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Year: 2011

Working capital management in the Swiss chemical industry

Seeger, S; Locker, A; Jergen, C

Abstract: The performance of Swiss based chemical and pharmaceutical companies regarding their work-ing capital management and its underlying components, namely accounts receivable, inventories andaccounts payable differs over time and between the single firms. The calculation of a cash potential forthe year 2008 shows that 17 billion CHF is tied up in the companies’ balance sheets if they would realisethe Swiss best practice performance. It has also been shown that in recent years Swiss chemical andpharmaceutical companies have a considerably higher working capital level compared to their Europeanand US peers. The managerial implications for the achievement of best practice are the awareness of thetop management, efficient processes on the operating level as well as an enhanced collaboration withinthe company as well as throughout the entire supply chain.

Posted at the Zurich Open Repository and Archive, University of ZurichZORA URL: https://doi.org/10.5167/uzh-58453Published Version

Originally published at:Seeger, S; Locker, A; Jergen, C (2011). Working capital management in the Swiss chemical industry.Journal of Business Chemistry, 8(2):87-98.

https://doi.org/10.5167/uzh-58453


© 2011 Institute of Business Administration87Journal of Business Chemistry 2011 8 (2)

* Universität Zürich, Physikalisch Chemisches Institut,Winterthurerstrasse 190, CH-8057 Zürich,Switzerland, [email protected]

** Soltar AG, Eichstrasse 25, CH-8045 Zürich, [email protected]*** Universität Zürich, Physikalisch-Chemisches Institut,Winterthurerstrasse 190, CH-8057 Zürich

Switzerland

Stefan Seeger*, Alwin Locker** and Christian Jergen***

Practitioner’s SectionWorking capital management in the Swisschemical industry

daily operations and the short run funding needsof a company. Improvements within the workingcapital levels thus offer various benefits, likelower capital requirements and lower capitalcosts, but also optimized supply chains andoperational excellence. Eventually, these changeslead to higher profitability and to competitiveadvantages.

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The operating cycle is composed of the inventoryperiod and the accounts receivable period place(Ross et al., 2008). The inventory period is theaverage amount of time the inventory is held,whereas the receivables period is the averagenumber of days it takes from the sale of thegoods until the cash receipt from the customer.The accounts payable period, in turn, is theaverage time span between the purchase of theraw materials and the cash outflow to thesupplier.The difference between the operating cycle andthe accounts payable period is called the cashcycle. It is the time period it takes on averagefrom the cash outlay by the firm to the suppliersto the cash inflow from the customer. In otherwords, it shows the financing needs of acompany regarding the operating activities,since part of the inventory and accountsreceivable have to be financed by eitherborrowing money or holding a liquidity reserve(Farris and Hutchison, 2003). The amount of thisadditional financing depends on the length ofthe cash cycle: the longer the cash cycle is, thehigher are the capital requirements and viceversa (Boer, 1999). This is due to the fact thatthe longer a firm has to wait after the cashoutflow to the supplier to the cash inflow fromthe customer, the longer it has to finance theoperations through other sources.

Introduction

The performance of Swiss based chemical andpharmaceutical companies regarding their workingcapital management and its underlyingcomponents, namely accounts receivable, inventoriesand accounts payable differs over time and betweenthe single firms. The calculation of a cash potentialfor the year 2008 shows that 17 billion CHF is tiedup in the companies’ balance sheets if they wouldrealise the Swiss best practice performance. It hasalso been shown that in recent years Swiss chemicaland pharmaceutical companies have a considerablyhigher working capital level compared to theirEuropean and US peers. The managerial implicationsfor the achievement of best practice are theawareness of the top management, efficientprocesses on the operating level as well as anenhanced collaboration within the company as wellas throughout the entire supply chain.

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The chemical and pharmaceutical sectors arefacing significant changes: the ongoingconsolidation in the supplier, competitor andcustomer base, as well as the proceedingglobalization is posing numerous challenges.Moreover, the increasing price competition andrising feedstock prices bring margins underpressure and force the chemical andpharmaceutical firms to seek for ways to opposethose trends. Working capital optimizations offervarious opportunities, both in the short as wellas in the long run. The working capital mainlycomprises accounts receivable, inventories andaccounts payable. These three balance sheetentries are the immediate financial picture ofa company’s operating activities. At this pointthe relevance of the working capital becomesobvious: it lies at the interface between a firm’s

88© 2011 Institute of Business Administration Journal of Business Chemistry 2011 8 (2)

Stefan Seeger, Alwin Locker and Christian Jergen

whether a company is able to meet its currentlymaturing financial obligations by its currentlymaturing short-term assets, and hence examinea firm’s liquidity.

