Published: June 01, 2008
Numico is a high growth, high margin, specialist baby food and clinical nutrition company, acquired by Danone in October 2007. Acknowledged as the European and Asia Pacific market leader in infant nutrition and medical nutrition, products range from infant milk formula to specialised nutrition for babies and mothers. For people with specific nutritional requirements, Numico offers a complete range of enteral clinical nutrition, diet products and disease-specific nutrition. An important element in retaining the company’s competitive position has been a focus on optimising its working capital. For example, the Introduction to the Financial Statements as part of the 2006 Annual Report read,
“We were able to generate healthy cash flows through continued high levels of profitability and substantial reductions in working capital”
Tying up large amounts of capital adds no value to the company.
To achieve this, Numico established an internal initiative to reduce working capital within the company, This article explains the objectives of this working capital project and how we achieved these in practice.
Companies use their cash for a variety of purposes in addition to funding working capital requirements, such as financing acquisitions, investing in research and development, share buy backs and capital expenditure. While many of these have a direct impact on the competitive position and value of the company, tying up large amounts of cash in working capital adds no value to the company. The project was therefore set up to identify where reductions in working capital could be achieved and find ways to achieve this. The objectives of the project included:
These initiatives would then fuel DWC improvement activities and cascade the DWC principles and tools across the organisation.
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We identified significant benefits from reducing TWC. For example, improved cash flow would allow the company to invest more in organic growth and acquisitions with a resulting increase in the share price. We could reduce the amount of cash spent on interest payments, increase our agility to respond to market opportunities and meet bonus targets.
Our achievements in this area have resulted in a gradual reduction in working capital levels over recent years, from 16.2% of net sales value (NSV) in 2002 to 7.3% in 2006 (fig 2). Looking towards 2007, we recognised that without greater focus, based the same percentage of TWC to NSV, the amount of TWC required would move from €190m to €215m based on sales growth of 15%. Instead of an increase of TWC by €25m, the project objective was to decrease TWC by €35m, an improvement of €60m.
Bearing in mind that it takes €2.95bn in sales to generate €440m cashflow, a €60m improvement in working capital equates to an additional €400m in additional sales.
An important part of the project was to implement a TWC governance model.
The conclusion to our evaluation was that reducing DWC would generate the cash we needed to finance capital expenditure, investment in research and development and acquisitions. Furthermore, maintaining a strong cash position with low TWC requirements was critical to preserving and enhancing the company’s competitive position.
As well as establishing short-term targets, we recognied that a long-term strategy for TWC reduction relied on a broad awareness of the need to minimise TWC requirements across the company and consistent tools and guidelines to promote best practices. As a project of this diversity had so many ‘touch points’ across the organisation, we needed senior management support to achieve visibility of the project and encourage the right behaviours. For example, reports of DWC progress were added to management meeting agendas. Local champions were nominated in different parts of the business to create the right mind set for reducing DWC alongside the need to achieve business growth and higher margin. These individuals then participated in a global DWC champions network to share experiences and best practices.
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As part of the project, we identified three key areas of focus to achieve our working capital objectives, each of which we will expand later in the article:
Firstly, reducing DSO (days sales outstanding) by shortening customer payment terms and reducing overdue balances.
Secondly, maintaining the same level of DIO (days inventory outstanding) by streamlining processes and introducing tighter service level agreements.
Thirdly, increasing DPO (days payable outstanding) by increasing payment terms to suppliers and focusing on indirect costs.
An important part of the project was to implement a TWC governance model to ensure that we had in place a pragmatic policy to sustain low levels of TWC in the future. The governance policy included internal guidelines to preserve our working capital position, but also to maintain fair relations with customers and suppliers such as:
* A global policy on factoring (see below)
* Maximum discounts offered to customers of a certain percentage of invoice value for payments received within a certain number of days
* Maximum cost-on amount for suppliers of a certain percentage of invoice value for payments made within a certain number of days
* The stipulation for timely payment
As part of our initiative to reduce DSO, we recognised the need for sustained focus, similar alignment across the organisation and transparent, consistent information. As well as implementing strategic and tactical improvements in DSO management, we developed a clear understanding of DSO by country, internal organisation and issues. We conducted a detailed review of our customer base and were therefore in a position to implement a detailed action plan based on our customer needs and issues we had experienced in different regions.
