NCMM Executive Director Tom Stewart examines how middle market companies unnecessarily tie up their cash, and as a result, miss out on opportunities when they arise. Special guest Rob Tague, Managing Director, Transaction Services, Grant Thornton LLP.


Your company can produce a lot more cash than it does now. We'll tell you how.

Welcome to The Market That Moves America, a podcast from the National Center for the Middle Market, which will educate you about the challenges facing mid-sized companies, and help you take advantage of new opportunities.

Today's podcast is about cash. In particular, it's about the cash that middle market companies tie up unnecessarily. When they do that, they're less efficient, less profitable, and less able to take advantage of opportunities when they arise.

Welcome to The Market That Moves America. I'm Tom Stewart, the executive director of the National Center for the Middle Market at the Ohio State University Fisher College of Business. We're the nation's leading research center studying mid-sized companies, which account for a third of private sector employment and GDP, and the lion's share of economic growth. It is the market that moves America.

The National Center for the Middle Market is a partnership between Ohio State and SunTrust Banks, Grant Thornton LLP, and Cisco Systems. And with me today is a special guest, who is Rob Tague, managing director of Grant Thornton's Advisory Services practice. Welcome, Rob.

Thanks for having me, Tom. Appreciate it.

So at an earlier podcast, we talked about a surprising finding from a new National Center for the Middle Market report on working capital management. What we found is that 75% of executives say they are highly or very satisfied with how well they manage working capital, but that there are enormous differences-- 2 to 4x differences-- across all industries and across all revenue bands between the top performing companies-- those in the top 75% and the 75th percentile-- and the bottom quarter-- those in the 25th percentile-- enormous differences. So that satisfaction that they express is, well-- it's wrong.

And let me remind you about why this is important. Working capital is the money, the cash, the capital that you tie up in the ordinary course of business. It's money that a company uses. It's the float between payables and receivables. It's money tied up in inventory or in in-progress inventory that isn't yet sold.

I like to think of working capital sort of like the gas that's in your car, that's already in your car being used to operate it. And the difference between 2 and 4x in working capital management is like the difference between getting 15 miles to a gallon and 35 miles to a gallon, without any cost in performance. So it can really make a difference. And Rob, talk to me a little bit about how you see working capital making a difference for companies that you work with.

Sure. Well I think, as you had referred, you know, working capital is really all about the cash, right? So that to optimize your working capital levels will free up additional cash for your business so you can invest that in growth, product development, expansion opportunities, capital improvements. And I think that's really the focus that you need to have on working capital is really, how do I free up more cash, be more efficient so I can invest those dollars in other places than AP, AR inventory?

And it's a lot of cash, in many cases.

It can be, absolutely. Absolutely.

One of the things that we found in our study for the NCMM that Rob was very helpful in developing is that a company that really improves working capital management can often free up more cash in the course of a year than its annual revenues. It's an almost mind blowing fact. But it really can be a significant contribution to my ability to get more money to run my business or invest in growth.

That's correct. It really depends on, what type of industry are you in? Where are your dollars tied up? So if you have heavy capital requirements, heavy inventory, you're certainly going to have a lot more tied up.

If you think about payment terms, cash receipt terms you get from your customers, again, those vary widely between industries. So again, some industries have quick churn cycles. Other ones, you have to tie up a lot more money in inventory, longer lead times, and it takes longer to collect your cash.

So one of the mysteries to me in this study is why companies seem to be satisfied with, clearly-- with performance that's mediocre. And I was thinking, for example, that there are companies, mostly smaller companies, where they sort of take pride in writing a check to pay my bills the day the bill comes in. What's wrong with that?

Well, again, going back to the investment theme, it's, where do you want to spend your dollars? I think when you look at middle market, especially on the lower end, a lot of these are family-owned enterprises. A lot of those companies are run, as you had said, virtually like a checkbook. Cash comes in. If I have enough in the bank to pay my bills, let's get those vendors taken care of. And that's how I assess how am I doing in the business.

I think as those businesses grow and become more sophisticated, that gets to a point where you really have to focus more on the cycle of your cash and where it's flowing. How long is it tied up? Where do I lodge those dollars in inventory, et cetera? And I think you have to take a step back and begin to do further assessments of, where do I stand? Am I best in class?

And one of the challenges is, if I'm a middle market company, how do I compare myself? Many companies will compare year-over-year changes, and say, well, I've got, you know, higher or lower levels versus last year, so I'm doing pretty good. The key is to, again, step back and say, am I doing better than my competition? Am I doing better than the industry as a whole? And I think that's where you garner additional insights that will really vet out are you doing a good job or not.

So when you guys at Grant Thornton-- you're auditors, you're tax guys, you're also advisors-- when you guys go into a company to sort of do that kind of diagnostic, where do you start looking?

