Working Capital Magic - From Customers to Cash Flow

The Lowdown on Credit & Collections Software

Does Your Company Really Need Credit and Collections Software?

The real answer is: It depends. I know what all of you are thinking – Here’s the blog posting which is going to be a complete advertisement for his company. Well, rest assured, this is going to be more of an infomercial (edutainment even!) than an ad.

What we’ve found is that there are many factors that drive companies to enhance their receivables management process with credit and collections software. Companies really have to start by looking at how well their A/R departments are doing and compare that with the averages and Best In Class figures for their industry. After all, if your DSO is 31 and the Best In Class DSO for your industry is 30, you may not have a significant problem to solve. Some of the A/R metrics that companies should be looking at initially also include average days pat due, percentage of A/R over 90 days and Deductions Days Outstanding. You can find a tremendous wealth of information at the Credit Research Foundation. They are truly a class organization.

Next, you really have to look at the capabilities of your company’s existing systems. A lot of major companies have ERP systems like SAP, Oracle, JD Edwards or Baan. Many others have homegrown legacy systems. And some have multiple ERP systems in different divisions. The challenge is to arm your credit and collections staff with the tools that they need to reach the goals you have put in front of them. The major problem with many ERP systems is this: they are transactional systems. What this means is that ERPs are meant to serve as the repository for documents that facilitate a business process like sales order entry or invoicing or shipping. They typically do not have the specific functionality that enables a credit and collection team to completely do their jobs from conducting credit reviews, managing A/R portfolios, making collections calls, to resolving disputes and applying cash. ERP systems just aren’t able to be that specific; they are more the general backbone tool for housing all of the business data, if you will.

So where does credit and collections software come in? Well, if you see shortcomings in your ERP systems, then credit and collections software can really take your team to the next level. Everything from doing portfolio management (with full slice-and-dice payment analysis), to automating collections tasks (like faxing/emailing invoices) to using workflow to quickly resolve disputes and deductions is available. In addition, all those yellow sticky-notes that your credit and collections department uses to keep track of different accounts and invoices all goes into one repository for future reference. For many companies, having credit and collections software is equal to having a number of extra people in the A/R department, all at your beck and call. A lot of companies have been able to their DSO and improve their A/R metrics to be more line with Best In Class figures. Not to mention being able to tie together all of those disconnected back-end systems into one single view of receivables.

However, there is one thing I'd like to point out. In your quest to look for a software solution, don't forget the most important thing: You have to have the right people in place. Make sure you have the best people managing your A/R and you will find that the domain expertise and efficiencies cannot be beat. Providing the software to a group of seasoned, motivated employees is just the icing on the cake.

So enough with the ad, already. If your company needs more information on credit and collections software (or deductions management software), check out 5 Helpful Tips On Buying Credit and Collections Software. It might save you from making the wrong decision.

What Does That Have To Do With The Price of Inventory In China?

The CFO conference on Working Capital in Boston had a lot of intriguing presentations. One of them was on the financial aspects of supply chain management, specifically inventory. Now, as a former manufacturing operations person, this is a subject near and dear to my heart.

I think everyone agrees that too much inventory is bad. It sucks up working capital, it dilutes your balance sheet (even though it shows up as an asset), and it goes obsolete or gets damaged without getting paid for by a customer.

The question is, how do you define the cost of too much inventory?

When it comes to working capital management, inventory is a critical component of the Cash-to-Cash Cycle. We all know that Cash-to-Cash (C2C) is defined as DSO + DSI - DPO. DSO is your Days Sales Outstanding, DSI is your Days Supply Inventory and DPO is Days Payables Outstanding. Companies are looking to shrink their Cash-to-Cash Cycle, so they look at compressing DSO, DSI and extending DPO. Pretty much common knowledge.