Measuring the success of out endeavours was a significant element in emphasising the value of the project to senior management.
Establishing the right organisation and incentivising the individuals who could deliver TWC targets was key, and some of the best practices we implemented included:
One of the reasons for overdue amounts was customer claims or queries on invoices, which led to invoice payments being postponed. We reduced the complexity of our invoicing system to limit the number of queries, and therefore the number of overdue invoices. We also controlled overdue amounts more proactively by keeping closer contact with customers to identify issues earlier in the invoice period. Wherever possible, we tried to move to more predictable payment methods, such as direct debits, to simplify the collection and reconciliation process. These were important initiatives to improve the predictability of collections as well as the actual amount of overdue invoices outstanding.
While aiming to reduce DSO, we also wanted to maintain good relationships with customers and ensure that Numico remained their business partner of choice. We implemented a more integrated way of negotiating payment terms with customers, such as understanding the global, rather than regional picture with each customer, as the premise to embarking on discussions on payment terms. It was important to identify the right time for negotiating terms, which could be during annual pricing discussions or at another time depending on when finance director and customer logistic involvement can be leveraged most effectively. Invoice discounting also adds to the unpredictability of cash flow, so we looked at more strategic ways of incentivising customers, such as year end rebates rather than invoice discounting. There were also tactical changes we could make, such as arranging with distributors that order placement should be at the beginning rather than the end of the month, and payment terms linked to the invoice date rather than a fixed date. [[[PAGE]]]
Measuring the success of our endeavours was a significant element in emphasising the value of the project to senior management, and allowing us to refine our plans to ensure the maximum benefit to the organisation. Some of the information we produced included:
The second issue which the working capital project aimed to address was minimising the amount of cash tied up in inventory between the point of production and delivery to customers, whilst ensuring that supply and service to customers was not interrupted. It was important to focus our attention not on the actual amount of inventory, but the process for determining inventory levels.
Inventory exists for a variety of reasons:
We implemented various ways of aligning our supply and demand cycles with a view to maintaining the same level of inventory despite business growth. Firstly, we implemented a Service Framework. The aim of this was to achieve formal agreement and a standardised approach between supply points and sales units. It takes into account the demand and supply planning process, shipping and receiving process and the inventory management process for both unfinished (raw, pack, semi-finished) and finished product supply. It also includes escalation and reporting guidelines to provide visibility across the whole physical supply chain.
Secondly, we implemented a streamlining project to support DIO reduction. This had three watchwords: Simplicity, Speed and Sustainability:
Simplicity: the way in which demand is segmented (regular versus ad hoc) and an inventory management strategy.
Speed: Establishing a master production plan and ensuring that production processes were as reliable and flexible to changing demand as possible.
Sustainability: We wanted to establish procedures which would be robust through different business cycles and as new products were introduced. Part of this was to implement single-person accountability for new product introductions to ensure that these were incorporated as part of the master production plan.
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As part of our project, we wanted to achieve 90 day payment terms to our suppliers. Inevitably, this sort of initiative is unlikely to be popular, so it was important to approach suppliers in a collaborative way, focusing on how to address their concerns and secure our long-term relationship. Supplier financing was an important element in achieving this (see below) particularly to address cashflow and working capital concerns of smaller suppliers. As part of this process, we also made commitments to prompt payment, ensuring cashflow predictability for both Numico and our suppliers. We have achieved considerable success in extending payment terms, with payment terms to some suppliers extending to 120 days. Adopting a strategic approach to negotiating payment terms was key to the success of this initiative together with careful planning, based on our global relationship with each supplier.
Adopting a strategic approach to negotiating payment terms was key to the success of this initiative.