So we look at a number of different areas. I mean, we have a trifecta of initial points, which is people, process, technology. So we'll look at, from a people perspective, it's more about human capital. What are your resources? What are the levels of training? What's your culture like? Is it focused on cash?

Process really goes to, how do those people work the payables, the receivables, inventory? How can the processes be streamlined to bring down or bring in more efficiencies?

And then from a technology perspective, which is your tools, it's really, do you have the latest technology, the most efficient? A lot of these companies may be on systems that are antiquated, not as sophisticated systems, say, QuickBooks. They don't have the potential tools available for really high-level inventory management. It's really about, if I'm short, I'm going to order some materials. And those come in and then I produce my goods.

So what you're saying is, in a sense, at the lower end, particularly, companies have informal systems, pencil, paper, calculator, and an abacus that was good enough, or seems to be good enough to make sure I don't run out of cash this week or this month, but is not good enough to maximize the opportunity.

You know, I think it's all about enhancement, right? So these businesses have grown over the years. Again, they're always looking internally. How do I make things faster, cheaper, better? And they use those tools for working capital management as well.

I think what's hard to get your hands around is, you know, what else is out there? I don't know what I don't know. And I think that's where looking to outside advisers, benchmarking, looking at other KPIs, that can really be helpful for companies to identify where they have opportunities. And then they need to understand, how do I deploy the tools or other requirements to really achieve those results?

So I'm a $20 million manufacturer in Kansas City. How do I benchmark myself? What should I be doing to sort of see whether I'm up to the standards, up to the best or up to the best that I can be?

Yeah. That's a great question, because from a data perspective, a lot of that data is hard to come by. There's publicly available information for companies that are traded on the open markets. I think, from a size perspective, that can sometimes be misleading.

And a lot of the information really has to be specific to a subsegment of your industry, in addition to size.

So transistors are going to be different from capacitors, right?

Exactly. Exactly. And so one of the challenges is, how do I get that information? You may have other companies in your area, regionally, statewide, et cetera, that may share some of that information. Usually that's not available.

But for a firm like ours, we have access to certain databases that are proprietary, with a lot of middle market information, including our own clients, right? So we have visibility into, what are the typical KPIs, what are the typical levels of working capital management of our current clients, as well as access to these databases. So we get a general feel for where those targets should be.

In addition, in our day-to-day job, we're out visiting hundreds of companies every year to help them improve operations, so we see it firsthand. So we can combine the objective information available along with more subjective, visual cues, as we talk with the management, walk through the facility, et cetera.

So you mentioned the people part of this. And I guess one of the questions that I'm intrigued by is, how do you create, from the top of an organization all the way down to the shop floor or to a bookkeeper-- what does a culture of, a cash conscious culture, look like? And how do you help people who may not have an MBA understand what a cash culture looks like and pick it up and make it part of the way they work?

Yeah. So when we talk about the people side of things and the culture of the organization, it's really a journey, if you will. It's not like you snap your fingers and the whole culture of an organization changes. Again, it takes time to implement all these changes. When we talk about that culture of cash, there's a few critical points, right? The top of the house has to be bought in on it. So you think your CEO, your board, et cetera. They have to say, hey, this is really important, and we're going to push that down throughout the organization.

In addition, each department has to buy in as well. And I think where that really becomes important is if you really want to minimize working capital levels, there's more than the CEO and the accounting department involved. There has to be heavy collaboration. So if you think about payables, receivables, inventory, where do all those things touch the business?

So you know, you've got to sit down with operations and talk to them about their S&OP planning. You know, how often are you ordering product? What's your lead time? For the inventory you have in the back, how quickly is it going to be used? Have you done any analysis on it to say, hey, maybe we should scrap this inventory out, reduce levels of this inventory, talk about SKU rationalization?

It's really a combination of both the front office, which is the accounting function, purchasing, executive folks as well. And then you have to combine that with the operations and get a full buy-in throughout the organization for everyone that has an impact on those drivers.

And it's interesting because different departments, thinking about their own best interest, may miss the company's best interest. So if I'm running ops, if I'm running the factory floor, I want to make sure I never run out of parts. So it's sort of, I might think it's in my department's best interest to have a big stock room full of stuff, even though I've got six weeks worth of stuff in it.

I mean, it's like, my metaphor for this is, everybody's got a box of staples in the top drawer of his desk, and I don't know anybody who's ever not bought a new box of staples, unless he changed jobs, and then goes-- so you know, I sort of think there's this massive inventory of staples that we, in some sort of ideal world, we wouldn't have.

