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In brief
Companies worldwide have had ample experience in the last two years with what can go wrong when bad things happen, and it’s not limited to the pandemic. Setbacks can come at any time and from any quarter, from severe weather to war in Ukraine, moving resilience to the top of the CFO agenda.
But how do you create resilience?
A new EY-Parthenon analysis shows that companies with a strong cash management culture are also the ones well positioned to meet sudden challenges or downturns.
To understand better how cash management affects operational resilience, we created a global index that tracked 5,000 of the largest public companies across market downturns, using total shareholder return (TSR) as a gauge. We measured how organizations were able to prevent, respond, and recover from adverse events. We found that companies with better cash management were 19% more resilient than their low-performing peers and 21% better at limiting initial shocks in the first place.
We applied the same combination of cash management metrics and our resiliency index to understand how several key industry sectors performed, including advanced manufacturing and mobility; health, science and wellness; technology, media and telecommunications; and consumer products and retail. The results confirmed the overall trends also held true for different sectors and yielded sector-specific insights.
We also see this in our work with clients: it is not enough just to keep operating during a crisis. Companies need to sustain shocks and keep building for the future. When chaos strikes, resilient companies survive; non-adapters often do not.
Chapter 1
Companies with cash-conscious cultures and better cash management are also the most resilient.
As important a quality as resilience is, for companies, it has been a difficult thing to measure and especially difficult to achieve. Fortunately, cash management, or working capital management, is a well-understood and measurable improvement to make. Elements of net working capital are: accounts receivable, measured as days sales outstanding (DSO); accounts payable, or days payables outstanding (DPO); and inventory, or days inventory outstanding (DIO). The benefits include not only better liquidity and financial flexibility, but also operational resilience to withstand downturns.
A cash conscious culture:
Companies with weaker cash management abilities are faced with a cycle of constant recovery and have, on average, 26% more quarters of below market performance than their peers, based on total shareholder return (TSR).
Companies neglect resilience for a variety of reasons.
Chapter 2
We set out to shed light on how the best-run companies are creating more resilient organizations through better cash management.
We developed an approach to measure organizational resilience, using market data and metrics such as TSR, to establish an overall resiliency score, comprised of measurements in three categories of resilience—prevention, response and recovery. These align with the early, middle and late stages of a given market downturn that is experienced collectively by companies in the overall sample or industry peer group.
We used this data with recognized indicators of cash management capability, such as CCC efficiency, liquidity ratios and others, to understand how high performers in cash management fare, during a market dip, against their peer group’s average performance in the three resilience measures and overall. We compared high and low cash management performers for an overall, cross-industry view, and broke down the analysis by several industrial sectors, as well. In our index, a lower score (as with CCC) indicates higher performance.
The findings confirm our thesis that companies with better cash management are more resilient, with an average resilience score 19% better than the low performers. The logical expectation is that high performers in cash management should excel in the response and recovery stages by having cash on hand to react to a given market setback. While such companies are indeed better in these categories, a more intriguing finding is the significantly greater preventive advantage demonstrated by companies that excel in cash management. High performers in cash management led low performers by 21%, in prevention, compared with a narrower advantage of just 2% in recovery.
The lesson: while it’s undoubtedly good to have available cash during a crisis, the indirect benefits for the business of superior cash management practices are even more valuable because they help companies limit their exposure to risks in the first place.
This is because the high performer scores are measuring total business health—not only the top and bottom line, but also the balance sheet. The high performers’ leaner business operations gave them better access to credit (as seen in their 23% advantage in credit score), allowing them to experience lower volatility in downturns compared to peers.
Results in the response category demonstrate that companies that are cash efficient are better able to withstand financial downturns, supply shortages and industry-specific challenges, and therefore have more options when downturns occur. This is because their comparatively strong balance sheet, again, enables them to access credit, when needed. For example, a better-managed company can borrow to invest in more inventory to meet a short-term market need, such as a supply shortage or a sudden rise or drop in demand; or a company with cash may be able to afford additional air freight for needed raw materials in an emergency.
The results also indicated that high performers are economically more efficient in the response stage of a given downturn, with higher operating cash flow (OCF) per employee than low performers, on average. These measures help explain their stronger market performance during downturns, where they remained 13% above the poorer cash performers, giving them a 14% advantage in the overall response score.
Stronger cash management performers benefit by being able to absorb business shocks without laying off workers or downsizing. Thus, they are not only more efficient when times are good, they are able to avoid painful choices during downturns.