What Dr. Stephen Timme talked about at the conference was quantifying the carrying costs of inventory. A lot of companies arbitrarily assign a 10% carrying cost charge to inventory while they are calculating inventory stock levels, reorder quantities, and supply chain management metrics. Dr. Timme's argument is that this number needs to be looked into further.

He breaks the carrying cost charge down into its root components - things like warehousing costs, labor costs, shrinkage costs, overhead, costs of obsolescence, etc... He also talks about using a before-tax calculation of inventory costs which would use the Weighted Average Cost of Capital (WACC). Due to the modification of this formula, the inventory carrying costs could balloon up to 30% annually in some cases. This would then place a much sharper focus on inventory reduction throughout the supply chain, especially for finished goods. After all, who wants to stock up with carrying cost charges of 30% annually?

And this is somewhat consistent with my experience in high tech and chemcials manufacturing. Typically as a rule of thumb, we've used 1% inventory carrying cost per month for commodity goods. For specialty goods with a high deal of obsolescence risk, we've used 1.5% per month. Either way, this is still low, because we really haven't looked at the opportunity cost of investing in inventory. Yep, the old WACC.

The thing is, although I agree with all this and apparantly so do legions of industry experts for the last 30 years (look at JIT, Kanban, Lean Six Sigma, etc...), my question has always been about balancing carrying costs with the costs of a stockout.

It is often very diffucult to assess the costs of a stockout. How do you know the sales lost due to the fact that you didn't have a particluar brand of product on the retailer's shelves? How do you calculate the stockout loss of not having a specific ASIC ready at a bonded warehouse for your customer? This is what makes the full assessment of how much inventory to have available difficult. And then you hear from the peanut gallery: Sales people scream when there isn't enough stock on had to service that "absolutely important" order. Finance people scream about not amortizing capital equipment costs with too little throughput AND they scream about having too much cash locked up in inventory when throughput is high. Purchasing negotiates some great price breaks based on volume, but the problem is, you still end up with way more raw material inventory than you need.

Some days, you just can't win. But I'm convinced that with better supply and demand information (here I go again with RFID), you can remarkably improve this process.

As far the tea in China, that's another topic - Has outsourcing manufacturing to places on the other side of the globe increased lead times and inventory investments, or has it really cut total supply chain costs?

Back in SF

I got back from the CFO Working Capital Conference in Boston. The trip was crazy, but extremely fruitful from a marketing perspective. The fact that the Boston Red Sox and the Patriots were playing along with the Head of the Charles going on, made the city a madhouse. It was great watching the Sox win games though. I bet the whole of Boston went nuts after they won the World Series.

More posts on working capital later...

The Last Mile Before the Big Show

I think I'm almost ready for the CFO Working Capital Conference after too many sleepless nights. I wouldn't be surprised if they asked me to check in the bags under my eyes when I board the plane for Boston. Ah... the life of a marketing professional...

By the way, I absolutely love this very informative site on working capital management. Sure, it's low tech, but it really puts the working capital cycle into perspective. I use it for reference from time to time.

Also keep in mind that I'm going to Boston during the height of the World Series. I hear that they already had some riots. Someone also told me that they are thinking of outlawing all alcohol sales in Boston during the Series. Drat! I guess I'll have to stock up on the mini-bottles on the plane.

However, I am looking forward to some great seafood. Legal Seafoods is one of my favorites, but luckily there are some Boston locals in my company who'll probably take us to some new places.

That is, if there's time to eat. Tradeshows are grueling, before, during and after, but the right one can be gold for a company like ours. Might be fodder for another post.

I wonder if they'll let me bring riot-protection gear on board the plane. Think it'll fit in the overhead compartment?

Shared Services and Why I'm Tired of Eating at Applebee's

I recently conducted a survey of 76 companies about their Shared Services organizations. Shared services are a very common trend where companies are establishing smaller specialized teams around non-core functions like A/R and A/P to service multiple business units. A lot of times these Shared Services Centers (SSCs) are located in lower cost areas around the country like Podunk, Alaska. OK, maybe I'm kidding, but you get the idea.