Yeah. That's exactly right. So once you look at all the drivers of the various departments, the front and back of the shop, then you have to take a look at, OK, well, how do I incentivize people, right? And so you need to have incentives or a bonus plan or some type of performance metrics that are, number one, objective. So can you measure them?

You need to record them consistently and share them, to say, are you getting better or are you backsliding? And it has to be linked to some type of reward program, whether that's your annual performance bonus, year-end bonus, quarterly bonus, year-over-year change or improvement bonus. But that should be a part of your overall compensation package.

So again, you look at, I've driven the concept through my culture. Everyone's aligned. They're having recurring meetings. I've set up the IT system so that my tools support it. I've got my KPIs that I measure. And then reward my people for improvement. And I think that's when you start to get to a full culture, as we talk about.

You know, we're having this conversation on the sidelines of the annual InterGrowth Convention of the Association for Corporate Growth, which is private equity firms. Private equity firms are masters of coming into a company and, among other things, working the working capital equation really hard. You've mentioned a bunch of really good points about culture, technology, and process. Are there some other tips that you've seen, from the way private equity firms work, that other people can pick up, or maybe that other people should say, that works for private equity, but it might not work for you?

Yeah. I think there's a number of different viewpoints or approaches. You know, we use heavy analytics, so we'll look at inventory detail. We'll look at shipping records and do analytics, or complete analytics, around inventory levels and when that inventory moves. I mentioned processes, which is, what are your procedures? What are the requirements for when do I pay, et cetera, terms? And then as we go to tools, we talked about the IT function. I think you really need to take a look at all of those various areas.

And there's different tools and tricks you can use, some of those analytical, some objective. And of course there's a lot of subjectivity as well. And I think that's where, again, having someone that's seen a few more companies or been around the block a bit more can bring some different perspectives. And we like to say, well, that's where the value-add of potentially bringing in a consultant might be helpful.

But if you're a smaller company-- and there's also other avenues available. You can look to really leverage folks that have come from other companies, other industries, to say, how did you do it at your company? And try to garner one or two points of value and deploy that in your company.

Let's wrap this up. Rob, if I can ask you to sort of paint two pictures, a before and after picture, a picture of a company that's doing fine but could do a lot better, and what can happen if it does a lot better. What options become available to me if I'm doing better at managing my working capital?

Yeah. So like, with a typical client that we'll see, we will do, as I had mentioned, some analytical detail or analysis around inventory metrics. We'll look at their S&OP process and really look to make those more efficient. That means they're having a quicker production time frame, requiring less inventory, reducing overall inventory levels. That frees up cash.

We might go in and look at the movement of specific products or line items and do a SKU rationalization. So again, it provides a more focused approach to the business.

And then we'll look at procedures, policies, technology around AP and AR. What's your staffing levels look like? How far can you stretch out your terms or pull them in? Are there other ways to negotiate better terms, both with the vendors and the customers, to again, free up cash?

And then once we have that bucket of excess cash, then we can say, OK, now we have this extra money. What are we going to do with it? And that's where we can go to a conversation about, OK. I've done SKU rationalization. I've reduced my inventory. I'm getting my money in faster, paying it out slower.

I can now use those resources who have more time, or my extra dollars, to go out and say, what new product should I develop? What new customers should I pursue? Do I add another extension on to my current production facility to meet up with demand?

It really allows you the opportunity to take a step back and say, I have cash to invest now. Where's the best place to put that? I have time available now. Where should I focus my resources? And it all goes towards a more strategic opportunity to grow the business, versus just running the business.

And which is a wonderful way of summarizing it-- an opportunity to grow the business, capital to grow the business, instead of just capital to run the business. And you can think about some things like, all right, if I reduce the amount of inventory I carry by a third, I reduce my inventory space by a third. Wow. There's my new office. Right? I mean, either that or I'm not renting so much.

I mean, so that's-- I mean, I can find, by freeing up working capital or tightening up working capital, I free up all kinds of other, sometimes literally, physical space. Or I don't need to borrow that money from the bank. I can fund my own acquisition or my own future investment from my going concern, my more profitable going concern business.

And again, to take advantage of the fact that we're here among a bunch of private equity people, if they come in and buy a company, they're going to get a lot of value out of that from working on working capital. Why shouldn't you get that for yourself? I mean, why shouldn't that be your reward? And by the way, if you ever do sell, it would probably increase the price at which you could sell anyway, so you'd get paid twice for the same thing.

So, Rob Tague from Grant Thornton, thank you very much for joining us. And thank you for listening to The Market That Moves America. Never miss a new episode. Subscribe to the podcast on iTunes, Stitcher, Google Play, or wherever fine podcasts can be found. And visit us, the National Center for the Middle Market, at middlemarketcenter.org. Thanks for listening.