By Michael Stapleton
Woolworths was in the news the other day, amid reports it is standardising its supplier terms and extending a number of legacy creditors to 60-day payment terms. You can read the full article here.
A most curious plan
Why is Woolworths doing this, I wondered? Consider the Woolworths business model for a moment:
- The company gets paid at the point of sale (no debtors); and
- Its distribution centre system means it decides when and how much stock it buy (no unintended build up of inventory).
So, its working capital cycle is underpinned by very sound characteristics. Why then the need to take action?
What does Woolworths working capital cycle look like?
I decided to take a look at Woolworths’ working capital cycle. What I discovered was at the end of the first half of the 2015 financial year the company’s inventory was turning over on average every 39 days and trade payables were being paid on average every 35 days.
Fast forward a year to the end of the first half of the 2016 financial year and the company’s inventory turnover has slowed to an average of 43 days and trade payables were being paid more slowly – on average (also) every 43 days.
So it looks like Woolworths has been “normalising” their creditors for some time.
What is in it for them?
The slowing of trade payables by around eight days resulted in Woolworths retaining a little over $900 million dollars of cash.
For each extra day the company slows the payment process, it retains around $125 million of additional dollars. Clearly significant sums of money!
The Masters write down is not a “non-cash” item
And yet I still wondered, why are they doing this? It seems so unnecessary. They are a big company (ninth largest by market capitalisation on the Australian Securities Exchange), with a good credit rating and access to bank debt, public debt and equity markets.
We all know about Masters and although Woolworths will say the write-down associated with the hardware chain it took in the last half is a “non-cash” item, its actions clearly indicate there is a substantial cash impact. Think for a moment of the money spent in prior periods on premises, people, stock and advertising for which Woolworths will now not receive a return.
In addition, Woolworths’ gross margin is under pressure. I estimate it has fallen by 1.3% between the first half of FY15 and the first half of FY16. This equates to a $435 million dollar impact on its first half FY16 result.
The rub for small business
I think we can conclude that Woolworths are “sharing” its problems with their suppliers. It is fair to say this behaviour is not simply limited to them.
However, what are the lessons for the small business owner? I think there are several:
- First, it is imperative you build a business with a diversified group of customers of roughly equal importance. Over-reliance on a small number of significant customers will leave you vulnerable to the type of action reportedly being taken by Woolworths.
- Next, research your market. What are the payment terms of the businesses that will buy your product? For instance, if Woolworths is a natural buyer of your product, what do you know about Coles, Aldi or Metcash? Let me help you: Coles offers 30-day (from the end of month) terms and a really good, simple to use and cost-effective supplier finance facility. Aldi offers 33-day (from invoice date) terms and creates great relationships with their suppliers. Metcash has a convoluted system of discounts and rebates that requires a lot of effort to reconcile and complicates cash flow forecasting. Target those buyers who fit your business best first.
- Finally, make sure you fully understand the working capital cycle of your business, and have the ability to quantify what a change to payment terms by a major customer means to your business in dollars and cents.
I’d love to hear from anyone who is already a supplier to Woolworths. Have your payment terms been changed? Are they simply paying you more slowly than in the past? Do you know how much additional funding you will need to accommodated these changes? How do you plan to respond to these challenges? What help do you need?
Michael Stapleton is a Melbourne-based virtual CFO, helping owners of small but substantial businesses understand the drivers of their cashflow and make financially informed decisions. He is also an executive committee member of the Association of Virtual CFOs. This article was first published on LinkedIn.