In order to incorporate the dynamic natureof a firm’s business the working capital ratiosand the cash cycle are becoming more popular(Losbichler and Rothböck, 2008). The DaysWorking Capital ratio (DWC, also called cashconversion cycle or cash-to-cash cycle) expressesthe cash cycle in terms of days, and is calculatedbased on the lengths of the underlying periods,which are depicted in Fig. 1.

The days sales outstanding ratio (DSO)converts the receivables period into days (Brealeyand Myers, 2005):

......Accounts Receivable..* 365 = Accounts Receivable

DSO = ........Sales ................................Average Daily Sales

The DSO measures how many days it takeson average from the sale of the goods until thecustomers pay their bills. A high DSO leads to alonger cash cycle, and hence also to higherworking capital levels.

The days inventory outstanding (DIO) denotesthe average time span in terms of days for agood to be purchased as raw material, convertedinto the finished good, and finally sold to thecustomer:

The connection between the operating activitiesand the financing needs of a company becomesmore obvious when considering its impacts onthe balance sheet. The length of the operatingcycle determines the actual inventory andaccounts receivables levels and henceconsiderably affects the amount of current assetswhich is held by the company. On the other hand,the length of the ac-counts payable period hasa substantial impact on the level of a firm’scurrent liabilities, namely the amount ofaccounts payable. The capital needs, with respectto the operating activities are finally determinedby taking the difference between the sum ofthe accounts receivable and the inventoriesminus the accounts payable. This difference iscalled the net working capital and correspondsto a company’s short run financing needs(Wagner and Locker, 2008).

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Various ratios can be used in order to evaluatea company’s short term assets and liabilities.Well-known examples are the liquidity ratioslike the current and the quick ratio (Volkart,2006). These ratios focus on a firm’s short-termsolvency, since they provide an indication of howwell the short-term liabilities are covered byshort-term assets. In other words, they indicate

Inventory Purchased

Inventory Sold

Inventory Period Accounts Receivable Period

Time

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Cash Paid toSupplier

Cash Received from Customer

Operating Activities

Cash Flows

Figure 1 Operating and cash cycle

Source: Own elaboration, based on Ross et al., 2008


Journal of Business Chemistry 2011 8 (2) © 2011 Institute of Business Administration 89

Inventory Outstanding and Days PayableOutstanding represent the metric for theassessment of accounts receivable, inventoriesand accounts payable, respectively. The DaysWorking Capital ratio is considered as measurefor the overall examination of the workingcapital levels, i.e. providing the collaborativeworking capital view. Year-end balance sheetentries have been used for the calculations ofall ratios.

The sample consists of 18 companies that arelisted at the SIX Swiss Exchange andheadquartered in Switzerland. Furthermore,firms were chosen according to the StandardIndustrial Classification (SIC) system: onlycorporations classified as Chemicals & AlliedProducts (SIC Code 2800) and its sub-segmentswere considered. Based on those requirements,the study includes the following eighteen firms:

Actelion Ltd., Bachem Holding AG, CibaAG (now part of BASF), Clariant AG, CPHChemie & Papier Holding AG, Dottikon ESHolding AG, Ems-Chemie Holding AG,Galenica AG, Givaudan SA, Gurit Holding AG,Lonza Group AG, Novartis AG, Quadrant AG,Roche Holding AG, Acino Holding AG(formerly Schweizerhall Holding AG), SiegfriedHolding AG, Sika AG, Syngenta AGOutliers (mainly start-up companies) have

been excluded in order to provide a moreaccurate view. 1 The five firms below are notconsidered for the survey:

Arpida AG, Basilea Pharmaceutica AG,Cytos Biotechnology AG, SantheraPharmaceuticals Holding AG, Speedel HoldingAGThe starting data, namely the year-end

figures of the accounts receivable, inventories,accounts payable, and sales, was taken from theTHOMSON REUTERS OneBanker data base. Theworking capital performance metrics are thuscalculated based on publicly available financialstatements issued by the companies. Althoughthe study focuses on firms headquartered inSwitzerland, the individual figures correspondto their respective global values.

values.

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There is no clear trend regarding receivablesperformance within the last eight years: theDays Sales Outstanding (DSO) median followeda very volatile path and there have been great

......Inventory..* 365 = Inventory .DIO = .....Sales ..............Average Daily Sales

The sum of the DSO and DIO result in theoperating cycle. Therefore, an increase in theseratios leads also to an increase in the cash cycle.

