When performance is an issue,

executives focus mainly on the

income statement and cut costs.
But tight management of the
balance sheet often liberates more
cash, preserves a company’s options
and drives value for shareholders.

Right-sizing the balance sheet

By Michael C. Mankins, David Sweig and Mike Baxter

Michael C. Mankins is a partner in Bain & Company’s San Francisco office and
leads the firm’s Organization practice in the Americas. David Sweig is a Bain
partner in Chicago and a leader in Bain’s Corporate Renewal Group. Mike Baxter is
a partner in London and member of the firm’s Global Financial Services practice.

Copyright © 2010 Bain & Company, Inc. All rights reserved.

Content: Editorial team
Layout: Global Design
 Right-sizing the balance sheet

When the pressure fact, some measures designed to manage costs

can actually inflate the balance sheet, consum-
builds to improve ing cash and destroying value.
performance, most But a handful of high-performing companies
business leaders adopt pursue a more evenhanded approach to finan-
cial management. They manage the balance
measures that affect sheet as tightly and as assiduously as they
the income statement manage the P&L, and they reap outsized rewards
for their efforts. While these companies approach
They cut discretionary spending. They centralize it differently, they usually have six common
support functions. They lop off unnecessary imperatives (see Figure 1). The companies:
layers of management, eliminate low-value
projects and so on, all with an eye to “right- 1. Track the current deployment of capital
sizing” the cost structure. And of course they
do what they can to increase profitable sales. 2. Actively manage working capital

While all these efforts can boost results, they 3. Zero-base the capital budget
overlook one of the largest sources of value:
4. Liberate fixed capital
the balance sheet. Companies often hold far
more working capital than they need to. They
5. Consider alternative ownership models
make ill-timed or ill-advised capital investments.
They own unnecessary or unproductive fixed 6. Create processes and systems to prevent
assets. When management teams focus dis- “capital creep”
proportionately on the profit and loss state-
ment (P&L), they often miss those issues. In

Figure 1. The most effective companies use a six-step approach to cash and
capital management

• Implement disciplined processes— • Develop a grounded and integrated cash

establish procedures to prevent and capital forecast consistent with strategy
“capital creep” Cash and
6 capital
Processes
and protocols requirements
1

5
Working
• Explore new ownership New • Streamline working capital—
capital
models—shift capital to ownership workinprocess, finished
taxadvantaged owners models goods, customer advances
and holders
2

4
Capital
Fixed
expenditures
capital base 3

• Rightsize the installed capital base— • Zerobase the capital budget—

liberate capital from lowvalue projects “stress test” the amount and timing
and programs of planned capital expenditures

1
 Right-sizing the balance sheet

Measures like these typically free up significant Companywide, Deere’s return on invested
amounts of cash, which can then be redeployed capital (ROIC) rose from negative 5 percent
to generate the greatest returns. The result is in 2001 to nearly 40 percent in 2008.
increased shareholder value at a lower cost than
efforts focusing on the P&L alone. There is Without a visible balance sheet, operating man-
no magic here, just a different frame of refer- agers are encouraged to play the game of mak-
ence and a series of practical, well-honed dis- ing the best case for their business’s allocation
ciplines—disciplines that any company can use of capital—because once the allocation is made,
to improve its performance. the resources will carry no costs. Companies
with granular balance sheet information, in
1. Track the current deployment of capital, contrast, can assign appropriate capital costs to
mapping capital to each business, product, each unit and product, assess true performance
customer, geography and activity. and take appropriate action. When Northrop
Grumman began compiling detailed balance
Few companies track balance sheet information sheet data and assessing return on net assets
deeper than the company level. In our experi- (RONA) results, for instance, it found that
ence, fewer than 15 percent of CFOs from com- some areas of the company were “capital hogs”
panies in North America and Western Europe with low RONA. Senior executives were then
have routine visibility into the balance sheet of able to reduce capital use, drive profit improve-
any unit or area below a division. It seems the ments and de-emphasize units that weren’t
vast majority of CFOs have only a limited under- able to generate adequate return on capital.
standing of where their capital is currently
invested. And their managers can’t know the 2. Actively manage working capital, limiting the
true economic profitability of the products and resources tied up in funding other people’s
services for which they are responsible. businesses and using others’ money where
possible to fund your own.
John Deere is different. The big-equipment
manufacturer compiles detailed balance sheet Beginning in 2001, Deere mounted a multi-
information business by business, product by pronged attack on working capital. First it
product and plant by plant. “Granularity is honed its information technology systems, to
essential,” says former CFO Mike Mack, now the point where it had good, easily accessible
president of the company’s worldwide con- data on fill rates for each product by week and
struction and forestry division. So, he adds, are by SKU (stock-keeping unit). That allowed it
transparency and consistency. “We use the to shorten terms for dealers while giving them
same measures for every business everywhere confidence that the company could replace
in the world.” inventories fast enough to avoid lost sales.
Between 1998 and 2008, Deere tripled its
Once capital use is measured at that level, exec- sales but kept trade receivables flat, avoiding
utives can manage it closely. At Deere, every a $7 billion increase in working capital. The
division, product and plant in the company has company also took bold measures to reduce
what’s known as an “OROA line”—an annual work-in-process inventory. One drive-train
target for operating return on assets. Managers assembly line, for instance, cut production
have quickly learned what actions are required time over a four-year period from 44 days to
to hit their targets and have been remarkably just 6 days by modernizing production facilities
successful in boosting Deere’s performance. and introducing lean manufacturing techniques.

