The Currency for Value

Restructuring measures are currently booming, often resulting from cash flow problems and triggered by the multiple crises of recent years, which have mercilessly exposed the weaknesses of existing business models. The strength of a business model is primarily reflected in a company’s market value, which is determined by expected future cash flows, and helps gauge if a company is heading in the right direction. Cash flow itself reflects a company’s ability to generate profits, invest in growth opportunities, and repay liabilities. Consequently, a strong cash flow position is crucial for financial health and adaptability to evolving market conditions, improving the company’s long-term prospects. Business decisions should therefore involve careful consideration of cash flow, an often underestimated but critical currency for growth.

Cash flow as key figure for value creation

Porsche Consulting’s analysis, focusing on the leading companies—ten from each sector—in industrial goods, consumer goods, and automotive supply in the West from 2018 to 2023, highlights the critical role of cash flow management. According to their annual reports^1-32, 80 percent of these companies consider cash flow a primary key performance indicator (KPI) for actual performance and future potential. Additionally, 90 percent set explicit cash flow targets as key financial objectives for the upcoming fiscal year. Consequently, integrating cash flow considerations alongside EBIT steering in strategic decision-making emphasizes the need to understand cash flow drivers and design effective value creation strategies.

Analyzing industrial goods, consumer goods, and automotive supplier industries reveals valuable insights into critical cash flow drivers, considering their distinct product types, value chain positions, market power, and profitability. Industrial goods companies sell capital goods, often custom-made and in small volumes. Consumer goods manufacturers produce items for end consumers, emphasizing shorter usage cycles and comparability across competitors. Automotive suppliers rely on a few key customers and global automotive trends. In the subsequent analysis, “cash flow” refers to free cash flow, defined as the sum of operating cash flow, thereby a short-term view on performance and challenges, and investing cash flow, a long-term view on liquidity and growth opportunities. From 2018, cash flow within these industries rose steadily, faced a sharp downturn during the COVID-19 crisis in 2021/2022, and recovered in 2023. The analysis points out that four steerable key drivers account for 60 percent of this cash flow evolution: 

1. Net Working Capital (NWC) (24 percent impact): NWC reflects a company’s short-term ability to convert revenues into cash and its tied-up capital. Lower NWC signifies more efficient capital utilization. 
2. Equity investments (19 percent): These influence short-term cash flow through investment activities and future cash flow through dividends from affiliates or synergies.
3. Operating cost (11 percent): Operating cost includes direct and indirect expenses (e.g., materials, administration). Employment dependency is particularly crucial in managing these costs.
4. Capital expenditures (Capex) (6 percent): Capex investments affect short- and long-term cash flow, e.g., by optimizing processes through new machinery. Efficient capital allocation minimizes unsuccessful investments and enhances financial performance.

The remaining cash flow developments are driven by sales revenues (13 percent capturing cash flow changes from changing sales quantities) and other factors (27 percent) such as pensions or tax payments.

Cash flow steering by industry leaders decoded

The ten leading industrial goods companies increased their cash flow from €1.7 to 3.7 billion by improving NWC, equity investments, and operating costs. To reduce NWC, six out of ten participated in supplier finance programs, accelerating revenue conversion into cash. Additionally, inventory management was a key focus for six out of ten companies given the industry’s typically high inventory levels. Positive cash flow was further driven by six of the examined companies reducing investment activities. Moreover, nine out of ten implemented cost-saving programs, lowering costs of goods sold (COGS) despite rising indirect costs. This contrasts with rising Capex investments, which six of the examined companies attribute primarily to sustainability measures. Future Capex increases are expected due to aging machinery and rising R&D expenses.

The ten leading companies in consumer goods increased their cash flows from €6.3 to 6.6 billion. NWC was the only contributor to positive cash flow, with half of the companies participating in supplier financing programs and improving payables management. On the other hand, only two of the companies were responsible for the average increase in equity investments. The majority faced cost pressures, as American companies dealt with raw material shortages and rising labor and energy costs, prompting seven out of ten companies to start cost-cutting measures. Capex spending increased slightly, primarily for capacity expansions due to rising demand.