The day‘s payable outstanding (DPO)expresses the average number of days acompany waits until it pays its suppliers:

......Accounts Payable..* 365 = Accounts Payable.DPO= .............Sales .............. Average Daily Sales

Since the cash cycle is the difference betweenthe operating cycle and the payables period, anin-crease in the DPO results in a shorter cashcycle. Hence, the later the cash outflows to thesuppliers occur, the less capital is needed tofinance the operating activities of a company.

The Days Working Capital is calculated byputting these ratios together:

DWC = Days Sales Outstanding + Days Inventory Out....... ......standing – Days Payable Outstanding

The cash conversion cycle thus measures theaverage time span between the cash outflowfor the purchase of inventories and the cashinflow from the collection of receivables.

The importance of an efficient workingcapital management is confirmed by severalstudies (e.g. Jose et al., 1996 or Shin and Soenen,1998), which show that a shorter cash cycle leadsto higher profitability and rising share pricesthus, resulting in an increased enterprise value.

The working capital survey of the Swisschemical industry

The survey is aimed to reveal the workingcapital performance of Swiss based chemicaland pharmaceutical companies within recentyears. Moreover, general trends and peculiaritiesof the chemical sector are presented and thecorresponding drivers and causes are identified.In addition to this quantitative approach, aquestionnaire was forwarded to all investigatedcompanies in order to evaluate the awarenessand relevance of an efficient working capitalmanagement for the firms and the responsibleexecutives.

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The ratios Days Sales Outstanding, Days

1) Start-up companies usually are quickly expanding and have less constant sales volumes. Therefore, working capital levels and turnovers sometimes vary considerably from yearto year, and hence also the measured ratios (DSO, DIO, DPO and DWC). Furthermore, since those firms are growing very fast, the processes are not very harmonized and thus notsuited for comparisons with established companies.


Journal of Business Chemistry 2011 8 (2)© 2011 Institute of Business Administration 90

to a geographical shift of the customer base,mainly to Eastern European and Asian countries.That entailed changing customer relationshipsand threatened established supply chains.Probably, the management did not want toendanger those sensitive relationships by forcingstricter payment terms.

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A lean inventory leads to less tied-up capitaland less inventory costs. Therefore, a lower DaysInventory Outstanding (DIO) ratio leads to lesscapital requirements and higher profitability.The Days Inventory Outstanding (DIO) medianvalue has improved over the whole period by11%, since it has decreased by 7 days from 64days in 2001 down to 57 days in 2008. Despitethis respectable overall lowering in inventorylevels, the study results imply no constant andongoing improvements for the whole sector: infact, the DIO median has risen in years 2001 to2003, substantially declined in year 2004, buthas stayed almost unchanged until 2008.However, there has been a decrease of 3 days in2008, which at least shows a positive trend inthe recent past.

As mentioned above, the economy wasslowing down in years 2001 to 2004, and it islikely that this downturn has led to anoptimization within the inventories. Thecompanies reduced its stocks in the light of

fluctuations even between certain single years,as displayed in Fig. 2. Overall, the DSO medianhas deteriorated within the last eight years by5 days from 65 days in 2001 to 70 days in 2008.That corresponds to an increase of 8%.

The greatest increase occured during 2005,when the median went up by 19%, in accordancewith the fact three quarters of the firmsdisplayed a higher DSO value in 2005 comparedto 2004. In the light of this industry-widedeterioration, it seems that there existedexternal causes which put pressure on the entiresector. Actually, the economic circumstanceswere hard in the years 2000 to 2005: the Swisseconomy was suffering heavily from the impactsand aftermath of the Dotcom bubble. Therecovery of the economy in the third quarter of2005 is likely to be the cause of the rise in DSO.The chemical and pharmaceutical companieshave probably tried to achieve more sales volumeand to bind their customers by agreeing to lessrigorous payment terms and hence longerpayment periods.

