Working Capital Magic - From Customers to Cash Flow

Maximizing Cash Conversion Efficiency

Maximizing cash conversion efficiency is a fundamental part of better working capital management.  The cash conversion cycle is a great measure of how companies manage their receivables, inventory and payables and transform them to liquid assets : cold hard cash.

Focusing on the full working capital cycle is where companies can find opportunites to maximize their free cash flow.  Emagia provides software that allows companies to manipulate their cash flow levers to drive significant performance improvements and increased cash conversion efficiency.

A couple of thoughts on the cash conversion cycle:

1.  Having a negative cash coversion cycle is a lot easier when your company is at the downstream end of the supply chain (e.g. Cisco and Wal-Mart).  This isn't the only factor, but it certainly helps

2.  Being as close to the end consumer demand is critical to drive inventory efficiencies.  Again, this is a factor of being the downstream end of the cupply chain

3.  Being the 800 lb. gorilla in teh chain is a big factor.  Retailers command the actual distribution and can therefore squeeze their suppliers as much as they want.  In addition, they have little in the way of actual receivables (based on credit card type consumer transactions).  Also, they force their suppliers into VMI or consignment oriented inventory management practices, thereby diminishing their inventory liability

Another example is Cisco during the dot-com boom.  Cisco was clearly in a sweet spot where demand for telecom products was initially far outstripping supply.  And their suppliers were scrambling to fill up the pipeline and were more than willing to extend elongated credit terms.  So the negative cash-to-cash cycle was easy to attain.  It probably didn't hurt that the economy had bouyed the suppliers and well as Cisco's customers into a cash-rich status.

An interesting study would be to look at different supply chains across various verticals and see where the 800 lb. working capital gorillas are...

Liquidity Management - the Process of Multi-Lateral Netting

Global corporations that span multiple business units tend to have a big mess of inter-company transactions to clean up.  Not wanting to spend a lot of time, money and effort on individually carrying out reconciliation, a lot of companies rely on netting centers.

Multi-lateral netting is the process by which buy/sell transactions between different operating units in a company get settled.  Typically, one unit may be buying (generating payables) from another unit while at the same time selling (generating receivables) to this same unit.  At the end of the day, there are numerous complexities with foreign exchange exposure, float management, and inter-company receivables that need to be addressed.

The costs of these inter-company transactions extend from cross border flows, to redundant banking charges to currency exchange fluctuations.  On the other hand, I don’t know if there is a lot of benefit to be gained from inter-company transactions – they’re just a cost of doing business.  The key is to use multi-lateral netting to reduce this cost across the company.

The netting cycle is a key component of liquidity management.  If carried out properly, the savings can be substantial and also drive improvements in global cash forecasting.  At a high level, the netting cycle follows this process:

1. The trading business units send their transactions over to the netting center.  For example this would be the receivables, payables, and backup documents (inter-company Purchase Orders and Sales Orders)

2. The netting center reviews all sent transactions within a fixed time period.  These are then process further in the cycle

3. The netting center uses currency exchange rates to a common currency.  Since the two business units could be in different countries, this is an important step

4. This common currency (indicative rate) tries to be in line with market fluctuations, but is not always 100% representative.  These variances need to be taken care of during the full iquidity management fucntoion.  This idicative rate is used to normalize all buy/sell transactions for the participating business units and then the “netting” process occurs.  The result is the net payment or receipt per business unit

5. Based on the netting cycle period, the netting center notifies each business unit when their payment or disbursement will occur.  In addition, taking into account the currency rates, a decision is made on how much the net payment or receipt is for.

6. The netting center then contacts the banking institution and spot buys or sells its currency surplus or shortfall to cover the transaction. 

7. The settlement occurs where the netting center appropriately carries out the net transaction between the participating business units

I’m going to talk about the benefits of this process next and also some of the challenges of dealing with the FX exposure.  Also, the netting schedule is clearly a factor that needs to be taken into consideration during cash forecasting.

Making Sense of Accounts Receivable Metrics

I know I’ve talked a lot about delving into Key Performance Indicators for working capital management, especially A/R.  It’s great when companies benchmark internally and externally to look for ways to improve their businesses.  However, it’s also important to keep a few things in mind when you do this:

1. Deriving a global DSO figure from publicly available financial statements can be misleading.  After all, global companies typically have different terms and trade practices in different regions around the world.  So the aggregate DSO calculated from the SEC filing, might be skewed by DSOs extended by 100 days in East Asia.  So when this is compared to industry benchmarks, this may look like a dire situation, but in reality the region specific DSO may be right in line with the average.  Metrics need to be compared to reasonable benchmarks for industry, region, etc… not always a global benchmark.