High cash management performers outscored low performers by 5% in the third category, recovery, due to a much stronger rebound (35%) in their operating margin score. This is an indication of the greater profitability of companies with better cash management.
Chapter 3
Based on our client experience and analysis, cash management affects resilience in different industries. There are sector-specific considerations to keep in mind.
High performers in industrial manufacturing have also benefited from sustainable cash programs that have enabled them to fund future-ready business models. In the last four years, high performing companies were 11% better than low performers in the overall resiliency rating. Companies that were able to carefully manage cash performance in the three key areas of days payable outstanding (DPO), days sales outstanding (DSO) and days inventory outstanding (DIO), were also the ones best positioned to adapt to changing economic conditions by reinvesting flexibly.
A manufacturing company has been able to invest in business opportunities as well as its pursuit of carbon-reduction goals after embarking on a five-year program to unlock cash flow. The project identified quick wins that helped realize $40 million in just the first four months. When completed, the highly focused and sustained effort helped unlock $1.5 billion in trapped working capital to help fund strategic investments in future-proofing the business model. The changes included a new cash leadership officer position and team to help drive improvements that impacted resilience, such as enhanced cash-flow forecasting, and a roadmap of working capital opportunities across accounts receivable, accounts payable and inventory.
Analysis of data from the consumer products and retail sector provides an interesting view of the interplay between payables and inventory management, as critical elements of cash management, and how these are affected when supply chain troubles threaten. Over the last four years, CPR high performers had 74% longer payable schedules and kept inventory on hand for 43% longer than low performers, enabling better prevention and recovery. The data show that CPR companies that fared best through the pandemic and recent supply chain shocks were those that carefully manage both their DPO and DIO as a means of freeing up cash to reinvest.
In normal times, less inventory means shorter DIO, which leads to better overall cash management and more available cash. This becomes complicated when supply chain tie-ups force companies to hold more inventory as security against shortages. To do this, companies need to have both a strong cash position and good supplier relationships. Those that manage the overall supplier relationship effectively are in the best position to prevent and recover from events.
This is because companies that can negotiate longer payment terms with suppliers, by adopting a transparent, communicative approach, for example, are also likely to have preferred customer status, which can be especially valuable when a supply shock hits and they need access to product inputs to increase inventory. This reflects the notion that a rounded approach to cash management generates benefits that add value for the organization in more than just financial ways.
A CPR company undertook an extensive cash management improvement program after a benchmarking exercise showed it was lagging its peers in recovery and prevention capabilities. The company took action to enhance its own DPO and DIO metrics, freeing up $115 million in trapped cash. It used the money to invest in areas that improve resilience, such as improving process efficiencies and funding a program to create a more sustainable and lucrative product line.
The analysis showed a different pattern in the healthcare sector, which faced severe strains during the last two years due to shortages of staff and materials and the huge rise in demand during the pandemic. Higher performers differentiated themselves primarily by their ability to respond rather than prevent or recover from downturns. In total, healthcare high performers were 16% better in response compared to low performers and just 9% and 5% better in prevention and recovery, respectively. The results show that high performing healthcare companies were particularly good at using cash effectively to adapt to changing market conditions over the four-year period. A reduction in OCF per employee, a component of the response measure, indicates that high performing healthcare companies were able to hire more healthcare workers to cope with demands from the pandemic.
In our index, high performers in the life sciences sub-sector have significantly better CCC than their lower-performing peers. As a result, over the last four years, life sciences high performers were able to take on more debt and invest in future development and sustainability. For example, high performers spent three times more on research and development as a percentage of revenue, which led, in turn, to better results in preventing downturns, compared to low performers. The other area where better cash management delivered results for life sciences companies was in the ability to invest in inventory when necessary to gain control over supply chain disruptions, which resulted in high cash performers having better responsiveness than lower performing companies.
A major US pharmaceutical company began a program to get its cash management under control after commissioning a benchmarking report that identified it as a laggard in the sector. The company lacked accountability for important balance sheet accounts, and executive priorities emphasized profit optimization and cost containment more than the overall value chain. EY helped implement a cash leadership office that establishes accountability and executive incentives that balance growth and costs with cash performance measures. Functional management groups oversee continuous process improvement.
The program has delivered $7.4 billion in cash benefits since it began in 2012, by establishing a culture of attentiveness and accountability for cash performance. The greater transparency and stronger inventory management capabilities have had a strong positive effect on corporate resilience by encouraging “out-of-box” thinking about ways to further optimize the supply chain and decrease inventory levels.