So while I was at some of these places, doing my interviews, I realized that the only places to eat at around these places are invariably family-style restaurants like Applebee's. I was getting really tired of eating chicken fried steak. I think my arteries might have just cemented over.

You can read the article on the survey results, but this post is basically like a "Behind the Music" kind of expose. Or I should call it "Behind the Survey".

Besides all of the nice business stuff, I learned a few things about these Shared Service Centers:

1. It's really hard to get people to relocate to these Shared Services "outposts". Think about it: you're a veteran credit manager with over 20 years experience. You know your customers in an out. You know your company, you know who to squeeze and who to coddle to get your cash. Now, not only do you have to support a large number of business units, but you have to move to Timbuktoo (or someplace like that) as well. Doesn't sound extremely appealing, does it?

2. Some people are excited about the SSCs. Most of these people are the management team, because obviously it saves costs by trying to do more with less people. But some of the people that are happy are also key individuals who are going to get the chance to be superstars in their organizations. Still, they have a lot of work ahead of them and a whole lotta high expectations of targets to hit.

3. Companies need to figure out how to incentive and retain these people. I've heard some pretty nifty ideas about compensation packages that really hand out sizeable bonuses to employees who hit corporate targets in these SSCs. Sounds like that would help make up for uprooting your life. And your money goes a lot further in some of these areas. You can buy a lot more house in South Carolina than in say, Northern California (I should know, my apartment's rent alone is still pretty astronomical compared to other places in the country. And the views nice, but it isn't all that great). Otherwise, I have to imagine the turnover rates in these SSCs have to be pretty high from burnout alone.

I think the survey points out that there are significant challenges in the concept, but an awful lot of promise. Like everything else, you have to have great people. Then you put the processes and technology around them, and you're ready to do business.

All I know is that if I were asked to move to a SSC, I'd insist on a rider in the contract that flew in dinner from my favorite restaurants once a month. You know, like Morton's or Taqueria Cancun or House of Nanking? Because nothing is more onerous than "doing more with less" than trying to do it on an empty stomach.

And what is up with all of those Applebee's?

You're Absolutely Fabless, Baby

Everyone knows the value of the virtual manufacturing enterprise, especially fabless semiconductor companies. For those of you that might not know this, chip manufacturing is a very complex, long lead time process. The bulk of manufacturing is done in the "front end" fab process where raw silicon wafers get transformed step by step into die. A big part of this process is the photolithography where the circuit is imprinted and etched onto the wafer in a series of masking layers. Basically, this front end process requires enormous capital investment in manufacturing equipment. We're talking billions of dollars.

In the last 10 years or so, a lot of companies have cropped up that outsourced the front end to contract manufacturers in Asia like TSMC and UMC. Many times they have also outsourced the back end packaging assembly and final test processes too. These are collectively known as "fabless" semiconductor companies. They have decided to focus on their core competencies which are largely product design, sales and marketing. Some well known fabless companies are Xilinx and Altera. I think Broadcom is also fabless (or at least fab-lite, implying minimal capacity investments).

What I want to know is this - With the advent of 300mm wafers, the transition to copper from aluminum, low-k dielectrics and the new damascene process, what does this mean for the upcoming low volume ASIC and specialized chip houses? We know feature sizes are getting smaller. We know copper interconnects and low-k dielectrics are ramping up because as I understand it they offer less resistance. But if all of the contract manufacturers are converting their fabs to accommodate 300mm wafers, how are the small fabless companies going to make it?

300mm seems really geared to lowering average cost per die and driving higher yield volumes through fab into die bank. So if I'm a chip maker and a startup to boot, how do I "sell" my business to my supplier, who is clearly gearing for high volume business? For that matter, even if I am more established, how do I run NPI (New Product Introduction) programs which are typically lower volumes through the contract manufacturer?