2
 Right-sizing the balance sheet

Cisco Systems is another company that focused depreciation while disadvantaged businesses
intensely on working capital. Earlier in the might get only 50 percent. The process allows
decade, the company improved days sales the company to fuel its growth without over-
outstanding every year for three years—“We investing in unattractive businesses.
were maniacal about collections,” says one exec-
utive. Inventory turns also improved, and the ITT also stretches out its capital plan when
company began tracking purchase commitments appropriate. During the recent downturn, the
closely to keep payables under tight control. company asked several of its businesses to
Cisco even began examining its customers’ reschedule their facilities and slow down orders
working capital levels. Bottlenecks in a cus- to prevent the buildup of excess inventory. ITT
tomer’s operations, the company found, often corporate management then held back half of
led to slow collections on the customer’s part the capital it had budgeted in order to ensure
and slow receivables for Cisco. Helping customers sufficient liquidity, pay down debt and reduce
fix their problems benefited both parties. borrowing costs. Thanks to such measures,
the company wound up with a stronger liquidity
3. Zero-base your capital budgets, setting an position than many of its peers and was able
implicit (or explicit) limit on capital expendi- to make more strategic investments.
tures based on the performance of the business.
One key to effective capital budgeting is to set
At most companies, of course, working capital targets for asset productivity. Like individuals,
represents a relatively small percentage of total capital should become more productive over
capital requirements. For the average company time. Yet many companies don’t have explicit
in the Standard & Poor’s 500, investments in capital productivity targets, and so they spend
fixed assets account for more than 40 percent more capital without requiring more output.
of total investments. Therefore, right-sizing the Companies such as Deere, in contrast, set
balance sheet requires companies to challenge explicit, granular productivity targets for their
conventional assumptions about fixed capital. assets and use these targets to reverse-engineer
ITT is a prime example of a company that does the appropriate level of capital expenditures
just that. for each business.

ITT develops detailed capital budgets by value 4. Liberate fixed capital, identifying low-hanging
center and by group. The company’s rule of fruit and redeploying your capital accordingly.
thumb is that any business should be able to
sustain its position by investing at a rate equal Many companies have paid so little attention
to 70 percent of depreciation. But ITT doesn’t to their balance sheets that 20 percent of their
assume that every business is entitled to that invested capital accounts for 100 percent or
much. And it doesn’t spread capital like peanut more of the company’s value. Even better-man-
butter across its various units, giving each a aged companies typically have their share of
proportionately equal amount. Instead it ana- unprofitable products, customers and businesses.
lyzes the strategic position of each business— The capital devoted to those areas is essentially
its market attractiveness and its ability to win— wasted, and liberating it can lead to significant
and applies differential targets for investment. value creation.
Thus highly advantaged businesses, those with
high ROIC and good growth prospects, might That’s why many companies—particularly those
receive investment at 90 percent or more of with new owners or those facing a cash crunch—

3
 Right-sizing the balance sheet

Allocate resources differentially based on the strategic position of each business

