This report takes a look back at working capital trends in Europe in 2023 as a way of informing what we can expect ahead in 2024. It also includes an overview of how businesses should respond to maximise their working capital optimisation.
High-level working capital numbers in Europe: 2019-2023
In 2022, the cash conversion cycle experienced an overall decrease from 65 days to 60. This was largely driven by a reduction in days receivable outstanding due to the effects of the pandemic wearing off and companies paying in a timelier manner.
However, numbers reported for 2023 performance indicate the opposite: in effect, the cash conversion cycle is on the rise in Europe, having increased by 4 days against 2022. This has been mainly due to a Days Inventory Outstanding (DIO) increase of 4.5 days, whilst Days payable outstanding (DPO) and Days Sales Outstanding (DSO) only slightly changed (see Figure 1).
In the last few years, the destabilisation of supply chains has triggered a risk averse behaviour where companies started stockpiling cash due to low trust in the market.
Figure 1: High-level working capital numbers 2019 - 2023
Source: Financial reports from 1,144 European companies that had published their 2022 results by May 2023; Efficio Analysis
Key elements impacting working capital performance
Inflation and raised interest rates have pushed companies to revise their priorities. There is a higher focus on cash reserves and prompt payment collection, and payment terms have tightened across most of industries. This more cautious attitude is also translating into increased inventory levels to make sure that deadlines are met and demands fulfilled.
In 2021, low interest rates enabled firms to cheaply fund the additional investment in inventories, but circumstances have changed since then, mostly due to expensive energy prices and the rising costs of raw materials and salary increases to retain key skills. In light of this unfavourable cost evolution, companies are still willing to increase inventory levels, but are now supporting this investment with cash from clients’ payments rather than debt, hence the general reduction in DSO.
As we anticipated in our 2022 report, the interest rate increases were bound to impact companies’ ability to fund working capital from the financial market. Therefore, companies that did not wait to address their weaknesses in working capital management were able to get through these uncertain times with a healthy balance sheet and a strong cash generation capability.
CCC and DxO (Days) Change per Sector: 2022 to 2023
This report examines shifts and trends in each working capital component: Days Payable Outstanding, Days Inventory Outstanding, and Days Sales Outstanding. The charts below present the CCC, DPO, DIO, and DSO data for different sectors, comparing these to 2022 figures. In the following chapters, we will review any notable movements in each working capital component across these sectors and examine key drivers causing these changes.
Deep-dive by CCC Component
Accounts Payables (DPO) continues to trend down
The overall DPO trend across Europe is generally stable, with some variation between different sectors.
In general, there is a push for reduced payment terms due to two main drivers:
- High interest rates
- Proposed new EU regulation and stricter local government laws
A new EU regulation has been proposed to tighten up the late payment regime across the EU. If approved in the EU parliament as currently proposed, the regulation will set a maximum of 30 days net for payment terms, introduce stricter enforcement measures, reduce the possibility of extending payment terms, and set a late payment interest at 8% above base rate.
This follows a series of payment terms restrictions published by local governments across Europe in recent years, which aim to prevent large corporations from forcing through more favourable payment conditions to the disadvantage of their counterparts.
Meanwhile, high interest rates are upping the pressure on companies, pushing them to chase debtors to pay earlier. In fact, more and more suppliers have been less willing to provide any sort of credit to their clients due to the perceived increase in risk. This shift for payables is in line with post-pandemic trends. During 2020 and 2021, payments were delayed without any renegotiation, with suppliers were basically financing clients during a challenging time as a result. With the return to normalcy (or a “new normal”), suppliers started demanding the reinstatement of payment terms of 2019 levels and chasing slow payers.
Similar dynamics have been observed across different industries. In Construction, the rising cost of raw materials and capacity constraints along the entire supply chain have put the industry under pressure. Companies have reduced their DPO in response, with better billing and collections processes lowering it to the lowest level since 2017. A similar trend has been seen in Transportation and Logistics where companies paid their suppliers quicker but offset this through better DSO, therefore strengthening their overall Working Capital position.
Inventory (DIO) increases as a result of supply chain disruptions
In 2022, DIO levels across 21 sectors increased by an average of 5 days, reflecting the recovery of supply chains after pandemic disruptions, with companies able to carry desired stock levels. Since then, ongoing geopolitical tensions and climatic conditions have led companies to stock up on inventories as a precautionary measure against potential disruptions. This trend is expected to persist in the foreseeable future.
Despite the anticipated DIO increases, three industries – Consumer Goods, Electronic Equipment, and Pharmaceuticals – stand out with significantly larger DIO increases of 15, 13, and 9 days respectively. Conversely, the Metals and Minerals sector exhibited a decrease of 5 days in their DIO.