I have to imagine that one of two things will occur (maybe both):

(1) Contract manufacturers will charge a higher premium for lower volume items to justify their operating costs. I think this will deter a lot of smaller companies from using foundries and CMs.

(2) A new breed of contract manufacturers and foundries will spring up which will be geared to servicing lower volume, high mix type of demands. I don't know how this operating model would be structured, but I guess until the technology investment gets to the break even point for lower volumes, these new breeds would be using the older manufacturing technology.

Just a thought, but Moore's Law talks about speed of chips getting exponentially faster. The corollary to this is that price will drop because of the short lifecycle of the chip. After all, everyone wants the better, faster cellphone that comes out month after month. So how do the economic realities fit in into the chip manufacturing capabilities?

Sematech has a great paper on the Future Productivity of the Semiconductor Industry. It makes sense for high volume, commoditized (e.g. standard logic microprocessors) chips. But where do the future economics for the low volume specialty chips get addressed?

Current Working Capital Management Trends Around the Globe

I'm sure many of you have read CFO magazine's Working Capital Survey. I've been following these trends very closely over the last 4 years, and I've always been surprised by the disparity between North American companies and European companies. However, in this recent article in CFO magazine, it looks like the gap in performance "across the pond" is shrinking.

Maybe this is the way the Europeans are getting back at us for the years of Euro-bashing. (Freedom fries, anyone?).

On a different note, the article talks about Dell's DSO going up! I can't believe the poster child for Cash Cycle Compression is increasing its Cash-to-Cash Cycle. I have to imagine that some of the DSO is coming from B2B trade credit sales along with European sales as quoted in the article. What could be more surprising? Maybe Dell's going to start paying its suppliers for inventory before selling it... Yeah right...

Here's an image I put together that puts some perspective into DSO and cash-to-cash cycles in the electronics manufacturing supply chain. This was based on looking at the 2003 financial performance of leading companies in each sub-vertical (Dell was one of the OEM companies in my analysis). It'd be interesting to see how DSOs have changed for commodity suppliers versus high margin sole-source component suppliers in 2004. I guess we'll have to wait until 2004 Q4 results are announced.

Customer Segmentation to Manage Working Capital Risk

"All animals are equal. Some animals are more equal than others." - Animal Farm by George Orwell

To paraphrase Orwell, I would have to say that all Customers are equal in many respects. But revenue-wise and risk-wise, some Customers are more equal than others. As many of us know, Pareto's law holds quite true for most business situations. I have yet to run into a major company where 80% of revenues did not come from 20% of the customer base.

What this means to me is that the old saying "Treat your customer like a king" really needs to look at the size of the customer's kingdom. Although customer service should still stay paramount, the way you handle the customer from quote-to-cash should be well defined. This is where customer segmentation comes into play for all working capital management and supply chain functions.

From an end-to-end working capital perspective, I would suggest that customers be looked at and segmented along these lines:

1. Revenue and Gross Margin factors: First, look at and divide up your customers in terms of how much they contribute to your revenues and also how much margin they generate for you. High revenue, high margin and low volume customers need to have different strategies applied for doing business than high volume, low margin customers. Also, this detailed segmentation will allow you to apply different pricing procedures to maximize overall revenues. For example, you may typically create different pricing tiers for different custoemr segments. By the way, the retailers use a metric that is useful called GMROI (Gross Margin Return On Investment) ot help do this.

2. Credit Risk: Now this has been done for years. Clearly not all customers have the same level of credit risk. A flexible credit scoring model and access to external bureau data and internal payment history is critical here. After all, if a customer places a sizeable order, but never pays your bill, you may as well have burned the money that you put into building and shipping that product. Credit risk needs to be closely gauged and reviewed on a periodic basis.

3. Collections & Accounts Receivable Risk: This is the back end of the transaction. How do you really go after different customers when their accounts go past due? Do you mobilize your collections staff and burn up the phones? Do you send friendly reminder letters or scathing dunning letters? When should you chase them - 15 days past due? 30 days past due? etc? Do you want to avoid pissing off a burgeoning customer that will probably end up buying millions of dollars from you next year? It all really depends on the customer segment. And if you use these tactics judiciously, you can really keep your DSO from ramping up and maximize your working capital efficiency.

