Cancel OK

Optimizing Working Capital

Unlocking the power of your receivables

Improving working capital is a focus for every financial executive and is crucial to business growth and profitability. Yet current strategies often fail to recognize the role accounts receivable can play in reducing the cost of working capital, while also having a positive impact on customer relationships and even the wider economy.

Sustainable working capital provides a company with the flexibility to expand and enhance its operations, improve liquidity, maintain or increase profitability, and respond to challenging economic conditions. Yet all too often money can become tied up in the accounts receivable entry on the balance sheet, something that firms looking to optimize working capital have often overlooked as part of their financial strategy.

The importance of unlocking funds in accounts receivable has been exacerbated by the economic climate and the continued reluctance of banks to lend. Indeed, innovative firms are looking internally to raise funds by taking a customer-centric approach to improve accounts receivable and therefore optimize working capital.

Historically, firms have looked to optimize on three key aspects of working capital—cost cutting, inventory management, and obtaining the best possible returns on cash reserves while prolonging the accounts payable process. These functions are already considered strategic, yet accounts receivable, often the largest entry on a balance sheet, has traditionally been more of an administrative concern. However, as the fourth key factor of working capital, accounts receivable is where an untapped opportunity for innovation in optimizing working capital lies.

A rethink is required to ensure that the credit, collections, and complaints functions unlock the true value tied up in accounts receivable and therefore become a strategic concern. If done successfully, this will not only keep cash flowing through a business, but will free up funds for investment in future growth.

Turning from Tradition

Over the last several years, cost cutting has been at the heart of most strategies, meaning the majority of firms are now as lean as they can be without affecting performance. Moreover, long-term inventory management strategies are well supported by logistics theories and systems, so the potential for further improvement is minimal.

The same can be said for cash management, with larger corporations applying sophisticated strategies to manage and utilize their daily cash reserves.  However, in the short term, there is a ceiling to the potential returns realized from cash and money market instruments.

Lessons learned over the last few years have shown that relying on these liquid asset classes or stable interest rates is no longer a safe bet. Meanwhile, accounts payable is often the subject of shortsighted policies.

Granted, firms can improve liquidity by withholding payment of invoices to protect cash, but this is not a sustainable strategy since all monies owed will ultimately be collected. But such an approach can and has contributed to an uncertain business climate in which cynicism has replaced trust as companies withhold payment for their own short-term benefit.

Twitter

Improving working capital is a focus for every financial executive and is crucial to business growth and profitability. Yet current strategies often fail to recognize the role accounts receivable can play in reducing the cost of working capital, while also having a positive impact on customer relationships and even the wider economy.

Sustainable working capital provides a company with the flexibility to expand and enhance its operations, improve liquidity, maintain or increase profitability, and respond to challenging economic conditions. Yet all too often money can become tied up in the accounts receivable entry on the balance sheet, something that firms looking to optimize working capital have often overlooked as part of their financial strategy.

The importance of unlocking funds in accounts receivable has been exacerbated by the economic climate and the continued reluctance of banks to lend. Indeed, innovative firms are looking internally to raise funds by taking a customer-centric approach to improve accounts receivable and therefore optimize working capital.

Historically, firms have looked to optimize on three key aspects of working capital—cost cutting, inventory management, and obtaining the best possible returns on cash reserves while prolonging the accounts payable process. These functions are already considered strategic, yet accounts receivable, often the largest entry on a balance sheet, has traditionally been more of an administrative concern. However, as the fourth key factor of working capital, accounts receivable is where an untapped opportunity for innovation in optimizing working capital lies.

A rethink is required to ensure that the credit, collections, and complaints functions unlock the true value tied up in accounts receivable and therefore become a strategic concern. If done successfully, this will not only keep cash flowing through a business, but will free up funds for investment in future growth.

Turning from Tradition

Over the last several years, cost cutting has been at the heart of most strategies, meaning the majority of firms are now as lean as they can be without affecting performance. Moreover, long-term inventory management strategies are well supported by logistics theories and systems, so the potential for further improvement is minimal.

The same can be said for cash management, with larger corporations applying sophisticated strategies to manage and utilize their daily cash reserves.  However, in the short term, there is a ceiling to the potential returns realized from cash and money market instruments.

