A generic framework for working capital models in the value chain

The third research question of the thesis was related to the categorization of different working capital models, and it was studied in Publications V and VI. The papers concentrate on developing a way to analyze working capital models in the value chains, and finally, on a framework of generic working capital models. This research question was motivated by the finding of similar working capital models in different industries, which indicated of a possibility to develop a generic approach to working capital models.

Additionally, it was found that there is a need for a tool which would enable the analysis of working capital positions between the companies in the value chains and value chain stages, as well as provide the possibility to have a holistic view on the working capital models consisting of both, the material and financial flow of working capital. Publication V takes an initial step towards working capital model definition by introducing a working capital management (WCM) matrix. Publication VI uses this matrix to define a framework for working capital models.

4.4 A generic framework for working capital models in the value chain 79 Publication V

Publication V studied working capital models in the automotive industry in 2006–2015.

In this chapter, the focus is on the WCM matrix introduced in the paper. The positions of the 41 automotive companies in the WCM matrix were analyzed. The paper also studied and compared the cycle times of working capital in the years 2006–2010 and 2011–2015.

The results of this analysis were presented in chapter 4.1, and the identified working capital models were presented in chapter 4.2.

The construction of the WCM matrix started with the idea of combining the observation on the material and financial flows of working capital in the same picture. In earlier literature of working capital, these two flows have been separated under two research streams, finance and operations management. In the matrix, the Y-axis presents the material flow of working capital, measured by the cycle time of inventories (DIO). The X-axis illustrates the financial flows of working capital by net trade credit, i.e. the difference between the cycle times of trade credit components accounts receivable and accounts payable (DSO-DPO). The aim of the WCM matrix is to enable a holistic view on working capital as a whole. The WCM matrix was illustrated in Figure 7 in the research methodology section of this thesis.

In Publication V, different categories in the WCM matrix were outlined by the average figures of DIO and DSO-DPO of the sample, as the average is a commonly accepted classification method in statistical analysis. The limitations of this approach were recognized, and it was pointed out that border values may be quite different in different samples and in different industries. However, previous research on working capital management has not defined specific limits for “good” or “bad” DIO and DSO-DPO which could have been set as benchmark values in the WCM matrix.

In this paper, the WCM matrix was tested with the data from 41 automotive companies.

The matrix was used in three different contexts. First, the positions of the average value chain stages were analyzed. Second, all observations were placed in the matrix in order to analyze the emphasis of different working capital models in the value chain. Third, the working capital models were analyzed within the stages. The WCM matrix provides an opportunity to categorize companies on the basis of their working capital management performance. It enables the observation of how companies in the value chain are positioned against each other, and, for example, which companies hold inventories or finance others with trade credit. In this paper, companies were placed in four different categories. According to previous literature, the most beneficial option for the company is to have both cycle times as short as possible. On the contrary, the least desired option for the company is the category where both cycle times are long. This means that they hold more inventories than average companies, as well as finance customers with trade credit.

Publication VI

Publication VI studied working capital models in the context of three different industries:

automotive, pulp and paper, and ICT. The working capital models were analyzed with the WCM matrix and by cluster analysis. These results were reviewed in chapter 4.2. In this chapter, a generic framework for the working capital models proposed in the paper is introduced.

The construction of the framework was motivated by the finding that, regardless of the industry, all value chains seemed to have similar working capital models in use. The structure of the framework followed the structure of the WCM matrix introduced in Publication V: The Y-axis presents the effectiveness of the material flow with the cycle time of inventories (DIO), and the X-axis is formed by trade credit balance, i.e. net trade credit (DSO-DPO). The relevance of the choice of axes is also supported by the fact that inventories and trade credit are usually managed by separate functions in the companies.

The generic working capital models were based on the empirical findings from the analysis of the results in the matrix as well as the results of the complementary cluster analysis. The framework illustrated in Figure 19 concludes the findings and introduces six generic working capital models and one sub-model.

Figure 19. Generic framework for working capital models in Publication VI.

medium

DSO-DPO

DIO

high

high low

low medium

MATERIALFLOW (inventory efficiency)

FINANCIAL FLOW (trade credit balance) 0

Trade credit users

Aiming-at-minimum Inventory

holders

Financiers Moderates

Under-performers

4.4 A generic framework for working capital models in the value chain 81 Minimizers were found especially in the automotive and ICT industries, but some companies in the pulp and paper industry also operated with minimum working capital.

This working capital model is based on short cycle times, and negotiation power is required in order to have a low DSO-DPO. In other words, the payment terms with the customers need to be relatively short in comparison to the payment terms with the suppliers. This variable can even be negative. In this case, the company also applies the sub-model Trade credit users.

The Aiming-at-minimum working capital model was identified in the automotive industry in particular. The results indicated that several companies may have aimed at minimizing their working capital, but had not succeeded in achieving the lowest working capital levels in the value chain for one reason or another.

Moderates focused on operating with medium levels of DIO and DSO-DPO. The companies may not be willing to take risks and, therefore, they keep a certain level of inventories. The companies also do not take advantage of the value chain partners in terms of trade credit nor finance the value chain with exceptionally generous payment terms.

Moderates were identified especially in the pulp and paper industry, where the working capital models around the center of the WCM matrix were used the most.

Inventory holders were identified in all studied value chains. These companies carry large inventories or have a long production lead time that ties up working capital into work-in-progress inventories. The results showed that especially in the automotive and ICT industries, several inventory holders applied the sub-model Trade credit users. In the value chain context, it could mean that the suppliers holding the inventories are compensated with fast payments by customers.

Underperformers have large investments in working capital. They carry large inventories and finance the value chain or end customers with generous credit terms. Therefore, their CCCs are the longest in the value chain. The results showed, however, that this undesired working capital model was only applied occasionally.

Financiers were also found in all value chains. These companies have notable differences in their payment terms towards upstream and downstream, and therefore, an inefficient financial flow of working capital. By operating this way, they finance the other value chain partners or end customers.

Trade credit users, as an opposite to Financiers, take advantage of trade credit by having long payment terms towards suppliers in comparison to the payment terms towards customers. As discussed above, this can be used as a sub-model by Minimizers and Inventory holders. With efficient inventory management, Trade credit users may achieve a negative working capital.

Summary

The third research question dealt with the issue of how to analyze working capital models.

Publications V and VI contributed to this question. The development of the analysis method was two-fold. First, the WCM matrix was developed in order to be able to analyze both the material and financial flows of working capital, as well as all three working capital components, in one matrix. The matrix has two dimensions: inventory management and trade credit management. The WCM matrix combines all variables of the working capital model, and it was tested in different contexts and with different samples.

Publication VI finally concluded the findings of all publications of this thesis by providing a generic framework for working capital models. The framework is based on the WCM matrix, but the main contribution of the framework is the definition of six generic working capital models and one sub-model, which were identified on the basis of systematically analyzed empirical financial data: Minimizers, Aiming-at-minimum, Moderates, Inventory holders, Underperformers, Financiers, and Trade credit users. The generic working capital models were identified by analyzing the value chains in the automotive, ICT, and pulp and paper industries.

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