4. Inventory Liability Risk: Whether or not you have contractual liability in place regarding inventory with you customer or not, you definitely want to be aware of how much it costs to service a customer, how they react and how reliable they are. You have to look at inventory turns specific to customers, average days supply of inventory, average variation in the demand forecast, the cost of the inventory (inclduing carrying costs, stockout costs and liability costs), etc... The reason for the big inventory buuble in the early 2000s when a bunch of electronics suppliers got stuck holding the bag on millions of dollars worth of inventory was because they failed to clearly understand the viability and reliability of their OEM customers. When the tech bubble burst, clearly dropping demand would force OEMs like Cisco to cancel supply orders. Now many OEMs were hit hard and had to write off tremendous amounts of E&O (Excess & Obsolete) Inventory. But the suppliers had stocked also up and had hard supply pipelined for manufacturing. So because the contracts were so vaguely defined, the suppliers often had to eat the loss for the inventory. And that's huge because most margins for the suppliers were tight, and resell channels for the E&O inventory were little to none. Tying up inventory needlessly really hits your working capital too. Don't even let me get started on channel stuffing...

I'm sure there are a lot more factors to consider when deciding how to treat a specific customer - potential for product development partnerships, potential for acquisition, geographic dispersion, etc...

I'm still looking for the Grand Unified Theory of Working Capital Management which will tie up all of the loose ends.

RFID and Trade Promotion: Using the Confluence to Influence

I was in Walgreens last night, looking to fill up on my favorite toothpaste, but I found the shelves to be completely empty. Now I know that store level replenishment is not always perfect and wasn’t created with my specific requirements in mind. After all, I should probably have stocked up in advance. But it did get me thinking about tying together RFID (or Auto-ID) and real-time trade promotion and pricing.

If the RFID revolution goes through, and retailers and CPG suppliers attain this instantaneous picture of all inventory movements down to a case/package level, one great application would be in pricing and promotion. Everyone’s heard of pull-based replenishment systems on the supply side. But how about real-time push systems for the demand management side? It might just be a quick brain-tremor, but I was thinking that if the retailer knows the in-transits, on hands and the sell-throughs, they could also provide dynamic pricing and promotion. Then, if there was a supply/demand imbalance where supply was high, pricing and bundling changes could be done in real-time. All this would be geared to hit the retailer’s (and supplier’s) revenue targets.

So for example, in a slightly overstock situation, the pricing/promotion could dynamically lower price at the store for particular SKUs and bundle it with other slow moving SKUs. I would buy another brand of toothpaste if I was also getting a bottle of mouthwash too, at a total lower price than paying for each separately. And when I pulled the stock from the shelves and bought it, a real time replenishment process could look at RFID information about in-transits, optimal stocking levels and open-to-buy quantities to decide if and when a replenishment pull signal should be sent to the supplier. I have to imagine that this would not just help sell through and increase inventory turns but also cut down on product returns to the supplier and deductions from retailers.

I probably shouldn’t be babbling on about running out of toothpaste and mouthwash – you people might get the idea that my oral hygiene is not up to par.

None of this would immediately help me in my quest for my particular flavor of Crest, but all the same, mini-applications to leverage real-time supply chain and demand information to maximize profitability would be pretty cool. More on easy-to-use replenishment algorithms later, along with Active vs. Passive RFID technology.

I chose to buy Colgate. It worked out fine.

Cash Forecasting for Fun and Profit

In today’s real time enterprises, getting a tight grip on cash flow is top on everyone’s to-do list.  Working capital improvement projects are getting a lot of buzz in major corporations.  If you add to this some of the requirements from Sarbanes Oxley Section 404 demanding that any material changes pertaining to a company’s finances be accurately predicted and managed, you know accurate cash forecasting is going to play a key part in how companies do business.