The trends towards consolidation andglobalization supposedly are other factors thathave caused stagnating or even rising DSOfigures: the consolidation phase has led to biggercustomers in terms of sales volume. It is likelythat the power has shifted to the buyers andthat more pressure is put on the suppliers inorder to negotiate longer payment terms (Buddeet al., 2006). Moreover, the globalization has led

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Figure 2 Overview ratio evolution 2001 - 2008

Source: Thomson Reuters, based on publicly available financial statements



the inventory level with the daily sales, therelationship becomes apparent: only if the salesvolume increases equally to the inventory level,in relative terms, the DIO will stay the same.However, that not only requires a full shift ofthe higher costs to the customer, but also thesame sales volume in terms of units despite theprice increase. It is likely that most of thecompanies have not been able to fully pass onthose increases to their customers in the short-run.4 Therefore, the rise in feedstock prices mostprobably had a negative influence on theindustry’s inventory performance, except for theyear 2008. On the other hand, the considerablefall in the oil price in 2008 might partly havecaused the decreasing DIO figures for themedian.

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In contrast to the DSO and the DIO, a higherDays Payable Outstanding (DPO) ratio leads tolower net working capital levels. In other words:rising DPO ratios mean an improvement,whereas falling DPO ratios indicate deterioration.

The DPO median exhibits an overall upwardtrend, with a temporary downfall in the years2005 and 2006. Overall, it has increased by 5.5days or 22% from 24 days in 2001 up to 29 daysin 2008. In the year 2008 however, the medianagain has fallen by 2 days, which means anegative tendency for the recent past. Theeconomic circumstances seem to play animportant role also with regard to the payablesperformance. The median increases in years 2001to 2004, which leads to the assumption thatthe companies have stretched their accountspayable by later payments to their suppliers.This is in accordance with the fact that themedian has declined in 2005, when the economyexperienced an upturn. The median decreasedin 2008 after an increase in 2007. Since the rawmaterial prices have risen sharply in 2007 andthe first half of 2008, it is likely that thecompanies have recently focused on the pricerather than on the payment terms.

As mentioned above, the sector hasexperienced a consolidation and globalizationphase (Jakobi, 2001). Whereas those trends canthreaten the receivables performance, it alsoprovides chances regarding the payablesperformance. The increasing size of the firmswithin the chemical and phar-maceutical

decreasing sales and bad business prospects.That led to declining DIO values across the entireindustry. However, although the economyrecovered in the second half of 2005, the DIOmedian shows no considerable increase. Thecompanies obviously have been able to increasetheir sales by keeping the production lean. In2008, the decrease in the median might be againpartly due to the bad business outlook.

Furthermore, a study of the consultingcompany KPMG (KPMG, 2008) has stated thatmost of the improvements regarding theinventory management were most likelyachieved through a

“[…] continual investment in themanufacturing process to improve yields,remove bottlenecks and accelerate production.”

KPMG mentions in the same report that thecompanies have tried to transfer theresponsibility of the raw material inventory tothe suppliers. That happened for examplethrough the creation of consignment stocks2,and hence led to lower inventory levels in thefirms’ balance sheets.

The two main trends stated in the DSOchapter, consolidation and globalization, alsogive rise to new challenges with regard to theinventory management. Supply chains arebecoming more and more international, e.g.through the outsourcing of certain activities orthe global purchase of raw materials, resultingin a lengthening of the supply chains(Christopher, 2008). Moreover, new supply chainsarising from mergers and acquisitions have tobe developed and integrated.

Another impact on the inventoryperformance originated from the constantlyrising raw material prices, like crude oil, naturalgas and petrochemicals. Not surprisingly, thechemical industry suffered more from increasingoil prices than other industries. The high oildependency lies in the nature of the chemicaland pharmaceutical production: oil is the basisof virtually every organic product. A priceinflation in raw materials leads to higherinventory levels in monetary terms, because thesame amount of stock keeping units has a highervalue.3 The effect of the rising feedstock priceson the inventory performance, measured by theDIO, partly depends on a company’s ability topass on these higher costs to its customers,namely through price increases of the products(Ernst & Young, 2008). Since the DIO compares

2) Inventories held in a consignment stock belong to the supplier until the customer uses them. In other words, the stock legally belongs to the supplier, but it is held by thecustomer. The customer has the advantage that the stock is stored at the production site, but the inventories do not appear in its balance sheet.3) This is true for the raw material fraction of the inventory. The valuation of the WIP and finished goods may also depend on market prices.4) Since a firm’s negotiation position is enhanced when the raw material prices are staying at higher levels, it is more likely that the higher costs can be passed on to the customersin the long run. The effect on the inventory performance should therefore be mitigated in the long term.



industry, resulting from various mergers andacquisitions, increases the supplier’s dependencyon the customer, and leads to more power forthe buying firm with regard to the negotiationsof payment terms.

