The global recession has recently shone a spotlight on the way many companies in the Gulf Cooperation Council region manage their business. Before the economic downturn, there was a collective belief that growth would continue unabated and liquidity would be endlessly available. As a result, companies chased the top line while ignoring critical aspects of their cash flow and balance sheet, making sales under terms favorable to their customers but that undermined their own profitability. They took on debt from multiple sources to build factories, took stakes in other companies, covered finance charges and cut dividend checks to shareholders.
This approach to growth is akin to living on borrowed time. Liquidity issues bubbled beneath the surface while the economy was booming, but rose to the top when the global recession hit. Now, many GCC companies are in a full-fledged cash crunch. In Saudi Arabia, for instance, our analysis of 75 listed companies shows that more than 20 percent have a cash ratio of less than 0.1 as of the end of fiscal year 2008, putting those companies in a highly vulnerable position. In the United Arab Emirates, our analysis of 50 listed companies shows that more than 60 percent had a negative free cash flow in 2008, amounting to a cumulative shortfall of $11.1 billion.
As executives now prepare for an eventual economic recovery, they should get their house in order and free up cash by improving the management of their working capital, calibrating their asset base and rightsizing their capital structure. Beyond those quick tactical fixes, executives should use this period to adopt a change in philosophy in their approach to managing their business. They should synchronize the execution of all elements of their business strategy: adopting the appropriate financing approach, anticipating a buildup of operational capabilities and strengthening relationships with key stakeholders and suppliers. Companies that address these challenges now will be able to improve their cash position and move aggressively to seize the next wave of growth and strategic opportunities that present themselves.
Immediate action required
Managing the top line in isolation from cash flow and balance sheet considerations is clearly unsustainable. Companies don’t necessarily have to stop investing, but they do need to get their house in order in the short term by addressing three challenges through a series of quick tactical measures to free up and hoard cash.
• Improve management of working capital. GCC companies should take a more rigorous approach to accounts receivables, ensuring that every stage in the receivables process happens promptly, as well as offering discounts for early payment. They can overhaul their inventory management, eliminating redundant and obsolete inventory, even at a book loss, to save the cost of its handling, storage, and insurance. Finally, they can increase management accountability for cash flow, tying incentives to measures such as working capital over sales and interest coverage ratio.
• Improve asset utilization. Companies should consider deferring large capital investments and maintenance capital, or else introducing them in phases instead of all at once. They should also look into selling idle or under-utilized noncore investments to generate cash to reinvest in value-adding operations. Top companies go even further by continuously evaluating their portfolios in search of opportunities to create value with businesses that are worth more to a different owner or in a different form of ownership.
• Improve capital utilization. Companies should suspend or reduce dividend payments in the short term to save cash and help restore their balance sheets’ health. There will be no better time to find understanding investors and to convince them of the importance of keeping cash in the company. They should also work closely with their lenders to solve the short-term crunch, adjusting the terms of their loans and extending their maturities. They could also explore hybrid capital instruments to address short-term needs.
The long-term perspective
After executives explore these near-term fixes and take action to weather the immediate cash crunch, it is imperative that they begin to lay the groundwork for a more strategic approach to managing their companies’ financials. The day-to-day operations of many GCC businesses are governed by a patchwork of independent individuals, departments and business units. Strategy, operations and finance are often not coordinated, operating in silos, which is a recipe for unstable growth rather than sustainable market leadership. Tearing down those silos and fostering an environment of cooperation requires a fresh look at the way information is shared and decisions are made within the company. Ensuring that strategy decisions are subjected to rigorous due diligence and risk assessments will, in most cases, help companies steer clear of major financial harm.
Finance’s role in this reorganization is to design a clear financial strategy that takes into account the company’s operational capabilities and overall growth strategy, and aligns its capital structure, cash management and shareholder distributions. In this, finance becomes a business partner to the CEO and the board of directors, rather than a scorekeeper focused solely on accounting and financial reporting. As a business partner, the finance executive would revamp the relationship with investors. Strategically reviewing banking relationships can yield opportunities to foster closer ties by consolidating activities under a select few. On the equity side, finance executives could help reset shareholders’ expectations by communicating goals for total shareholder returns over a five to 10-year period.
Finally, GCC companies should focus on improving productivity across all areas of the business and instituting the right management incentives to maintain a high level of productivity. Most important, companies should not be shy when making significant changes to their operating mode — for example, introducing centralized purchasing or consolidating supply chain activities — to ensure a radical, competitive and sustainable change in cost position. Successful GCC companies will emerge from the downturn with a more competitive and sustainable cost structure than their competitors.
Ahmed Youssef is a principal at Booz & Company