The following key excerpts highlighting A New Approach to Cash Forecasting from an article by Veena Gundavelli from Emagia show that this is really a collaborative enterprise-wide process.

Treasury groups rely on short term cash forecasts to understand projected surpluses and deficits, drive investment strategies and ensure sufficient liquidity.  In most companies, short term cash forecasts are modeled using one of two methods – the receipts and disbursements method and the distribution method.   The receipts and disbursements method involves simply comparing separate schedules of projected receipts and payments to determine liquidity and cash requirements.  This method may not be useful for many companies because it assumes a relatively uniform and unchanging stream of cash flows.  Similarly, the distribution method, which involves allocating cash flows throughout the specified time period, drives marginally higher levels of accuracy but does not take into account the dynamics of real world events.

Studies have shown that less than 27% of treasury groups feel satisfied with their current levels of accuracy.  The high degree of variance that corporations see when comparing actual results with cash flow projections can lead to costly hedging of funds required to cover liabilities and unforeseen risks. 

As treasury and cash management groups continue to place emphasis on the importance of cash forecasts, a new approach is required to quickly generate improvements.  The latest studies have shown that many of the challenges that companies currently face can be addressed by implementing the following tools and process changes within the organization.

Some of the key recommendations that are being tossed around about improving cash forecasting include:

1. Remove barriers to accessing information – The most important step is to quickly integrate data from disparate systems into one easily accessible source of information.  All relevant data such as outstanding balances, promises to pay, scheduled payments, off balance sheet liabilities, etc…from different parts of the organization needs to be available to all parties involved in the forecasting process. This data should also be reflective of the most up-to-date information that is based on current business events.

2. Develop a reliable consensus forecast – Putting the proper organizational procedures in place for cash forecasting is critical.  By focusing on developing a data driven, consensus forecast, companies can greatly improve the accuracy of the results.  Consensus forecasting entails combining multiple inputs from different levels of the corporation and developing a reliable forecast using a collaborative approach.  The latest cash forecasting tools allow companies to effectively manage this inter-departmental process.  As revisions of cash forecasts are developed, managers and treasury groups can manipulate data inputs and gauge results before finalizing the most realistic forecast.

3. Take into account changes in business conditions – All successful predictive functions need the ability to simulate the effects of varying business conditions.  Cash forecasting needs to be performed with an eye towards incorporating changing market conditions, contractual agreements and the varying ability of departments to achieve goals.  For example, cash forecasting should include performing “what-if” analysis on different levels of projected receipts and disbursements, varying payment discounts and simulating different levels of collections efficiency.  This is where a collaborative process along with intelligent cash forecasting tools allows companies to project results over multiple scenarios and proactively improve risk and liquidity management.  Also, cash forecasts should be “rolling” and updated to utilize the latest business information such as actual receipts and promises-to-pay.

4. Gauge the results of better cash forecasting – Finally, on an ongoing basis, companies should not only measure cash forecasting accuracy, but also the effects of the resulting decisions.  As forecasts are generated, companies need to be able to compare various business scenarios and also assess the possible resulting actions.  If higher accuracy led to higher investment gains in the short term, the process should be carefully analyzed to assess how the improvements were achieved.  Alternatively, if lower accuracy resulted in costly foreign currency exchange exposure or the inability to cover short term liabilities, then the root causes of the inaccuracies also need rigorous investigation.

It would be interesting to see how different industries address cash forecasting.  My initial guess is that companies which have high margins and tend to be cash rich, probably don’t put too high of an emphasis on cash forecasting accuracy.  But low margin companies who also get slammed with high costs of capital probably have to squeeze every last dollar out of short term investments and borrowings.  Also, a fantastic set of postings on forecasting can also be found at Synergy Partner's blog.

Time to go water my plant...  I think I see some signs of life...