Assess each business

The allocation of scarce resources—
time, talent and money—should be High
distinctly unegalitarian, reflecting the Extend and Extend and
different strategic position of each protect protect
Identify roadmap
niche leadership: leadership position;
business in a company’s portfolio. to leadership
evaluate drive to full
or harvest
opportunities potential profit
Businesses that compete in attractive in broader market and growth
Market 
markets (top half of the matrix at attractiveness
right)—where the average player in Sustain segment
the market creates value—can support Manage for leadership; Sustain leadership;
cash to fund pursue attractive pursue attractive
more profitable investment than those adjacencies in adjacencies or
other priorities
that compete in unattractive markets. broader market or manage for cash
manage for cash
Likewise, businesses with strong
competitive positions (right side of Low

matrix at right) can support more Follower Leader in Leader in market

defensible
profitable investment than those with
segment
follower positions.
Competitive position—ability to win

Many companies employ simple

heuristics that take into account each
Set differential targets for each business
business’s strategic position in allocating
resources—capital, most notably.
Businesses with strong competitive Differential
positions in attractive markets are Metrics
Full
Balance
Roadmap Prep
Fix
based on Overall growth Har now
expected to grow their investment potential to for
strategic portfolio and vest or
base. Accordingly, capex in these growth leadership sale
position profit divest
businesses should be a multiple of
depreciation, margin targets should
be set higher than market averages
Revenue 1.5x 1x 2x .75x .75x
and revenue targets should also exceed 10%
growth mkt. mkt. mkt. mkt. mkt.
market rates. For follower businesses,
Econ
resources should be allocated more omic
selectively and performance ambitions Operating +50 +100 +0 +150 +200 profit
20%
margin % bps bps bps bps bps >0
should be more modest. Capex for
follower businesses should be set at
(or below) depreciation; margin targets Capex as %
95% >100% 100% >100% <80% <70%
should be set at or above market depreciation
averages, and revenue expectations
should be at or below the market.

4
 Right-sizing the balance sheet

go on “liquidity hunts” to identify underuti- just a few of the steps superior capital man-
lized capital that can be converted into cash. agers use to streamline the balance sheet. Over
Meatpacker Swift & Co. is an example. Beef time, the obsession with a lean and efficient
gross margins were negative at points during balance sheet encourages many executives to
2005 and 2006 due to declining herd sizes explore entirely new approaches to their busi-
and the continued closure of foreign markets ness. They essentially create a new business
as a result of the mad cow scare. With close to model, disaggregating the value chain and
$1 billion in debt and declining free cash flow, shifting fixed capital from their own balance
management became concerned about future sheets to those of advantaged owners.
liquidity squeezes and launched a balance sheet
review to find “trapped” capital that could be The classic example is Marriott, which recognized
redeployed. It sold its cow division, liquidated in the mid-1980s that its core business was
excess real estate, sold water rights in Colorado, managing hotels, not owning real estate. As a
tightened working capital and divested a distri- result, it began divesting its hotel properties,
bution business in Hawaii. Raising $60 million creating limited partnership arrangements
through these and other measures, the com- and selling them to tax-advantaged investors.
pany got out in front of a possible liquidity Companies in semiconductors, transportation
crunch, avoided problems and maintained and other industries have taken similar meas-
flexibility. Its owners eventually sold the com- ures more recently. A logistics company today,
pany in 2007 for a 20 percent return. for example, may own few warehouses or
trucks, and instead contract with companies
In companies that have never managed capital, or individuals who do. Such tactics enable
such as Yahoo! until just recently, executives businesses that would otherwise be capital-
may be unfamiliar with the balance sheet or intensive to generate higher returns and grow
the cost of holding unnecessary assets. Freeing more profitably.
up capital can entail a substantial change in
mindset—executives must rethink the way they 6. Establish processes and systems to avoid “capital
run their business. Assets that previously were creep,” putting procedures and protocols in place
considered essential for the company to own, to reinforce prudent balance sheet management.
such as data centers, can be outsourced, lib-
erating significant amounts of cash and reduc- If you talk to executives at companies known
ing long-term costs. Sometimes entire segments for their balance sheet management, you imme-
of the business can be outsourced—the search diately hear a different way of thinking. People
business to Microsoft, for example. That can regularly discuss balance sheet measures.
simultaneously reduce future capital invest- They’re aware of the cost of capital. That kind of
ments and provide customers with a more culture is typically reinforced by a host of policies
appealing offer. and systems that encourage managers to con-
tinue taking the balance sheet into account
5. Consider new ownership models, pursuing in their day-to-day running of the business.
strategies that allow your business to own
fewer assets or seeking third parties to own One such policy—a powerful one—is to reward
your assets for you. managers for hitting balance sheet targets, just
as most are already rewarded for hitting income
Actively managing working capital, zero-basing statement targets. Deere ties compensation to
capital budgets and liberating fixed capital are performance against the OROA line.