Nevertheless, the overall rise is probably alsopartially caused by the price inflation of the rawmaterials. The mechanism is the same as for theDIO ratio: the increasing feedstock prices leadto higher accounts payable. Since it is not likelythat the entire increase in raw material costshas been transferred to the customers, the risein DPO is probably partially caused by the risingfeedstock prices.

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The Days working capital (DWC) ratio is used asa measure of the overall working capitalmanage-ment performance. The DWC combinesthe values of the different working capitalcomponents (DSO, DIO, and DPO), and serves asa measure of a company’s net working capitallevel in general.The DWC median shows a clear downward trendwithin the last eight years and hence, theworking capital levels have been lowered overall.Since 2001, the industry’s median has decreasedby 17.5 days from 111 days in 2001 to 93.5 days in2008, an improvement of 16%. This is supportedby the fact that eleven firms out of eighteenexhibit a lower Days Working Capital ratio in2008 than in 2001.Since the collaborative working capital measureDWC is composed of the underlying components’ratios DSO, DIO and DPO, the DWC evolution isthe result of the evolution of the singleunderlying ratios. Hence, changes in DSO, DIOor DPO cause a change in DWC. As describedabove, the economic situation has a big influenceon the single components of the working capital.The same is true for the DWC median, whichhas decreased during the years 2001 to 2004,when the economic circumstances were difficult.It increased in 2004 when the economy wasrecovering, and declined again in the yearsafterwards. This connection implies that thefirms are focusing on working capitalmanagement in times of difficult economicconditions and somehow neglect an efficientworking capital structure in times of an upturn.Since it is harder to generate profits or obtaincredits when the economy is slowing down,companies try to run their businesses by internalfunding and improve the operating results

through even stricter cost reduction programs.On the other hand, the firms focus more onmarket share and gaining sales volume duringpromising economic outlooks, and hence setdifferent priorities, which leads to a losing focuson the cash cycle.However, the amounts of net working capitalhave been lowered again after the achievementof the new production level in the years 2006and 2007, when the firms have beenaccommodating with the new output level. In2008, the DWC median once more declinesconsiderably, as the economic forecasts becamepessimistic due to the starting financial crisis.It seems that the firms again tried to mitigatethat impact partly by improving their workingcapital balances.Other drivers for a general improvement withregard to the working capital emerge fromchanges of traditional business circumstances:especially the pharmaceutical sector hashistorically displayed high profit margins andstrong balance sheets, what usually has led toa comparably facile access to new funds (Sage2009). Furthermore, pharmaceutical companiestended to hold high safety stocks, since stock-outs of essential drugs lead to a bad image andthe loss of the customers’ trust. In the light ofthese circumstances, pharmaceutical companiestraditionally have operated with comparablyhigh working capital levels and have experiencedlow pressure for improvements within this area.However, that comfortable state has beenjeopardized in recent years by decreasingmargins, reduced growth opportunities and lessproductive outcomes in drug discoveries. Theseunfavorable developments have forced thepharmaceutical firms to seek for ways to opposethose trends.The picture is similar for the chemical industry,which is facing on one hand rising costs, mainlydue to the increase of the raw material prices(Budde et al., 2006). On the other hand, thechemical sec-tor experiences a permanent pricepressure, originating from increased competition,for example through the entrance of new, mostlyAsian players. Therefore, the chemical industryis struggling heavily with maintaining the actuallevel of return on investment (ROI). It is likelythat those external pressures have caused thecompanies to seek for new opportunities tocounter these negative trends. Since anoptimization of the working capital and itsrelated practices leads to higher access to cash5,lower costs, lower capital requirements and alsoto higher sales growth (Losbichler and Rothböck,

5) For example through a better access to credit and through earlier cash inflows.



focused on the entire sector. The working capitallevels for the individual companies are depictedin Fig. 3. In the DWC portfolio, the Days WorkingCapital (DWC) ratio in 2008 is compared to therelative change of the DWC since 2004. Theinterception of the axes is at the DWC medianof 2008, at 94 days, and at the median of thechanges since 2004, at -1.6%.

Therefore, companies lying in the firstquadrant have a high DWC ratio in 2008 andhave shown a change less than the industry’smedian within the last five years. In the oppositequadrant, the third one, firms within thatquadrant have a comparably low DWC value inthe year 2008, and have still been able to furtherreduce their accounts receivable relative to salesvolume. The second quadrant includescorporations that have a DWC lower than theindustry’s median in 2008, but which haveexperienced a change less than the medianwithin the last five years. Finally, companieswithin the fourth quadrant have a DWC whichis higher than the industry’s median in 2008,but those firms have reduced their DWC since2004 to a higher extent than the median value.