2. Take a portfolio view of your A/R balance.  Some key measures to look at are % A/R current (within terms) and % A/R beyond 90 days.  It’s pretty much a given that if your receivables go long past 90 days, they are in serious jeopardy of being written off.

3. Collections Effectiveness Index (CEI) is one great measure of your credit and collections team’s productivity.  It shows how fast your collectors are converting outstanding A/R to cash. 

4. Look at DSO in the context of the complete Cash-to-Cash cycle.  Working capital gets tied up in the nooks and crannies of your company’s cash cycle.  Viewing DSO in comparison to Days Supply Inventory and DPO will give you an idea how your cash flow is materializing.  Also, some key insight can be gained by comparing average A/R balance to sales for a specific time period.  This helps to gauge your company’s cash conversion efficiency.

Bottom line: There are a lot of A/R metrics to examine and they can all be helpful.  Just keep in mind that in order to fully diagnose your company’s cash flow condition, you may have to look at multiple metrics and come up with a composite assessment of working capital management.

Pay the Invoice or Play the Float? The Dilemma of Accounts Payable

Managing vendor relationships is tricky enough without bringing A/P into the picture.  Typically, your purchasing or procurement department has jumped through hoops to beat down your vendors on pricing, quantity, terms, delivery, etc...  Now, it's time to take a look at the final step of procure-to-pay:  Paying your vendor's invoice.  Should you pay early and take a discount, should you pay on time or should you hang on to the gold and play the float?

I think the right answer is based on 3 things:

1.  Based on vendor segmentation, how critical is this vendor in your supply chain?  Are they a sole source, do you have competitive bids out there, can you afford to be on credit hold, etc...?  Also, how has their on time performance been?  Has their fill rate been dropping?  How about product quality?  These should all be taken into consideration in a vendor scorecard which gives you a quick glimpse into real-time vendor performance

2. What is you current cost of borrowing money?  Depending on whether its cheaper to borrow money or take a hit on the offered discount, companies should figure out when to pay invoices.  Just make sure that the invoices are reconciled with the original purchase order and goods receipt ticket.  If not, like many other companies, you just don't pay the bill until the vendor screams at your doorstep.

3.  Most of all, companies should aggressively but fairly negotiative payment terms with vendors.  Maybe in certain cases, your vendor might be willing to give you a bigger concession on discounts or volume buys than you otherwise might have been conditioned to expect.  After all, you don't get unless you first ask.  For example, if your vendor usually extends 2%net45, maybe they would be willing to extend 2.5%net30.  Or give you a higher volume discount, etc...

I have some data that I'll share on a future posting about proper procedures for float management and vendor payment portfolio management that will help your company maximize its cash flow.

And don't get me started on Evaluated Receipt Settlement.  Great for the customer, but a pain in the neck for the supplier...

Deductions and Chargebacks Burning a Hole In Your Company's Pocketbook?

Everyone that sells into distribution or retail channels knows about deductions.  This is when the retailer or distributor decides to short-pay a supplier's invoice due to a myriad of authorized and unauthorized issues.  Deductions (or chargebacks as they are often called), result in a lot of revenue leakages for these companies, and drain profits.

Now these are some random thoughts, but lately I've realized that deductions and chargebacks management is a very complex problem that has multiple root causes.  I'll have a cohesive posting on these later, but having talked to numerous companies, some of the key elements I've heard are:

1. Deductions are a cross-Financial Value Chain issue: Since the reasons for deductions can range from trade promotions, logistics, non-compliance and plain mismanagement, this is really a complex problem.  Many groups may be involved, both internal and external to the company.  For example, it could be a marketing issue, a retailer's A/P issue, a concealed shipment, an unauthorized deduction, a return to vendor (RTV), etc... the list goes on and on.

This leads me to believe that business process changes, coupled with collaborative approaches can help alleviate this problem.

2. Throwing more people at the deductions problem is not the answer.  This is just plain costly and I'm not sure of the long-term viability.  You really need to influence the retailer's behavior as well as clean up your own internal processes.

3. It would make sense to work with retailers to streamline the entire quote-to-cash process, but sometimes they don't want to cooperate.  After all, retailers are the 800 lb. gorilla.  Why would they want to pay you faster? 

More on this later...Meanwhile you can also read this Business Credit magazine article on Deductions Management.

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.