After surging to a 10-year high in 2020, the JP Morgan working capital index returned to pre-Covid levels in 2021, as a recovery in the global economy led to an increase in sales for global corporates.
JP Morgan launched the index, which tracks the average net working capital divided by sales values across the S&P 1500 companies, in 2019 to serve as an industry standard for companies to benchmark their working capital performances against peers.
The index uses 2011 as its base year. After peaking at 116.3 in 2020 as the Covid-19 crisis upended supply chains and stalled consumer demand worldwide, it sharply reversed course in 2021, improving by 11.2 points to reach the lowest level since 2014.
This, the bank’s researchers say, is due in large part to an average increase in sales of 20% over the year, which resulted in an average eight-day reduction in the time taken to convert inventory purchases into cash flows. “Supported by fiscal and monetary policy, the uplifted economic activity gave rise to higher-than-expected demand which meant corporates generated more sales, holding onto inventory for less time, reducing days inventory outstanding. Inventory reductions were also driven by supply-side disruptions like raw material shortages and logistic bottlenecks,” the report says.
The research also found cash levels amongst corporates reducing in 2021 compared to 2020 as companies began to deploy funds strategically after a period of cash preservation. Companies typically preserve their cash positions in times of crises or uncertainty to ensure ample liquidity.
“After the shocks experienced in the macro environment as a result of Covid-19, 2021 marked the transition from survival to revival of the global economy, supported by government stimulus, easy monetary policy and the rollout of effective vaccines around the world. As a result, we are seeing the working capital of corporates returning to pre-pandemic levels,” says Gourang Shah, JP Morgan’s global advisory head for payments and one of the report’s authors.
However, there is still much room for improvement: the report estimates that US$523bn of liquidity remained trapped within the supply chains of the S&P 1500 companies at the end of last year, up from US$507bn in 2020.
A closer look at the numbers also reveals sizeable differences in working capital performance between industrial sectors. While 68% of the S&P 1500 companies saw their cash conversion cycles (CCC) improve in 2021, the gap between leaders and laggards widened to 82 days as the pharmaceutical, apparel and accessories, and automotive sectors shortened their CCC by 33, 25 and 17 days respectively while the aerospace and defence, technology software and media sectors saw a lengthening in their CCC of two to three days.
This latest working capital index also explored how environmental, social and governance (ESG) risk ratings are impacting access to external financing across industries.
“ESG has become a key area of focus for corporates from a funding perspective as the extent to which they are perceived to be socially responsible is increasingly impacting their ability to access external sources of funding. We are seeing companies re-evaluating their business models, operations and supply chains to improve their ESG scores; oil and gas firms diversifying into renewable energy, automakers shifting to electric vehicles production, and metals and mining companies pivoting towards recycling are some clear examples,” says Shah.
While overall, the research paints a rosy picture of global balance sheet health, the index covers working capital performance in 2021, prior to the Russian invasion of Ukraine and its resultant impact on supply chains.
“In 2022, corporates will be navigating a new set of challenges such as high inflation, the impact of ongoing geopolitical tensions on supply chains and monetary tightening – all of which contribute to a volatile economic recovery,” Shah tells GTR. “With the learnings from the pandemic, we can expect companies to take a more proactive approach in responding to these risks, and focus on balance sheet discipline, working capital optimisation, cost management and resilience planning. The key for them will be striking an appropriate balance in response to all these risks in the short term and be operationally ready to capture longer-term growth opportunities.”
He adds that, as the impact of the pandemic wanes, corporates are increasingly looking for help to optimise their working capital, such as by using digital platforms and services. “JP Morgan is heavily invested in solutions that integrate financing, discounting and sustainability in core working capital processes for our clients, and we continue to roll out platforms and services that address digitisation needs for corporates in areas like suppliers and customer onboarding, digital payments, fraud management, electronic invoicing, virtual card payments, supply chain financing, reconciliation and reporting,” says Shah.
Thus far, 2022 has been characterised by a perfect storm of supply chain disruption, geopolitical tensions and quantitative tightening in response to inflation, which is at 40-year highs, the report says. JP Morgan predicts that while the working capital performance recovery will continue this year, it will be affected by near-term challenges including geopolitical tensions, high interest rates, inflation and tightening by central banks.