The importance of effective working capital management has become front and centre as companies globally look to tap internal sources of funding to manage the uncertainties presented by the COVID-19 crisis. While the full impact of the pandemic remains to be seen, it is paramount that companies look to improve their liquidity by adopting efficient working capital strategies in order to emerge from the crisis stronger.

J.P. Morgan's 2020 Working Capital Index report captures the key working capital trends of the S&P 1500 companies in the past year, when the global economy has endured extraordinary events including the trade tensions between the US and China, and the coronavirus outbreak that will undoubtedly have far-reaching impacts in the months and years ahead.

By providing an assessment of the working capital metrics dissected across industries, this report aims to deliver insights and benchmarks to help finance practitioners track and improve the working capital initiatives within their organisations.

Working Capital Index rose to its highest level in nine years in 2019

The Working Capital Index rose significantly in 2019, reaching its highest level in nine years during the first half of the year, as the uncertainties surrounding the US-China trade tensions prompted companies to hold more inventory to mitigate the impact from supply chain disruptions.

The moves by the US Federal Reserve to lower interest rates also supported working capital levels, as cheaper borrowing costs encouraged corporates to tap external sources over internal channels for funding.

Even as the trade tensions subsided in late 2019, the world faced a new uncertainty as the COVID-19 crisis, which unfolded in 2020, triggered the introduction of extensive measures by governments around the world to curtail movement and contain the virus. The policies have led to further supply chain disruptions and a collapse in consumer demand, particularly in transport and leisure-related industries, impacting company cash flows.

The ongoing challenges presented by the global trade disputes and the COVID-19 outbreak have put immense pressure on working capital levels of businesses worldwide. As organisations continue to grapple and adapt to the new normal, it’s important for treasurers not to lose sight of their working capital, as it can determine how quickly a company can rebound from the crisis.

Cash Index rose for the first time in four years in 2019

The Cash Index also rose in 2019 as companies shored up their cash buffers amid the US-China trade war, reversing four consecutive years of declines.

While cash levels remained relatively low during the first half of the year as the 2018 US tax cuts spurred companies to increase share buybacks and raise dividend payouts to shareholders, companies grew cautious in the second half of the year amid the growing macro-economic uncertainty and began bolstering their cash reserves. Going into 2020, the COVID-19 crisis has prompted companies to further strengthen their cash buffers to cushion the impact of the pandemic.

Treasurers typically seek to maintain an optimum level of cash to keep the company running during a regular business cycle. However, to cope with black swan events like COVID-19, it is critical that companies keep additional liquidity to manage contingencies.

Average Cash Conversion Cycle increased the most in nine years

The Cash Conversion Cycle (CCC) of S&P 1500 companies increased by 5.7 days on average in 2019 - the largest gain in nine years - largely due to rising inventory levels and the longer time taken to collect payments. Inventory levels (DIO) also reached nine-year highs, with companies carrying an average of 3.5 more days of inventory to alleviate supply chain shocks.

At the same time, companies began offering customers impacted by increased tariffs with better payment terms to help them adjust and adapt to the rise in levies, resulting in an average increase in DSO by 1.5 days.

Working capital management is a delicate balancing act due to its sensitivity to numerous external and internal forces. With the COVID-19 pandemic and risk of recession looming over the global economy, working capital management will likely become increasingly challenging and is a discipline that treasurers would need to prioritize during a crisis.

Majority of industries experienced deterioration of CCC

In terms of CCC performance across sectors, 16 out of 19 industries saw deterioration or longer CCCs. Companies within the pharmaceuticals, semiconductors, apparels and accessories industries experienced the biggest increases in their CCCs as they stockpiled on inventory and raw materials in preparation of further trade tariffs. The chemicals, utilities and consumer staples sectors showed the most improvement or biggest reductions in their CCCs.

Supply chains today are a complex ecosystem of suppliers and customers that share goods and information across the globe. It is important for companies to understand their own position and relationships with other players within the ecosystem to proactively manage any disruptions in the supply chain and mitigate impacts to working capital.

Nearly US$500bn estimated in potential working capital

There remains significant liquidity tied up in the supply chains across the S&P 1500 companies, as observed in the DSO, the DPO and the DIO metrics, as well as the cash levels within industries. 

Assuming every organisation improved its working capital and moved into the next performance quartile in their respective industries across the DSO, the DPO and the DIO metrics, an estimated US$497bn in working capital may have been released as of year-end 2019, up from US$460bn in 2018.

There remains significant capital trapped in the form of working capital that if released can become a vital source of additional liquidity for corporates to manage contingencies in the current crisis.