Preparation: Negotiating payment terms comprises both ‘carrot’ and ‘stick’. On the negative side, if Numico has less advantageous payment terms than competitors, we are effectively financing our competition. Furthermore, it is not in our interests if our suppliers provide less favourable payment terms than their competitors, and this could be a reason to change suppliers. On the other hand, it is important to Numico to build long-term relationships with our customers based on trust and mutual benefit. Therefore, we wanted to provide incentives to encourage improved payment terms. These include favoured supplier terms, such as working with these suppliers on new business initiatives and increasing the amount of business we provide to them as our business grows. We offer booster awards and a commitment to pay on time.
Communication: Having planned the best way of approaching each supplier, establishing an appropriate method of communication was important, as was selecting the timing of payment terms negotiations. This can vary depending on the supplier and could be at the point of initial contract negotiation, regular business reviews, annual price negotiations or at special meetings called for the purpose; the dependency in each case is choosing the time that Numico has the most leverage with the supplier. We found that this approach was particularly successful by adopting the same policies globally and engaging in a dialogue with the most senior personnel from the supplier company.
The final stage in the working capital project was to establish a centralised, consistent approach to factoring and supplier financing. During this phase of the project, Numico was taken over by Danone and this part of the project was put on hold, but the planned setup is described below.
We had had mixed experiences of factoring in the past. For example, there was a perception in some parts of the business that factoring is expensive, so some business units only did it at month-end to show positive balances. As factoring was undertaken at business unit level, factoring was time-consuming, there were inconsistencies in approach, the expected off-balance sheet treatment under IFRS was not always achieved and there were several legal agreements to be negotiated, reviewed and monitored. By moving to centralised factoring, we could establish a more attractive pan-European pricing arrangement at a competitive interest rate. We established a simple structure which was easy to maintain, did not require the issuance of securities or a special purpose vehicle (SPV) and allowed countries to be added over time. We planned to start with Italy and UK, with factored amounts of around €80m, with the ability to receive either 85% or 95% of the value of receivables (fig 3).
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In addition to factoring receivables, another element of the project was to establish central supplier financing to support our DPO objectives whilst bolstering our suppliers’ financial position which could otherwise present a risk to Numico. We planned to set up a central financing program with our primary suppliers, which means that suppliers sell core supplies on deferred payment terms. The sales relationship is not affected and it is an effective mechanism for managing our long-term, key supplier relationships. Using this mechanism, we have reduced working capital by extending payment terms to suppliers and we have centralised opportunities on the liability side of the balance sheet.
We consider supplier financing a 'win win' from both Numico's and our suppliers' perspectives.
We consider supplier financing a ‘win win’ from both Numico’s and our suppliers’ perspectives. For Numico, we can extend payment terms, while the supplier is paid on the same day or even earlier. We can leverage price discounts which suppliers provide for early payment and it improves working capital ratios and adds economic value. We are currently discussing with our banks and legal advisors whether supplier financing will appear as bank debt on the balance sheet, but supplier financing is now an important alternative source of financing.
For suppliers, cashflow and liquidity is improved by monetising receivables, improving DSO and working capital. This type of financing should appear off balance sheet and does not
require the use of their own credit facilities, so as with Numico, it is an important alternative source of financing. Documentation is straightforward, without the need for collateral or guarantees. Fig 4 outlines how supplier financing works in practice.
Establishing a centralised approach to financial supply chain management at Numico would have delivered substantial benefits at each stage of the process and along the whole value chain. With a central strategy to payables, receivables, inventory, factoring and supplier financing, we would have gained economies of scale which were not available when negotiating at business unit level. We would have the same business terms across all our subsidiaries, which improves control as well as being able to leverage our position more effectively with suppliers and building global relationships with customers.
Rather than having to maintain local skills and focus on working capital issues, expertise could be centralised within Treasury and the subsidiaries can concentrate more on their core business activities. Treasury is able to approach TWC systematically and by having an overview along the whole working capital cycle, we could forecast more effectively and ‘smooth’ working capital requirements and avoid payment or collection ‘spikes’ which increase the overall amount of working capital. Our cash management could be more strategic and we have achieved substantial reductions in working capital as well as business efficiency and creation of economic value.
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