In 2023, the ten leading automotive suppliers reversed their negative cash flow from €-0.6 to +0.6 billion the previous year by focusing on equity investments, NWC, and operating cost. With four out of ten reducing investments, equity investments emerged as the primary contributor to positive cash flow. Improved inventory strategies led to significant reductions in NWC for half of these companies. To cut operating costs, eight out of ten implemented cost-saving programs that have already begun to show promise. Capex increased mainly aiming towards enhancing automation and digital capabilities.

Value creation requires both short- and long-term measures

The analysis reveals that markets favor a balanced mix of short-term and long-term cash flow measures. Despite a 46 percent rise in cash flow from 2022 to 2023 across industries, investor skepticism regarding future growth has led to a 6 percent decrease in cash flow projections, diminishing market values. It is essential for companies to not only boost short-term cash flow, for example, by cutting working capital, but also to adopt long-term growth strategies, particularly through equity investments and Capex planning. While such investments may initially reduce cash flow, they promise substantial long-term increases. Hence, companies must adhere to a strategic plan for sustained long-term cash flow and value creation.

Creating sustainable value through a blend of growth strategies and cash flow measures

A balanced mix of cash flow measures incorporates all four key cash flow levers and aligns them with a strategic growth path to achieve both short- and long-term cash flow improvements. This approach establishes a road map for future growth, offering a compelling narrative for a company's value potential to investors. Properly executed, this strategy can lead to up to more than 100 percent cash flow enhancements while increasing profit according to our experience.

Effective NWC management is essential for ongoing cash flow improvements, presenting an opportunity to elevate cash. Therefore, companies should gauge the influence of NWC enhancements across their supply chain (e.g., with optimization of the production footprint, quality management improvement and orchestrated sales and operations planning). A well-structured NWC management harmonizes short- and long-term cash flow implications, freeing cash from operations early on and enabling impactful capital allocation.

Capex efficiency is crucial for future cash flow growth. Challenges such as global demand rises, transformation towards sustainability, or outdated and unreliable machinery call for judicious Capex spending. Effective spending of Capex funnels investments into the most promising opportunities, increases returns, and trims expenditures.

The balance in optimizing investment portfolios must immediately weigh against enduring cash effects. Immediate cash boosts can be achieved through divestitures or curbed investments, but overlooking worthwhile ventures might compromise long-term growth. Strategic portfolio management aligns investments with strategic goals, identifies potential acquisitions and divestments, and creates value beyond the sum of individual investments.

During prosperous times, companies often rack up direct and indirect costs without regularly reassessing them to increase efficiency. Increasing flexibility of the cost structure and routinely assessing them ensures expenses do not stay inflated during economic setbacks. Initiating a cost optimization program, which plans costs from scratch, increases cost driver transparency, identifies inefficiencies, strips unnecessary spending, and allocates resources with a future-oriented approach.

Learning from the best: an example from consumer goods

A large consumer goods company exemplifies successful cash flow steering, increasing its cash flow from €0.1 billion in the early 2000s to an average of €1.3 billion in recent years. Initially struggling with high costs, unprofitable products, and complex logistics, the company revamped its approach by focusing on profitable core products, capital expenditure efficiency, inventory reduction, and improved supplier terms. They also streamlined their investment portfolio by divesting non-core activities and adopting lean manufacturing, thus reducing operating costs from 99 percent to 71 percent of sales. This case illustrates how strategically employing cash flow levers promotes value creation.

It is evident that sustainable value creation transcends basic cash flow measures. For enduring success, it is imperative that operational steering be aligned with the company’s strategic direction. The subsequent cash flow steering necessitates a thorough comprehension of the determinants affecting cash flow and the impact of specific actions. Moreover, the establishment of definitive KPI objectives that resonate with the strategic plan, coupled with predetermined corrective actions for large deviations, is crucial. Therefore, the synergy of a lucid strategy and effective cash flow mechanisms is the cornerstone of unlocking a company’s full potential and fostering value creation. Utilizing free cash flow as the primary performance indicator, due to its close link to company value, enables a pragmatic approach to value-oriented management. The success of a transformation project, measured by the additional company value created, can be easily reported at any stage of the project and aligns precisely with how investors would evaluate the success of the transformation.