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REL Report Finds Evidence of Year-End Gamesmanship

Many large U.S. companies continue to try and “game the system” at year-end, artificially improving their balance sheets by manipulating receivables, payables and inventory, according to a new study from REL Consulting (of The Hackett Group Inc.)

The findings report that their efforts, which can range from deep discounting and extended payment terms on sales to simply “losing” supplier bills, do have a positive impact in Q4. But these companies pay a harsh price in Q1, when working capital performance bounces back to even worse levels than before.

“Rather than develop a strategy to drive sustainable working capital improvements, these companies play the same games each year, trying to pretty up their balance sheets to impress analysts and investors,” said Prathima Iddamsetty, Senior Manager, REL. “But like a rubber band stretched too far, they snap right back—and by the end of Q1 these companies are worse off than when they started. Their bad business practices may make them look good in the short-term, but they have a negative impact on the long-term bottom line.”

According to REL's research, which examined the working capital management performance of 979 of the largest publicly-traded companies in the U.S., nearly half of all companies in the study showed evidence of year-end gamesmanship. These companies improved working capital performance by 10 percent in Q4 2011, adding $52 billion to their balance sheets, or an average of $111 million per company. But in Q1 of 2012, these same companies saw working capital rebound dramatically, worsening by 11 percent, or $53 billion, an average of over $113 million per company.

Companies which play year-end games with working capital can get quite creative in their cash flow management approaches, according to REL’s research. To boost receivables, they often increase incentives for sales staff and extend payment terms to get companies to buy more. At the same time they strong-arm other customers into paying early. On the payables side, they take a wide range of actions that put tremendous strain on their supplier relationships. In many cases, they suddenly start finding discrepancies in supplier invoices, or other excuses to delay payment. Some simply tell suppliers “the check's in the mail” even if it isn't—or delay receipt of goods they have already ordered. To reduce inventory, these companies sometimes take the dramatic step of shipping orders early, regardless of when the customer has asked for them. In addition to all this, these same companies often keep their factories running at full capacity whether they need to or not, so they can claim higher operational efficiency and effectiveness.

REL's research also offered recommendations for how companies can avoid the trap of year-end gamesmanship and instead focus on sustainable working capital improvements. REL recommended that senior leadership make it clear that short-term practices designed to improve working capital performance will no longer be tolerated, and use an audit committee to monitor and track performance. Working capital management should be made a continuous process. Compensation structures should be realigned so that sales staff are rewarded based on the profitability of their sales and not just the revenue they generate. Finally, rolling targets should be used for working capital metrics, to discourage short-term thinking and encourage sustainable improvements.

Readers can download the research, with free registration at http://bit.ly/PqoobR.

This report is courtesy of The Hackett Group.

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