It becomes evident that Quadrant, Gurit, EmsChemie, Schweizerhall and Sika are not onlyamong the companies with the lowest DWC in

2008), it is likely that chemical andpharmaceutical firms have tried to takeadvantage of that leverage in recent years. Asmentioned above, the pharmaceutical sectorhistorically operates with high working capitallevels. It is therefore very likely that they havetried to enhance their performance throughleaner working capital practices.This conclusion is supported by a studyconcerning the life sciences industry carried outby the con-sulting firm Ernst & Young (Ernst &Young, 2009), which states that“within the last year (2008, note from theauthors), the number of initiatives launched bycom-panies to free up cash has risen sharply.”Last but not least, the further emergence anddevelopment of IT systems have enabledcompanies to improve their data managementand enhance their processes and planningaccuracies. Due to new and better possibilitiesarising from the progress in the informationtechnology, the companies are provided withtools for more accurate and resilient planningand controlling outcomes.

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The discussion of the results so far has

Galenica

Actelion

ClariantNovartis Givaudan

Lonza

CibaSikaSchweizerhall

QuadrantEms Chemie

Gurit Holding

Roche

SyngentaCPH Chemie & Papier

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Figure 3 DWC Portfolio: Current vs. past performance

Source: Own elaboration, based on publicly available financial statements* For Dottikon, the change since 2005 is considered, because it went public in 2005



compared to each other, but also to theperformance of chemical and pharmaceuticalfirms based in Europe and the US.

The median values for the different ratiosand regions are depicted in Fig. 4. It becomesapparent that the Swiss sector displays highermedian values than the European and the USsector for all the ratios and years, except for theDPO. With regard to the DSO median, the gapamounts to approx-imately 20 days to the USmedian and 10 days to the European median in2008. The difference be-tween the Swiss DIOmedian and the US median is 16 days, and 11days between the Swiss and the European one.The Swiss companies are only performing betterthan the US ones regarding the DPO median:the Swiss median lies 4 days above the US one,but is still 2 days lower than the European one.

The performances in the single components,especially with regard to the DSO and DIO ratios,lead also to a comparably high Days WorkingCapital median of 94 days in 2008. It is 19 dayshigher than the European median, and 21 dayshigher than the US median.

This comparison shows that Swiss basedcompanies are performing on a higher WorkingCapital level than their European and UScompetitors on a median basis. In fact, themedian Swiss company holds almost one fourthmore net working capital relative to the salesvolume than its US counterpart, and one fifthmore than its European counterpart. Hence,Swiss based companies are keeping considerablyhigher amounts of tied-up capital that is relatedto the working capital within their balancesheets. That in turn means that Swiss companiesare operating less efficiently than its foreigncompetitors with regard to their short-termassets and funds and that they could generatea higher shareholder value by adapting theworking capital practices of US and Europeanfirms (Losbichler and Rothböck, 2008).

Results of the questionnaire

In addition to the quantitative examinationof the working capital performance through theanalysis of the companies’ financial statements,a questionnaire was forwarded to each company(except for Ciba6 ) to obtain some qualitativedata. The aggregated results of that survey areintended to give a bigger picture of the relevanceof the working capital management for thefirms. Nine companies out of seventeenanswered the questionnaire.

2008, but show also the biggest improvementwithin the last five years. Bachem, Siegfried andDottikon, on the other hand, have high workingcapital levels relative to sales in 2008, and haveeven seen deterioration compared to 2004. Theyare thus located at the upper right side of theportfolio.

The amazingly great gap in DWC betweenthe companies in 2008 of 242 days reveals hugedifferences in working capital managementwithin the industry. The fact that ten out ofeighteen companies have been able to reducetheir working capital level in the last five yearsconfirms that it is possible to take advantageof the potential which is lying in the accountsreceivable, inventories and accounts payable.

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As shown above, the firms within thechemical sector hold different levels of workingcapital relative to their respective sales volume.By lowering those current assets or increasingthe short-term liabilities, companies can reducetheir capital and free up cash. The cash potentialis calculated by comparing the average networking capital to sales ratio of companieswithin the first quartile with the actual networking capital to sales ratio of the firms of theupper three quartiles. The companies in the firstquartile (in this case Quadrant, Galenica, Gurit,Schweizerhall and Sika) are taken as referencevalues and hence have no cash potential in thiscalculation. All other companies are comparedto the average of the 25% best performing firms,which amounts to 17.2% for the year 2008. Thedifference between a firm’s NWC to sales ratioand the benchmark taken from the first quartileresults in the company’s cash potential. It is thusthat amount of cash which would be freed upif the company reduced its NWC relative to salesto the average of the first quartile, instead ofholding the actual level. For the entire sector,the cash potential amounts to CHF 17 billion in2008, this is equal to 13.2% of annual sales ofthe companies in the upper three quartiles.

