. Much managerial effort is expended in bringing non-optimal levels of current assets and liabilities back toward optimal levels. An optimal level would be one in which a balance is achieved between risk and efficiency. A recent example of business attempting to maximize working capital management is the recurrent attention being given to the application of Six Sigma® methodology. Six Sigma® methodologies help companies measure and ensure quality in all areas of the enterprise. When used to identify and rectify discrepancies, inefficiencies and erroneous transactions in the financial supply chain, Six Sigma® reduces Days Sales Outstanding (DSO), accelerates the payment cycle, improves customer satisfaction and reduces the necessary amount and cost of working capital needs. There appear to be many success stories, including Jennifer Towne’s (2002) report of a 15 percent decrease in days that sales are outstanding, resulting in an increased cash flow of approximately $2 million at Thibodaux Regional Medical Center. Furthermore, bad debts declined from $3.4 million to $600,000. However, Waxer’s (2003) study of multiple firms employing Six Sigma® finds that it is really a “get rich slow” technique with a rate of return hovering in the 1.2 – 4.5 percent range. Even in a business using Six Sigma® methodology, an “optimal” level of working capital management needs to be identified. Industry factors may impact firm credit policy, inventory management, and bill-paying activities. Some firms may be better suited to minimize receivables and inventory, while others maximize payables. Another aspect of “optimal” is the extent to which poor financial results can be tied to sub-optimal performance. Fortunately, these issues are testable with data published by CFO magazine (Mintz and Lazere 1997; Corman 1998; Mintz 1999; Myers 2000; Fink 2001), which claims to be the source of “tools and information for the financial executive,” and are the subject of this research. In addition to providing mean and variance values for the working capital measures and the overall metric, two issues will be addressed in this research. One research question is, “are firms within a particular industry clustered together at consistent levels of working capital measures?” For instance, are firms in one industry able to quickly transfer sales into cash (i.e., have low accounts receivable levels), while firms from another industry tend to have high sales levels for the particular level of inventory (i.e., a high inventory turnover). The other research question is, “does working capital management performance for firms within a given industry change from year-to-year?” The following section presents a brief literature review. Next, the research method is described, including some information about the annual Working Capital Management Survey published by CFO magazine. Findings are then presented and conclusions are drawn. Related Literature

The importance of working capital management is not new to the finance literature. Over twenty years ago, Largay and Stickney (1980) reported that the then-recent bankruptcy of W.T. Grant, a nationwide chain...

References: Corman, L. 1998. The 1998 working capital survey: Cash masters. CFO 14 (7):30-48.
Farragher, E., R. Kleiman, and A. Sahu. 1999. Current capital investment practices. Engineering Economist 44 (2): 137-150.
Fink, R. 2001. The 2001 working capital survey: Forget the float? CFO 17 (9):54-64.
Gilbert, E. and A. Reichert. 1995. The practice of financialmanagement among large United States corporations. Financial Practice and Education 5 (1): 16-23.
Hadley, S. 2004. Making the business case: Supply chain management. Strategic Management (April):28-34.
Hill, N., W. Sartoris, and D. Ferguson. 1984. Corporate credit and payables policies: Two surveys. Journal of Cash Management 559-576.
Largay, J. and C. Stickney. 1980. Cash flows, ratio analysis and the W.T. Grant Company bankruptcy. Financial Analyst Journal 36 (4):51-54.
Maness, T. and J. Zietlow. 2004. Short-term Financial Management. Australia: Southwestern Press.
Mintz, S. 1999. The 1999 working capital survey: Dollars in the details. CFO 15 (7):55-68.
Mintz, S. and C. Lazere. 1997. The 1997 working capital survey: Inside the corporate cash machine. CFO 13 (6):54-68.
Myers, R. 2000. The 2000 working capital survey: Cash crop. CFO 16 (7):59-82.
Scherr, F. 1996. Optimal trade credit limits. Financial Management 25 (1):71-85.
Schwartz, R. 1974. An economic model of trade credit. Journal of Financial and Quantitative Analysis 9:643-657.
Towne, J. 2002. Black ink—Six Sigma archives, case study #5­—Thibodaux Regional Medial Center.
Waxer, C. 2003. Six Sigma costs and savings.
Weinraub, H
Weisel, J., N. Harm, and C. Bradley. 2003. The cash factor. Strategic Management (Sept.):29-33.
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