The Consumer Goods and Electronic Equipment sectors witnessed a substantial DIO rise in response to increased consumer spending and rising inflation rates. This strategic increase aimed to ensure ample stock availability for sales and address the challenge of rising inflation rates by buying in bulk and in advance.
The Pharmaceuticals industry also recorded a significant increase in DIO as a response to disrupted medicine supplies from China, a dominant player in the industry. While long-term strategies involve reducing reliance on Chinese firms, short-term measures included building up inventory to mitigate potential disruptions.
The Metals and Minerals sector experienced a double-digit growth in 2021 and H1 2022, driven by heightened construction and infrastructure activities. Inventory levels rose in anticipation of sustained demand, peaking in 2021. Subsequently, dwindling activity levels in H2 2022 reduced DIO by five days, signifying a shift from the upward trend observed in 2021 and early 2022.
DSO: a tale of contrasts
Overall DSO improvement was modest (0.9 days vs 2022) – but this does not paint the full picture. 16 out of the 24 sectors analysed improved their performance, but this was largely offset by the deterioration of the remaining eight sectors. The biggest difference between these two groups appears to be related to free cash flow generated by the business profitability amidst supply chain disruptions.
Sectors related to commodity supply chains, such as Chemicals, Metal & Minerals and Oil & Gas, managed to command higher prices for their output in a scenario of increased demand, therefore generating a healthy cash flow from profits. This was reflected in an overall reduction of payment terms with clients (and suppliers on the DPO side), which likely returned to terms agreed prior to the Covid crisis.
On the other hand, sectors that rely on higher value-added processes and longer capital cycles such as Aerospace & Defence and Automotive seem to have struggled to drive profitability up in line with higher commodity prices. In these cases, we can see increased payment terms and delays in payments from end customers trying to compensate for their cash shortfalls from lower profits.
High interest rates have put pressure on indebted businesses
Looking at the last five years, revenue dipped during the pandemic but economic recovery meant revenue increased and surpassed pre-pandemic levels in 2023. Debt levels increased from 2019 to 2021 due to cheap interest rates; conversely, in the last two years, debt has remained flat or even dropped in certain industries, which indicates that companies’ profitability has improved. It is important to note that profitability is also dependent on companies’ equity levels and profit margins, which we would expect disrupted supply chains and increasing inflation rates to impact.
According to figure 4, 2021 saw the highest ratio of long-term debt compared to short-term debt. This is in line with high levels of borrowing across Europe to fund increased operational costs and working capital shortages during the pandemic. In the last 18 months (figure 5), interest rates have more than doubled, significantly increasing the cost of borrowing and encouraging companies to find other ways to fund themselves and reduce their total levels of debt.
Figure 4: Last five years' revenue and total debt evolution
Source: Financial reports from 1,050 European companies that had published their 2022 results by May 2023 and have debt records going back to 2018, hence we have the same sample across years; Efficio Analysis
Loan duration is expected to decrease, given less favourable interest rates and the wider trend of taking short-term loans. Therefore, we anticipate an increased ratio for short-term debt.
High interest rates mean cash is king again. With external sources of funding becoming more expensive, it is advisable to leverage internal sources of cash from working capital optimisation to improve the ROI.
Figure 5: Last 18 months' UK and EU interest rates
Source: Central Bank Interest rates https://countryeconomy.com/key-rates; Efficio Analysis
Working Capital in Europe: Looking ahead
Increased material prices, labour shortages, supply chain disruptions, higher interest rates, and geopolitical tensions are among the key challenges that businesses are currently facing. In times of uncertainty, it is easy to fall into the trap of bloated inventories as a buffer between instability and strong customer demand – but the risk of demand dropping off and therefore increasing the burden of debt is not one to take lightly.
Instead, we strongly urge businesses to build more agile supply chains.
From the Working Capital perspective, this means taking actions including:
- Re-visiting the inventory mix to get rid of slow movers and obsolete items. However, keep the stocks you need to satisfy the market demand and protect against supply chain disruptions.
- Reviewing payment terms strategy and policies towards both clients and suppliers, taking the latest market movements and upcoming government regulations into consideration.
- Continuously focussing on "no regrets” actions, such as proactive collection, risk management on the receivables side, and leveraging payment terms in every contract negotiation with suppliers to achieve optimal total cost.
Needless to say, a foundation of strong cross-functional coordination and improvements in internal processes are key to sustaining the results of these measures in the longer term.
We're here to help
At Efficio, our consultants help organisations increase their shareholder value and working capital management – not only by reducing costs through strategic sourcing initiatives but also by releasing cash through the optimisation of payables, receivables, and inventory. If you’d like to discuss working capital optimisation for your organisation, feel free to get in touch via our Working Capital service page.