5
 Right-sizing the balance sheet

Northrop Grumman establishes long-term Conclusion

incentives for improvement in RONA; it has
also created formal training programs to help Right-sizing the balance sheet offers most com-
executives get comfortable with balance sheet panies an enormous opportunity to create
measures. ITT ties compensation to perform- shareholder value, in both good times and bad.
ance against all of its “premier metrics,” one Granular measures show where capital is
of which is return on invested capital. currently being deployed. Aggressive manage-
ment of both working and fixed capital frees up
Some astute balance sheet managers, such as large amounts of cash. New ownership models
Dow Chemical, create two-way performance enable once capital-intensive businesses to
contracts. The corporate center agrees to provide prosper with fewer assets. And processes and
a certain level of resources to the businesses; incentives that encourage careful balance sheet
and business-unit leaders commit to a certain management help ensure sustainable gains.
level of performance. That is an essential policy Over time, right-sizing the balance sheet becomes
for any investment requiring a long time horizon. part of a company’s culture—a culture where
Most balance sheet investments represent multi- managers at every level of the company see
year commitments—the corporation invests the importance of carefully managing assets
now and may not see a return until much later. and liabilities and act accordingly.
Without some form of contract, good money
can be poured after bad and losing projects will
never be cut short.

Ultimately, of course, managing the balance

sheet is all about freeing up cash and redeploy-
ing it in the best way possible. Most companies
that successfully manage their assets find them-
selves developing cultures that emphasize not
just the balance sheet but cash as well. Cash is
“in the water here,” says Steve Loranger of ITT.
An executive at Ford Motor Co. says, “We’ve
changed the culture at Ford from one focused
almost exclusively on the P&L to one focused
on the P&L and cash.” (See sidebar, “The ‘Cash
Lens’ at Ford,” next page.) Managers thus learn
to take into account the cash implications of
whatever they do—and they strengthen the
balance sheet accordingly.

6
 Right-sizing the balance sheet

The “Cash Lens” at Ford

“Everyone understands cash in their personal lives,” says Lewis Booth, chief financial officer
of Ford Motor Co. “But we didn’t begin to focus on it at Ford until just the last few years.
The reason? We had to.”

Facing a liquidity crunch in 2006, Ford executives under new CEO Alan Mulally rediscovered
the balance sheet—and the importance of cash. Today, say Booth and other top executives,
the company tracks cash balances every day instead of every month or every quarter. And
the cash implications of nearly every action are clearly laid out before any decision is made.

A company that focuses on cash, such as Ford, essentially learns to view its business
through a different lens. For example:

• People begin to understand the “physicals” of cash. When vehicles are on hold, for
instance, rather than being put into production, that creates a cash problem as well as
a profit problem for Ford. Therefore, managers do everything possible to avoid putting
a model on hold.

• They come up with new and better ideas for running the business. Ford’s focus on cash
led to a greater focus on the fastest-selling models, enabling dealers to reduce inventories
without hurting sales.

• The company can communicate differently with investors. When Ford talked to investors
almost exclusively about the P&L, some decided that the company wasn’t watching its
cash carefully. Today, regular communication about cash levels reassures investors and
helps ensure that the stock is fairly valued.

• Executives approach the capital budget differently. “When we were capital constrained
in the past,” one executive says, “we’d just slash capex. Now we recognize capex is
our future.” Instead of cutting capital expenditures, the company emphasizes efficiencies
in the way it spends capital, thus doing more with less.

How important is the cash lens? “This industry is going through a revolution,” says Booth.
“We wouldn’t have been able to survive had we not gone through this process and improved
the company’s focus on cash.”

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 Right-sizing the balance sheet

Notes

8
 Right-sizing the balance sheet

Bain’s business is helping make companies more valuable.

Founded in 1973 on the principle that consultants must measure their success in terms
of their clients’ financial results, Bain works with top management teams to beat competitors
and generate substantial, lasting financial impact. Our clients have historically outperformed
the stock market by 4:1.

Who we work with

Our clients are typically bold, ambitious business leaders. They have the talent, the will
and the open-mindedness required to succeed. They are not satisfied with the status quo.

What we do
We help companies find where to make their money, make more of it faster and sustain
its growth longer. We help management make the big decisions: on strategy, operations,
technology, mergers and acquisitions and organization. Where appropriate, we work with
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How we do it
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