Poor management of working capital can lead to companies leaving cash in the ground
Sustained low commodity prices, and a focus shifting from capital project delivery to moving down the cost curve, have driven a sharp focus on cutting costs and improving productivity in the mining sector. However, many mining companies and individual sites are missing out on ‘easy money’ because of poor working capital management. A recent EY report, Make working capital work for you: Unlocking cash in the mining sector, shows that as a sector, the mining industry performs fairly poorly in managing working capital – essentially leaving ‘cash in the ground’. In a time of declining margins, a lower draw on working capital can be the competitive difference between success and failure.
EY’s Cash in the ground report analysed the working capital performance of 80 of the largest mining companies globally from 2007 to 2013. Given the increased attention on working capital since, the working capital performance of the largest 80 global mining companies has been analysed again using the latest publically reported financial information (year-end 31 December 2014). Against a backdrop of ongoing price and currency volatility, the sector’s overall cash-to-cash (C2C) position has improved by two per cent. However, these results were not sufficient to cancel out the three per cent deterioration in C2C over the previous two years.
In our analysis, the average C2C for the mining sector was 38 days (on a sales-weighted basis). Iron ore displays the lowest level (23 days) and platinum the highest (with C2C of 82 days). Comparing the findings between companies within each commodity group also shows wide variations in working capital performance. Copper, gold, aluminium and zinc stand in the middle and range from C2C of 39 to 52 days.
The improved working capital performance has been driven by improved performance in both receivables and payables (days sales outstanding down five per cent and days payables outstanding up two per cent), partly offset by a poor showing in inventory (days inventory on-hand up three per cent).
Current working capital performance between the commodity groups varies considerably. These gaps can be explained by the way different commodities are mined, processed and sold. Simply put, those commodities that have a ‘dig and ship’ value chain should have lowest working capital, and those with multiple refining and stockpile stages will typically have highest. There are also complex and not always fully understood trade-offs between cash, costs, delivery levels and risks. Given the need to maximise capacity utilisation and offset considerable logistics and supply chain constraints in the business, each company must take and manage these trade-offs.
There is also increasing recognition of the importance of working capital to its trading parties. Mining companies now realise that there is a finite amount of working capital risk they can transfer to smaller suppliers, and in particular there are many community and indigenous organisations that require short payment terms. We should also remember that payment terms for government payments and taxes are usually not negotiable.
Not surprisingly, large mining companies also have large suppliers. Major industrial organisations are also trying to maintain their returns through improved inventory and terms management. Large equipment, explosives, services and fuel businesses also have focused supply chain and commercial teams either trying to optimise working capital or ensure that the trade-off between working capital and price is included in negotiations. The lessons here are clear: there is often a first mover advantage and working capital is no longer just a finance problem.
Gaps can also arise from fundamental differences in the intensity of management focus on cash and the effectiveness of working capital management processes. However, evidence also suggests that the degree of management attention on cash and working capital tends to weaken when the profitability of operations rises. Conversely, now that profitability is weakening, boards and CEOs are attempting to use working capital improvements as a lower risk way of improving return on capital and dividends to deliver greater value to shareholders on a more sustainable basis.
Proactive miners have established centrally led programs and top-down targets to lower working capital, including:
- Using supply chain as a source of finance, with a number of global miners extending supplier payment terms or looking to implement supply chain finance products.
- Reconfiguring logistics and supply chains to make them leaner and more agile, and allow sharing of spares inventory across mining operations. In some instances, we’ve seen maintenance teams build up five years’ worth of spares to minimise production disruption, and they are now left with expensive stockpiles in remote locations which are expensive to redeploy.
- Extending supplier terms and implementing improved controls to drive compliance.
- Better integrated planning to enable linkage between mine output and agreed sales forecast to minimise risk of inventory build-up.
- Changing asset maintenance strategies to move away from life cycle, to condition or risk-based models.
- Taking a closer look at customer trade terms, order processing and delivery scheduling.
- Reducing work in progress stock piles that have historically been set aside due to grade or quality.
Going forward, we expect the working capital results to reveal even wider divergences in performance between commodity groups and individual companies based on the performance of the respective commodity prices. Reductions in capex programs (with some choosing to be more selective) will be another contributing factor, especially with miners taking a much more forensic look at sustaining capital, and the resulting impact in inventory spares.
Increasingly we expect to see the obligations of working capital improvements to cascade down to all operational levels. These operational layers will be the ones who can ultimately implement changes required to address some critical challenges, including:
- cultural change such that all employees who can influence working capital understand what they can do to better manage cash across inventory, receivables and payables
- understanding the true cost of working capital when considering input pricing, safety stock levels and customer terms
- reconfiguration of supply chains to better control and manage the purchase and deployment of inventory spares
- better insights from IT systems on the operational drivers of working capital, not just the financial outcomes.
EY’s analysis and experience in the sector confirms that miners who have taken an enterprise-led approach, combined with a bottom-up change management program focused on the frontline, have released cash flows totalling tens of billions of US dollars. Given that the aggregate levels of working capital in the sector amount to more than US$200B, there remains plenty of opportunity.
While local market or geographical factors and the length of the end-to-end processes for some commodities impact working capital, companies would benefit from comparing their own performance to that of peers and other commodities. For example, while work-in-progress inventory is often dependant on the commodity, value of spare parts versus replacement value of assets can be meaningfully compared across a wide range of asset intensive industries.
Process and system improvements are critical enablers; however, the biggest influence of change is changing the culture from the CEO and CFO down and for the employees to treat the business’ money as their own.
EY’s report Make working capital work for you: Unlocking cash in the mining sector, is available online at www.ey.com/mining.
The views expressed in this article are the views of the authors, not Ernst & Young. This article provides general information, does not constitute advice and should not be relied on as such. Professional advice should be sought prior to any action being taken in reliance on any of the information. Liability limited by a scheme approved under Professional Standards Legislation.
Image courtesy Glencore.
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