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Swiss chemical and pharmaceuticalcompanies are operating in a global environmentand hence are facing global competition. It istherefore reasonable that they are not only

6) Ciba has been acquired by BASF in 2008, and is fully integrated since April 2009.

95


© 2011 Institute of Business Administration Journal of Business Chemistry 2011 8 (2)

the other hand, the firms see a lower impact onthe profitability in the short-run, with an averagerating of 3.22 out of 5. This might reflect the factthat the actions taken for the improvement ofthe working capital first cause certain one-timecosts and the benefits of the reduction in theWC levels occur later, in the long-run.

Concerning the potential for improvements,the companies were asked to rate the differentlevels of potential again on a scale from 1 to 5.The higher the number in the rating, the higheris the potential seen by the companies.

With seven companies out of nine statingthat they see a potential of 3 and higher, mostof the firms detect opportunities forimprovements within the working capitalmanagement in general. Whereas the companiessee the highest potential in accounts receivableand inventories, with an average potential of4.25, the lowest potential is seen in accountspayable, with an average of 2.875, as depicted inFig. 6. This is consistent with the rating of theimportance of WCM shown in Fig. 5: the firmshave stated that WCM plays a more importantrole as an internal funding source than as anexternal funding source.

The analysis of the received answers showsthat the firms are well aware of the importanceand impact of the working capital managementon the overall performance. Furthermore, theworking capital management is seen as adecisive factor and an important driver of thecompany’s present and future performance.Some of the most distinct answers are presentedbelow.

As shown in Fig. 5, the general importanceof WCM for the success of the company isconsidered as relatively high with an averagerating of 4.29 on a scale ranging from 1 to 5, witha higher number representing higherimportance. The firms see the highest impacton the cash management: eight out of ninecompanies have stated that the WCM is veryimportant for the cash management. Thiscertainly makes sense, since changes within theworking capital directly influence the timing ofthe cash flows and hence a firm’s cash balance.

Another big influence is seen in theprofitability in the long run and the reductionof tied-up capital. Those two are closely relatedto each other, since (all other things being equal)less capital leads to a higher profitability. On

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35

DSO Global evolution DIO Global evolution

DWC Global evolutionDPO Global evolution

Figure 4 Chemical and pharmaceutical industry performance in Europe, the US and Switzerland

Source: Own elaboration, Swiss values are based on publicly available financial statements, US and European values arebased on REL/CFO Working Capital Survey 2009

96© 2011 Institute of Business Administration Journal of Business Chemistry 2011 8 (2)


5

4

3

2

1

0

4.89

4.29 4.22 4.12 4.00

3.22 3.222.86

Cash m

anagemen

t

In genera

l

Profit

ability i

n the l

ong run

Reducti

on of tied

-up ca

pital

Integra

l funding so

urce

Profit

ybilit

y in th

e short

run

Exte

rnal fu

nding source

Credit

rating

Figure 5 Importance of the WCM concerning different Issues

1= not important at all, 5 = very imortant

Figure 6 Opportunities for improvement

Source: own elaboration, based on answers given by companies

1= not important at all, 5 = very imortant

5

4

3

2

1

0

3.625

4.25 4.25

2.875

In genera

l

Invento

ries

Accounts

receiv

able

Accounts

payable

Source: own elaboration, based on answers given by companies

97


© 2011 Institute of Business Administration Journal of Business Chemistry 2011 8 (2)

this time, in contrast to the receivablesmanagement. The negotiating power can belevered through the building of a central hub,i.e. the centralization of all procurementactivities. This is especially important in thechemical and pharmaceutical industry, wherebusiness-to-business contacts are predominantwith regard to sourcing.

The inventories are the most complexelement of the working capital, and often requirethe greatest effort in order for optimization.Moreover, supply chains and correspondingprocesses may vary substantially between thedifferent firms. It is therefore difficult to providegeneral suggestions for all companies. Asuccessful strategy has to be developed withregard to the firm’s structure and in collaborationwith the responsible operations and sitemanagers, among others. Modern inventorymanagement is supported by advanced ITsystems, and different scenarios can besimulated with the aid of sophisticatedsimulation tools (Adams, 2008). However, thevolatility of the oil price, and hence of the rawmaterial and energy prices for the chemicalindustry, remains a challenge in the future. Leaninventory management thus is likely to gainfurther importance.