Another pharmaceutical client created a cash culture that has delivered $5.2 billion in cash benefits over the past five years. The company set up a cash leadership office to coordinate enterprise-wide cash management changes, including operational metrics to provide visibility and enable prioritization of investment, cash, cost and service. As a result, the company gained financial flexibility to pay dividends, and invest in innovation, acquisitions and improving resilience during the COVID-19 pandemic.
In telecommunications, low cash management performers dropped 4% more in TSR during downturns than high performers. Conversely, high performers were able to ride out market volatility over the past four years by reinvesting in their business at nearly three times the rate of their lower performing peers. This is evident in high performers’ capital expenditure levels—which includes spending on new products, services and acquisitions—which was 8% of sales, on average, compared to 3% spent by low performing companies. This greater ability to invest in their business led to better results in prevention and response, and overall better resilience, during downturns.
An EY team helped a leading telecommunications company release $100 million in working capital by helping deploy an interim collections system and a new dispute approach for accounts receivable across five business units in North America. Other improvements included automation, collections outsourcing, terms negotiations and enhanced reporting. The initiative improved resilience by creating a sustainable program for continual, long-term cash improvement. It established a collections and dispute management framework, with metrics tracking to monitor and drive improvement to cash position and a balance sheet health. It also created a roadmap of additional order-to-cash initiatives.
Chapter 4
Companies that consistently maintain healthy levels of working capital are in a position of strength when trouble strikes, compared to their peers.
These companies achieve this by adopting a two-part strategy of improving cash performance in the short term with adjustments to processes and measurable metrics, while also making the changes sustainable by building a cash culture to embed new habits and expectations throughout the organization.
Strategic, cross-functional initiatives include:
Due to the broad scope of the objectives, including the change in mindset and the reorienting of the entire organization with new management metrics, this can be difficult for companies to do themselves.
The affected functions include finance and treasury, operations, corporate functions, human resources and investor relations. Performance management and incentives need to be linked to cash objectives.
Change management efforts should include consistent messaging and training across departments to explain why cash management matters to them. Success depends on the initiative addressing the whole enterprise, sustainable improvement rather than a one-time focus, and on buy-in from the entire organization, from top management on down.
Companies have made successful cash management transformations by implementing a cash leadership office. A typical CLO is overseen by the CFO and treasurer and includes members from finance, supply chain, procurement and controller to maintain accountability within operations, inventory, accounts payable and accounts receivable.
With a CLO in place, companies can:
To understand the relationship between resilience and working capital management, we compared cash management metrics with a reliable measurement of organizational resilience. Using available data from the global Capital IQ database, we first segmented the 1,000 worldwide companies in the sample group into equal tiers of high, medium and low performers in cash management, based on cash conversion cycle (CCC) and other cash management metrics, such as days payable outstanding, days sales outstanding and days inventory outstanding. We eliminated the medium tier to create groups of high and low performers.
There is no ready metric for gauging organizational resilience, so we created a proxy. We compared publicly listed global companies with peers using an index based on market metrics such as total shareholder return (TSR). Using the peer group average as a benchmark, we compared the performance of companies going into, during and exiting dips in the market that resulted from shocks experienced across peer groups — whether from pandemic, inflation, supply chain disruption, and so on.
Using this as the basis, we interpreted companies’ performance in the early, middle and end phases of collective market setbacks, in resilience terms, as preparation, response and recovery. In this analysis, companies that regularly perform better against peers in the early stages of a market shock are better in preparation. (A lower score is better, in our index.) Those that experience less of a decline than others at the bottom of the dip have a better response score. Those that come out of the slump faster or stronger than the peer group average are better at recovery. Likewise, those below the curve — dropping earlier, farther or recovering more slowly than their peers — are poorer performers in the three resilience categories.
Companies’ responses to market disruptions vary for many reasons, of course, and the data sample includes companies whose TSR performance is unrelated to either resilience or working capital efficiency. Through a combination of large sample size, the multiple periods measured and steps to control for outliers, the analysis produced statistically meaningful insights into the relationship between resilience and working capital performance across the sample. Due to the nature of resilience as a meaningful condition over the long term, we found the comparison works more reliably when multiple periods are averaged together, rather than as a single-year snapshot.
Companies we’ve worked with to help improve their cash management practices also seem to be the most resilient companies—they are affected later, are impacted less, and recover faster—when markets turn down. Companies can establish a cash leadership office as a first step to leaping past their peers in establishing a culture of cash management, which in turn can lead to a better competitive position in times when supply chain or other disruptions hit the sector.
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