Working Capital improves for Nordic companies

Working Capital offsets a drop in returns

Richard Hayes, Global Head of Working Capital Advisory at Nordea, says: “In this updated edition of our annual working capital study, one of the key findings of our research is that in contrast to the previous period of study margins have decreased, but working capital in relation to sales has continued to improve, though at a slower pace. With sales, margin and capital being the drivers for value creation (measured as Return on Capital Employed (ROCE)), the improvement in working capital has somewhat mitigated the fall in ROCE. However, large deviations were uncovered below the surface and there is a clear link between optimising net working capital and improving value creation.”

Return on Capital Employed decreased by 1.2%, from 8% to 6.8% over the analysed period from 2016 to 2019. The decrease in Return on Capital Employed is mainly explained by lower EBIT margins despite an overall growth in net sales during the period. With EBIT margins decreasing on an aggregated level companies have been able to improve working capital which has mitigated the decrease in ROCE. However, within the sample of companies in the study there are major differences between the best and worst performers as the average working capital level is 6% lower for companies improving working capital for each year over the analysed period from 2016 to 2019.

Net working capital to sales lowest for larger companies

Nordea’s Working Capital Study 2020 shows that large companies have a lower level of working capital compared to smaller companies. This might be explained by overall better conditions, such as size, bargaining power and perhaps by a greater focus on working capital in order to maintain a low level. However, the study also shows that some smaller companies are able to perform just as well as the large ones and succeed in continuously improving their working capital levels.

Richard adds: “The data confirms a clear link between size and working capital, with the larger the company, the smaller the ratio of working capital and the smaller the company, the larger the ratio of working capital. Also, companies improved on average Days Payables Outstanding (DPO) to a higher extent than Days Sales Outstanding (DSO) over the period of study. This conclusion holds true, if we look at data by industry, size or region. The findings suggest that it is easier for a company to extend payment terms towards suppliers rather than customers.”

Covid-19 makes an impact

When comparing 2020 second quarter results to 2019 second quarter, the study finds that Nordic companies have on averaged seen revenues decrease by 7%. In addition to revenues, operating profits are also lower, while net working capital levels are increasing. The increasing level of working capital is mainly caused by higher inventory levels in relation to sales.

Richard says: “The ongoing pandemic creates a very challenging and fluid environment for companies. This is accentuated by significant uncertainty about the anticipated economic recovery including if and when a rebound will occur and the ‘shape’ of the rebound (U, V, W etc). With this in mind we argue that working capital management is more import than ever as economic recovery requires cash and a sound balance sheet in order to grow sales and secure long-term competitiveness and value creation.”

“For these reasons Working Capital Management should be high on the strategic agenda for all companies and decision makers. Through our discussions with companies we have found that this is not always the case and so this report helps position the importance of working capital and how it can supports the strategic objectives of a company whilst offering a cost efficient source of financing,” concludes Richard.

For more information please write to Mathias at Mathias.Rasmussen@nordea.dk.