Lessons learned over the last few years have shown that relying on these liquid asset classes or stable interest rates is no longer a safe bet. Meanwhile, accounts payable is often the subject of shortsighted policies.

Granted, firms can improve liquidity by withholding payment of invoices to protect cash, but this is not a sustainable strategy since all monies owed will ultimately be collected. But such an approach can and has contributed to an uncertain business climate in which cynicism has replaced trust as companies withhold payment for their own short-term benefit.

Such shortsightedness has had a detrimental impact across the wider economy because whether by accident or design, late payments limit liquidity and can have a knock-on effect throughout the supply chain.

Winning the Late Payment War

In a perfect world, invoices flow from supplier to customer and money from customer to supplier in the most seamless fashion possible. Yet in today’s business environment, the payment of invoices is a battleground.

Adopting a strategic and “customer-centric” approach to credit, collections, and complaints management not only allows firms to counter this war of attrition and unlock the value of their accounts receivable, but will also directly improve profitability by reducing the financial risks posed by write-offs and late payments. This model also promotes a decent way of doing business, in which all companies are able to fulfill their duty to pay in a responsible manner.

So what does a customer-centric and strategic approach to credit, collections, and complaints management entail exactly? First, it is about recognizing how accounts receivable management operates at the very heart of the supplier-customer interface.

Yet by understanding and analyzing customer behavioral information using qualitative analysis, detailed reporting, and KPIs (key performance indicators), it is possible to segment the customer base and apply appropriate action profiles to minimize payment times. This reduces DSO (days sales outstanding), while identifying and targeting the weakest of customers to enable informed decisions on terms and conditions to be applied to future transactions.

Second, the ability to segment certain certain customers also allows firms to define a tailored collections strategy per group to reduce risk and improve customer relationships. Collection terms should be discussed and agreed upon from the very outset of a relationship and then applied consistently throughout.

A disciplined and structured approach to collections again reduces DSO and improves cash flow, while nurturing a much closer customer relationship. Naturally, this also provides more scope for flexibility in the collection process if required.

Lastly, by combining multiple sources of external and internal credit information, it is possible to actually predict the bad debtor of tomorrow. All customers, however, should be evaluated regularly for risk as a detailed analysis of their payment history and behavior will provide key risk indicators. For example, if every complaint raised by a customer is spurious, this is a sure sign that something is wrong.

Using historical data to analyze root causes for complaints allows a firm to both identify and counter illegitimate complaints at an earlier stage. More importantly, it allows a firm to modify its internal processes and procedures. Long-term structured complaint analysis leads to improvements in logistics, services, and administrative processes. The result is fewer complaints, improved payment time, and reduced write-offs.

A Transparent and ‘Customer-Centric’ Strategy

For many businesses, credit, complaints, and collection management are still functions considered to be outside the purview of senior management. But at a time when there is much greater scrutiny of a firm’s accounts receivable and its true value in respect of how much is actually tied up in high-risk customers, a good credit, collections, and complaints policy is no longer a luxury and is certainly not a burden for companies looking to reduce the cost of their working capital. It is, alternately, a valuable aspect of doing business that provides tangible financial and operational benefits.

Supplying the customer no longer ends when the product or service has been delivered. Rather, it means maintaining a 360-degree view of customer relationships, allowing businesses to benefit directly from the level and type of customer engagement these functions can and will provide.

A customer-intimate credit manager not only clears the path to payment and improves accounts receivables, but can also form the strongest of bonds by understanding and analyzing customer behavioral information to ensure the relationship is sustained.

Elevating accounts receivable to a strategic level also provides transparency throughout the company—from the collection department, through finance and account management, to the CFO and managing director. This ensures that all business functions can apply a consistent approach to managing the customer relationship with the ability to identify early on exactly why payments are being delayed, and allow an informed and timely response in accordance with the customer’s profile.

Transparency is just as important externally because lending by banks has fallen faster and further than ever before. Banks may still be happy to lend to a well-managed and growing business, but they are not prepared to lend money simply to plug holes in a firm’s balance sheet. A much better way to balance the books, optimize working capital, and boost profitability is in unlocking the funds tied up in accounts receivable by adopting a strategic and customer-centric approach to credit, collections, and complaints management.

——

Reprinted with permission of the National Association of Credit Management.  Article originally appeared in Business Credit magazine.  For more information visit www.nacm.org.

Twitter