Maybe it's globalization. As U.S. companies source more goods from the far corners of the world, it makes sense that they would stock more inventory as a guard against potential breakdowns in their supply chains. Or maybe it's economic priorities. With corporate coffers bulging like overloaded transpacific freighters, finance executives could be taking their eye off second-tier metrics like inventory, payables, and receivables. Whatever the explanation, 2006 marked the first time in five years that the 1,000 largest publicly traded companies in the United States (excluding automakers) failed to decrease the amount of cash they had tied up in working capital relative to sales. In fact, by year-end 2006, working-capital days were actually up a smidgen: 38.8 days versus 38.7 at year-end 2005.
Blame inventories, says REL, the research and consulting firm that compiles the data for this annual scorecard. According to its figures, the nation's biggest firms allowed their days inventory outstanding (DIO) to rise to 31.2 last year, up 2.1 percent from 2005. That performance overshadowed slight improvements on the payables and receivables fronts, the other two key components of working capital. Days sales outstanding (DSO, a measure of how efficiently companies convert receivables to cash) shrank to 39.5 from 39.9, an improvement of 1.2 percent, while days payables outstanding (DPO, a measure of how long companies hold onto their own cash before paying vendors) rose to 31.9 from 31.8, an improvement of 0.3 percent.
The paltry gains in DSO and DPO suggest that many CFOs are worrying less about working capital these days and more about taking advantage of a strong economy to drive sales. "We're in a very high growth stage right now," concedes a senior finance executive at one specialty retailer, who asked to remain anonymous. "Squeezing that last dime out of the payables account isn't the biggest focus of our attention at the moment."
That's understandable, perhaps, but also unfortunate. As cash-flow connoisseurs seldom tire of pointing out, money tied up in working capital is money that's not available to invest in the business, fund an acquisition, pay a dividend, or finance a stock-buyback program. And according to REL, the opportunity foregone by companies that haven't whittled down their working capital to best-practice levels is enormous: $764 billion excluding automakers, $877 billion if you include them. That's the amount of cash that would be freed up if companies in the bottom three quartiles of working-capital performance simply brought themselves in line with first-quartile performers...
Meanwhile, with companies searching ever farther afield for cheap goods and labor, some probably found it prudent to carry more inventory as a guard against potential supply-chain disruptions. And even if they didn't physically hold more inventory, notes REL analyst Karlo Bustos, they might have found themselves posting higher inventory values on their books anyway — particularly where their supplier contracts required them to take ownership of goods during the long transit from Asia, Eastern Europe, or South America.
"We're producing merchandise in places many people have never heard of, even places where there's a pretty significant element of instability," says the specialty retailing executive cited earlier. "Any time you start producing in places like that, you end up allowing for longer lead times and ordering and carrying more inventory. We carry a lot of items that remain popular year after year, but for a retailer that depends on having the most-updated trends in its stores at all times, that can be a challenge."
Payne agrees. The increased lead times associated with shipping product from low-cost and faraway countries, he says, force companies to house more inventory and reduce the speed with which they can respond to changes in customer demand. Not only can that increase overall inventory levels, he warns, but, more ominously, it also can inflate the amount of "slow and obsolete," or SLOB, inventory on corporate balance sheets. "Companies have to find the right balance between taking advantage of cheaper product and creating flexibility in their supply chains," he says.
Bloated Inventories and Globalization
♠ Posted by Emmanuel in Trade
at 7/24/2007 04:12:00 PM
Please don't ask me how on earth I find these articles, but they seem quite readable nonetheless. A few posts back I noted how Japanese car makers have difficulty coping with insufficient inventories to continue with production when supply chain disruptions hit as they have adopted just-in-time (JIT) processes. Here we have the opposite problem. According to CFO Magazine, American firms are becoming inundated with inventory buildup due to globalization. In contrast to their Japanese counterparts that like to keep their supplies lean, American firms have resorted to stockpiling large inventories to guard against possible problems in obtaining supplies from abroad. Call it loaded-all-the-time (LATT) production. Perhaps it's because Japanese firms are less reliant on gaijin (foreign) suppliers that they need to carry less "insurance." At this rate, my humble blog might become the IPE and Supply Chain Management Zone ;-) Anyway, on to the article: