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Calculum Inc
Our media pack is available for download and contains the Calculum logos and company information. If you’d like to receive our press releases, organise an interview, and collaborate on a content piece, please contact us.
Sooner or later, there comes a time every company needs to revisit and recast its working capital position. In most cases, that process is viewed as a ‘project’. This is in itself part of the reason why working capital as an embedded mindset is yet to take root across the corporate as a whole. Let us take a look at the pharmaceutical industry from a working capital perspective.
The pharma industry has witnessed a significant change during the Covid-19 pandemic. The pharma industry’s focus is on the fast release of medicines into the market to drive sales and revenue. As essential as a revenue-driven strategy is; it can also precipitate less focus on managing working capital. However, times have changed, and the spotlight has moved firmly on the effective management of working capital to secure investment, funding for growth, and gain competitive advantage.
Over the past five years, the pharma industry’s net working capital has grown 31.4% to approximately 26% of sales. This amount of working capital could have funded approximately one-third of the total Capex (US $181 billion) during the same period according to recent research. In addition, according to estimates by PWC, as of December 2020, the industry had 6% less capital that could be directed toward M&A versus 2019, and finding enough firepower to fuel new growth may become increasingly challenging.
In simple terms, that is an enormous amount of working capital tied up in upstream and downstream relationships that limit the ability to apply capital for opportunities to fund and challenges to overcome. The above-mentioned insights highlight the significance of working capital management. This article further highlights this importance along with some additional observations.
The pandemic has cemented the criticality of supply chains as well as affirming that whilst supply chains are not always this chaotic they are not necessarily permanently benign and balanced either. Every major industry, pharma included, is facing supply chain disruptions.
This time it is clear that supply chains are in a permanent flux to varying degrees. This necessitates the application of real-time data such that this flux can be measured, managed, and mitigated, as the case may be.
Combining the present supply chain discombobulation with the growing focus on ESG (Environmental, Social, and Governance), sustainability, and supply security it is clear that working capital as a strategic and logistical exercise needs a ground-up reconstruction.
It is eminently feasible to state that optimizing working capital can flow into and underpin the focus on ESG, supply chain resiliency, and in some cases, surmount the current suite of challenges.
With all these variables feeding into the commercial relationship between buyer and supplier, the term ‘optimized’ when used in a working capital sense needs to be recast to convey the term as meaning the best possible and balanced outcome for all participants taking into account the current backdrop.
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Sustainability stands as an important requirement of every industry, especially pharmaceuticals to ensure future growth and the ability to cater to the changing conditions around safe, sustainably sourced medicines. At first glance, working capital management doesn’t appear to have much of a direct influence on sustainability. However, as per recent research on 136 publicly-listed manufacturing firms, working capital management has a direct impact on the profitability of the business. This profitability, in return, holds a direct influence on sustainability.
Therefore, by managing working capital efficiently, the pharma industry can attain profitable growth while attaining sustainable supported growth, too.
Working capital management is more of a mindset than a strategy. It requires a change in the way daily operations are executed. It is not enough that the CEO or CFO articulates a focus on working capital, either driven by balance sheet metrics and/or as a lever to drive ESG processes. It will not happen until every member of the organization has skin in the game to successfully implement working capital strategies.
The grassroots mindset is necessary because working capital management incorporates payables, receivables, inventory, as well as data management and IT, where each department has its primary commercial objectives front and center.
Working capital mindset varies by industry and company and it needs to spread beyond treasury, procurement, and the C suite. Crucially, for this mindset to permeate the use of digital data, analytics, and tools that educate around working capital must now become mandatory for working capital to be part of the furniture in all commercial undertakings.
Research based on the healthcare and pharma organizations in the S&P Global 1200 Index holding a market capitalization of more than US$ 10 billion unveils different sorts of pressures faced by pharma industries and their different cash conversion cycle (CCC) development in the market.
In general, the cash-to-cash cycle expanded in 2020 in the pharma sector, with higher inventory held by companies in Europe and North America, increasing working capital requirements as underpinned by higher Days Inventory Outstanding (DIO) of four and two days.
On the other hand, in the Asia Pacific, research shows Days Sales Outstanding (DSO) increased by nine days with longer payment terms affecting negatively working capital in the pharmaceutical industry.
One of the key metrics measuring working capital efficiency is days payables outstanding (DPO), which can offer important benefits when managing effectively. DPO measures the time a company takes to pay its invoices. The higher the DPO, the more advantageous it is for organizations in reducing their working capital. Sourcing and procurement organizations can achieve improvement in DPO by optimizing payment terms with suppliers. The average DPO of the pharma industry is quite low, compared to other industries. For instance, the DPO of the pharma industry in North America is 22 days compared to the Asia Pacific region and Europe, where it is 34 days.
Some issues affecting DPO are not unique to pharmaceuticals. However, many are systemic in the pharma sector and result in low working capital performance. These include:
More specifically, for strategic spending, the focus should be on ensuring the security of supply, innovation, access to exclusive technology, and strategic collaboration. For tactical spend categories, organizations should focus on optimizing payment terms by leveraging buying power.
By optimizing payment terms with suppliers, pharma companies can hold onto the cash for a longer period and this cash can be utilized for growth such as new R&D initiatives.
For pharma to take advantage of the available cash trapped in their supply chains they will need to focus on their working capital management. Deprioritizing the significance of working capital only kicks the can down the road and the difficulty in addressing working capital shortages amplifies over time. When inevitable systemic shocks occur is not the time to get a working capital focus. Having systems and tools in place that create an everyday working capital focus is how to be ready for when commercial headwinds appear.
One consequence of the deteriorating economic outlook is that the impact of holding excess working capital could be amplified by increased interest rates in the future. Interest rates are a key factor in overall economic growth and working-capital performance. Interest rates heavily influence businesses’ cost of capital, which in turn amplifies the impact of excess working capital. With the upcoming rate increases, working capital efficiency will again be in the spotlight.
Corporates used to a benign working capital of the last decade need to refocus on capital efficiency once again and seize the opportunity to move away from project-managed working capital approaches and inculcate the mindset of working capital as an everyday process.
Intrinsic to how working capital is identified and released is the alignment between both procurement and treasury to optimize working capital, leveraging digital data insights and analytics to look across the entire supply chain to improve on working capital metrics.