Besides the operational excellence, theinventory level also highly depends on thecollaboration within the company, and withinthe entire supply chain. The various involveddivisions within the company have to share theirinformation in order to optimize for instanceproduction schedules or safety stock levels.Decisions and strategies should be developedby integrating the sales, supply chain, productionand finance view. A holistic view of operatingdecisions and its consequences is more likely tosucceed in the long term. Interdisciplinary, cross-functional teams can be established to intensifythe integration.

In addition, the internal view has to beextended to the whole supply chain (Rafuse,1996). It is not sufficient to cooperate inside thecompany. Instead, collaboration throughout theentire supply chain should be aimed, which offersconsiderable opportunities and competitiveadvantages. True collaboration includes theexchange of information about current andfuture demand and supply levels, and theworking capital levels are intended to be loweredthroughout all members of the chain. Thereduction through better data exchange andenhanced communication is more sustainableand promises long-lasting benefits. Collaborationleads to more responsive and resilient supply

Managerial implications

The very basic prerequisite of everyoptimization within the working capital is themanagement’s awareness of the benefits arisingfrom the improvements and the correspondingwill to implement the necessary actions and toconduct the appropriate changes (Randall andFarris, 2009). The com-mitment is thus a crucialfactor in the implementation of the appropriateactivities. Moreover, also the time period of theimprovement process highly relies on thewillingness of the top management: the higherthe commitment and importance given by thetop level executives, the earlier reductions innet working capital occur. Besides being a toppriority at the upper level, it is essential thatthe responsible divisions and managers areinformed and instructed appropriately. The beststrategic decisions do not lead to the desiredoutcome if they are not implemented on theoperational level. Therefore good communicationis vital for the achievement of the set targets.

In addition, appropriate actions have to betaken in order to ensure improvements withinthe ac-counts receivable, inventories andaccounts payable. The launch of specificinitiatives with quantita-tive as well asqualitative objectives often is a good way tointroduce changes in the culture and businessprocesses. Every element provides its ownopportunities for an improvement, and requiresmore or less sophisticated strategies. With regardto the accounts receivable, the negotiation ofthe payment terms decisively influences thecollection period. Moreover, payment delays andfailures can be partly avoided by a profoundcredit analysis of the customer. Other importantissues are consistent monitoring and a strictdunning process. There are alternatives to theconventional handling of the receivables, likefactoring or credit insurance. However, thebenefits of the outsourcing or insurance haveto exceed its costs.

An efficient management of the accountspayable is based on a close monitoring of thepayment deadlines and potential tradediscounts. As long as no cash discount is offered,the cash outflow should be postponed until thedue date. There is no benefit of an earlier cashdisbursement, and hence the full credit periodshould be utilized. Cash discounts should beused, if the benefits from the cash receipt arebigger than the opportunity loss of the cashoutlay. Similar to the accounts receivable, thepayables level depends on the payment terms.Of course, a longer payment period is favored

chains and that in turn results in lower overallinventory requirements and higher efficiency.Therefore, a paradigm shift is required from aninternal optimization of the processes to theoptimization of the whole supply chain. In thelight of the ongoing consolidation andglobalization within the chemical andpharmaceutical industry, the supply chaincollaboration becomes an increasingly decisivevalue driver.

The collaboration does not only offer chancesfor an inventory optimization. Closer and moreintense relationships with customers andsuppliers may also enable a company to improveits accounts receivable and payable, andeventually to optimize the whole net workingcapital.

Last but not least, a consistent and ongoingmonitoring and controlling ensures sustainableim-provements, and can be supported andenhanced by a benchmarking analysis and theadaption of best practices.

Summary

The investigation of Swiss chemical andpharmaceutical companies regarding theirworking capital management has revealed thehuge potential which is lying in the managementof short term assets and liabilities. Furthermore,the considerable differences between the singlefirms show that an optimized working capitalmanagement may play an important role for afirm’s competitiveness. A successful workingcapital strategy relies on the commitment andawareness of the management and on efficientworking capital practices on the operative level.In addition, internal and external collaborationleads to more competitiveness, both for the firmas well as for the whole supply chain. Aconsistent and ongoing monitoring ensuressustainable improvements, and can be supportedand enhanced by a benchmarking analysis andthe adaption of best practices.

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