The Stress Test Every Business Needs

8How well does working capital management contribute to cash flow and earnings?

Sven Braun and Steve Payne

If cash is king, why do so few companies take proper care of it? One of our recent studies used peer-to-peer performance comparison as a proxy, and found that more than US$1 trillion is tied up in excess working capital in companies across the globe. Why is all this unproductive cash just sitting around, waiting to be claimed by someone who knows where to look?

Sometimes companies focus too much on the income statement (revenue, profitability, and earnings), while overlooking key aspects of the balance sheet. Specifically, they forget about the importance of executing on the policies and processes that optimize the level of working capital required to support their business. This is exactly what happened when a major pharmaceutical company carved out a subsidiary in an attempt to focus on its core business. Being cash-rich, the parent company historically did not have a strong focus on working capital. In contrast, the private equity house that bought the subsidiary focused on working capital to drive value creation, generate free cash to pay down debt, and improve the company’s operations.

Within six months of focusing on the incentives, policies, and processes that drive and influence working capital, around US$100 million in cash was liberated. If the parent had done this work prior to the carve-out, the sale might have been valued at a higher multiple and the parent ...