Working Capital Management

Dr. Hendrik Vater, CFO DHL Supply Chain Southern Europe

Working Capital Management –

Current Trends and Success Factors in Working Capital Management

Results of the ICV Practice Group “Working Capital Management”

ACCID, VI Congress Universidad Abat Oliba CEU

May 2015 | Seite: 2

ICV “Internationaler Controller Verein” –

The Practice Group „Working Capital Management“

• Founded in 2009 in Bonn (Germany) – the first ever institutional connection between theory and practice via the participation of representatives from academia and

practitioners

• Development of a basic understanding of working capital management and its value drivers

• What role does the controller play in working capital management?

• Discussion and exchange of information on examples of best practices in working capital management

• Topic Leadership provided at the ICV

Working Capital Management Scope

Effects of globalization on WCM? Divisional-/ company-wide win-win situations? WCM objectives of companies? Sector-specific differences? Role of IT in WCM? Positive/ negative measures? Undiscovered potential in WCM (delivery times, scrapping, etc.)? Effects (liquidity/ profitability) on financial performance? Drivers? Framework for successful WCM? Main problems in practice? Effects of the financial and economic crisis on WCM and the role of the controller? Is top management aware of the importance of WCM? Leverage effects? Definition of working capital? Key metrics? Organizational foundation of WCM -> successful for the

long run? Possibilities to

control the life cycle by company/ sectors/ business cycle? Limits of WCM? WCM status quo in practice: organization, methods, tools Substantive questions about WCM Inventories Payables Receivables Working Capital Management (WCM) Different WCM at different strategic positioning?

Role of supply chain management in WCM? Best practices In payables, inventories, service levels, receivables Role of controlling/ controller in WCM? Best practice in WCM reporting? Which aspects of WCM are impacted by trade-offs between income statement and balance sheet?

Implementation of the CFO agenda in 2014

Companies have not yet implemented the levers of

CFO Agenda 2014 consistently

Focus of

CFO-Agenda 2014 Activities planned for 20141)

Actual 20142)  vs. Plan 1 52% -14% 2 44% -16% 3 45% -15% 4 49% -9% 5 39% -15% 6 38% -14% 7 39% -10% 8 40% -9% 9 31% -10% 52% Logistics 54% Working Capital Management 58% Controlling & Finance 60% Production 60% Product Portfolio 66% 50% 49% Sales & Marketing 41% Innovation & Development Administration & Overhead Purchasing Very Secure Secure • The CFO Agenda 2014 has not been

consistently

implemented

• All areas remain in the

implementation

behind the original plans from 2013

1) Percentage of companies that plan activities for 2014; 2) percentage of companies that evaluate the actual efficiency of the lever up (4) or very high (5)

May 2015 | Seite: 6

Fundamentally, working capital management (WCM)

focuses on five items in the balance sheet

Most comprehensive definition Most narrow definition

Definition of WCM based on the ICV

• Working capital comprises in detail:

– The current assets tied up in operating activities

– Whose positions do not earn interest and which

– Therefore must be financed with interest-bearing capital

• This narrow, operating definition of working capital management can be

expanded for each individual company

• But when doing so, care must be taken to ensure that the additional

positions to be included:

– Are material and related to operations

– Are controllable by management

– Are not interest-bearing

– Release liquidity and

May 2015 | Seite: 8

There are several ways to optimize a company’s

financial performance

Focus Measures (examples)

• Stabilize or increase revenue • Lower cost of materials • Reduce staff expense

• Decrease other operating expense • …

• Optimize inventories

• Optimize receivables management • Optimize payment terms

• …

• Lower debt

• Reduce cost of capital

• Optimize equity contributions • …

• Optimize investments (expand capacity, implement technological innovations) • Conduct disinvestments Optimizing financial performance Liquidity Profit Working Capital Capital structure Balance sheet structure

The Virtuous-cycle of successful Working Capital

Management

Improvements lower the finance needs Continuous Focus on key WCM Processes (O2C–P2P–F2F) Lower debt levels _Lower absolute finance costs Better KPIs and Ratings Lower Interest Rates & Debt Level Higher Equity (Shareholder Value) WCM measures Secondary Resulting Effects 1 2 3 4 5 6 7 8

WCM

• Working capital management measures should always be aimed at achieving long-term sustainability

It‘s worth it! Consequences:

May 2015 | Seite: 10

Current Trends and Success Factors in Working Capital

Management

Focus on Processes

May 2015 | Seite: 12

Support main KPIs for Working Capital

Management with operating drivers – A Selection

• Number of payment-term codes actually used

• ABC analysis

• Top procurement categories / top suppliers

• Use of purchase order numbers

• Procurement channels &

automatically generated purchase orders

• Incoming invoices and processing times

• Invoice sizes

• Structure of early & late payments

• Complaint management

• Payment behaviour towards top suppliers

• Breakdown of procurement volumes

• WADTP ("weighted average days to pay")

• Payment behaviour • Frequency of payment runs • Use of payment terms vs. targeted

standards

• Comparison of contractual payment terms vs. actual practice

Working capital management performance

• Working capital structure (absolute / % of sales / DIO+DSO+DPO-days)

• DSO (granted days of credit) vs. DPO (received days of credit) vs. DIO (inventory on hand)

Receivables Payables Inventories

• Coverage analysis • Inventory aging • Inventory coverage • Trend of WIP days

• Segmentation of inventories

• Top materials

• Coverage radar

• ABC analysis

• Inventory structure vs. sales

• Utilisation deviations

• Adjustment planning

• Availabilities

• Fulfilment ratios

• Alignment of the supply chain

• Delivery times

• Processing speeds

• Reasons and triggers for delays

• Deliveries in arrears • Product segmentation Management level 1 Management level 3 / Operating departments Management level 2 • Sales breakdown

• WADTC ("weighted average days to collect")

• Unbilled receivables • Trend of balances in arrears • Use of payment terms vs. targeted

standards

• Comparison of contractual payment terms vs. actual practice

• Risk structure customer portfolio

• Procurement channels

• ABC analysis / top suppliers

• Number of payment-term codes used

• Invoice sizes

• Doubtful accounts & bad debt losses

• Collections via external partners

• Payment methods

• Unjustified deductions

• Complaints about defects, reasons, and resolution times

• Credit notes

• Payment allocation

Harmonizing the divergent interests and priorities of the

functions and business units ...

• Maximize revenue

• Wide variety

• Readily deliverable • Attractive payment

terms for customers • Sales

• Large inventory of finished goods

• Long collection periods for receivables

• Minimize production costs

• High machine utilization • Large lots

• Limited variety • Supply security • Production

• Large inventory of work in progress and

finished goods

• Reduce purchase prices

• Large order quantities • High supply security • Rapid payments to

suppliers • Purchasing

• High raw materials inventories

• Low supplier payables

Department Traditional departmental objective Departmental Inclination / Desire Negative consequences on working capital 3

May 2015 | Seite: 14

Size of the circle = number of times mentioned N = 99 Responsible for No responsibility Payables Raw materials Work in progress Finished goods Receivables Functions Purchasing Production Logistics Sales Other 66 25 53 35 26 61 26 82 22 43 47 31

How are the responsibilities currently organized in your company?

Typical responsibilities of the WCM components, with

highly diverse interests along the value chain

Source: Horvath & Partners (2013)

Supply Chain Finance as a win-win opportunity

Bank

Buyer

_Supplier

Platform/ 3rd _Party Intermediary

Supplier send invoice to buyer 1

2

3

4

Decides if invoice should be paid prior to maturity

5 Bank pays supplier before maturity _{according to agreed SCF-conditions} 6 Pays the bank according to agreed terms

and conditions

Checks and approves invoice and sends it on to 3rd _{party platform}

Invoice is included in platform

May 2015 | Seite: 16

On-balance sheet solution Off-balance sheet solution

An IFRS compliant concept for large cap companies which enables:

•True sale and shift of inventory ownership to an operating company

•Cash and working capital optimization

•Improvement of financial KPIs, e.g. ROCE An asset based lending (ABL) program for small to mid

sized companies which offers:

•A secured loan with customers’ inventory in DHL operated warehouses taken as collateral

•Faster and cheaper financing cost due to DHL acting as custodian to the collateral

Customer Role: Receives financing Bank/Investor Role: Provides credit DHL Role: Custodian, facilitator for customer/bank Loan agreement • Custodian services • Sharing information for collaterals Custodian agreement Customer Role: Re-purchases inventory Bank/Investor Role: Provides credit DHL Role: Custodian, facilitator for customer/bank

Asset (re-) purchase agreement • Custodian services • Sharing information for collaterals Custodian and servicing agreement OpCo Role: Purchases and owns inventory

OpCo financing agreement

DHL offers inventory financing through an on- and

off-balance sheet solution

Working Capital and Risk Management in conjunction

contribute to increase the company‘s value

Working Capital and Risk Management

Liabilities

• Risk of default

• Foreign exchange risk

• Liquidity risk (cash flow)

Assets

• Foreign exchange risk

• Market price risk

(unsecured)

• Capacity risk (large

inventory stocks)

• Inventory risk

• Loss of stock, uninsured

accidents

• Seasonality

Third Party Liabilities

• Foreign exchange risk

• Risk of damaging the

company’s reputation

• Supply-stop risks

• Single-sourcing risk

• Sustainable business

relationships – strategic

partnerships with key

suppliers

• Successful and sustainable WCM does not only improve cash flow and financial

results, but is also a decisive success factor to conduct risk management

May 2015 | Seite: 18

Outlook