Rapid Returns in Receivables

Published: May 01, 2008

by Helen Sanders, Editor

Those who remember the late 1980s and who also grew up in the United States (I can feel my audience diminishing as I write!) may remember Ken Hakuta, better known as ‘Dr Fad’, TV personality and inventor - for those who missed out, he’s featured on the old VHS ‘I Love the ‘80’s: 1983’. I bet you never expected to pick up that sort of trivia in a treasury publication. I haven’t seen it, in case you were wondering. Anyway, amongst (I’m sure) very many sensible comments made by ‘Mr Fad’, one struck me as actually being quite relevant:

“Lack of money is no obstacle. Lack of an idea is an obstacle.”

While I am not suggesting that we all send our banknotes fluttering from a top storey window (after all, many of us might feel that this is already the effect of much of the current economic uncertainty) there are significant ways in which treasurers can substantially improve their liquidity and working capital with rapid return on investment. The key is not just to throw more money and more resources at a problem, but to think creatively about addressing challenges. In doing so, treasurers can achieve a return on investment which contributes directly to the company’s bottom line. Focusing on receivables is a prime example of where treasurers can act creatively to enhance liquidity and add economic value to the company. The watchwords here are Centralisation, Optimisation, Leverage and Protection. But what does these mean in practice?

Centralisation

According to a recent survey conducted by GTNews in association with SEB (‘Is Corporate Cash Management Changing?’ 19 July 2007) 43% of companies have a decentralised approach to receivables. The survey included a high proportion of SMEs and domestic companies, and according to research such as the Treasurers’ Benchmark of companies with a turnover above $1bn the percentage of companies which have not fully centralised their collections is far higher. Approximately 65% of larger multinational companies still have partially decentralised collections and only 5% have fully centralised (source: Treasurers’ Benchmark). However, there is a significant drive to centralise collections amongst companies of all sizes, either globally or regionally, depending on the structure of the organisation. While short-term priorities differ amongst firms, it appears that only 15% of those with decentralised collections ultimately intend to maintain this arrangement in the future.

Focusing on receivables is a prime example of where treasurers can act creatively to enhance liquidity and add economic value to the company.

Although many treasurers say they are planning to focus on collections, there are always other priorities, and like cashflow forecasting, which has appeared on treasurers’ list of top priorities for a number of years, it does not seem likely that all those who ideally want to centralise collections will end up doing so in the short to medium term. However, why should receivables be a priority now when they have not been in the past?

Bank & industry support

Firstly, the banks are now in a better position to support centralised collections, and indeed financial shared services more generally, with services such as automated pan-European collection services to repatriate funds. Wider industry initiatives also better support centralisation of financial functions, such as payables and receivables. For example, with SWIFT access becoming more prevalent amongst corporates, information from multiple banks can be exchanged through a single channel which is particularly suited to centralised financial functions. This allows infrastructure costs to be reduced, such as bank interface costs, typically estimated to cost $15,000 - $35,000 each per year. SEPA too is a catalyst for centralising receivables. In the past, this has not always been easy as companies have had to support local payment methods in each country and therefore have had in-country collection functions (or even more fragmented). With the transition to harmonised payment methods across Europe, it is easier to establish a centralised function with common business processes across countries.

Technology availability

The technology for centralising and optimising receivables has been available and proven from suppliers such as Atradius and SunGard, not only as a standalone tool but in the latter case, as part of an overall solution with treasury and other parts of the working capital chain such as payables.

Working capital

But this technology has been available and has delivered tangible benefits to many companies over a number of years, so why haven’t treasurers focused on this area before? In the past, receivables have been outside many treasurers’ remit. While treasurers have typically focused on high value, low value transactions, collections (and commercial payments) are more intense operational processes with high volumes and potentially lower value transactions. However, with the credit crisis as a catalyst in many cases, treasurers are appreciating (and in some cases, it is demanded of them) the importance of focusing on working capital on a broader basis - not just ensuring that cash is available in the right place at a right time, but working out how much cash the company actually needs and taking steps to minimise this. After all, the less cash which is tied up in working capital, the more there is available for research & development, mergers & acquisition, share buybacks and paying down debt. [[[PAGE]]]

Commercial sensitivity

Centralising collections is in many ways more difficult politically than treasury or payables. In particular, as it is a customer-facing activity, it is considered to have more commercial sensitivity than some other areas of finance and therefore sales functions generally have a significant involvement. This is particularly the case when the business itself is decentralised and customer relationships are distributed across multiple geographies. Although the business case may not be easy to communicate, and requires both clear and detailed descriptions of the value to the organisation, together with senior management support, the customer experience can be better when collections are centralised. Sales teams do not lose their role in the process and often remain a point of escalation or are involved in dispute resolution.

Relative value

Finally, bearing in mind that treasurers and finance professionals have many calls on their time and conflicting priorities, focusing on collections is sometimes considered to have less value than other financial initiatives. However, with receivables being the largest or second largest asset on the balance sheet for many companies, this view cannot be justified. We protect and seek to enhance every other asset, so bearing in mind the significance of receivables as a company asset, they should surely be a priority for every company. Lack of control over collections has a direct impact on the balance sheet and therefore the value of the company. Bad debt can affect a company’s credit rating, shareholder confidence, business insurance costs and the amount paid by potential acquirers.

Optimisation

Once centralised, there is the opportunity to improve receivables substantially by implementing standard procedures, key performance indicators (KPIs) and management and exception reporting using a common technology platform. Without standard processes and clear performance indicators, it is impossible to measure improvements and without transparency, these cannot be refined. Historically, receivables optimisation was frequently seen as squeezing customer payment terms as far as possible to ensure early payment, often including financial incentives to do so. However, this has changed. While ensuring prompt payment remains an objective, more important is the predictability of cashflow. For example, if a treasurer has to borrow to maintain short-term cashflow or does not invest cash in higher return instruments because s/he does not know when money will be received, this is more detrimental than waiting a day or so more for payment. One way of doing this is encouraging more predictable payment methods, such as direct debits, which with SEPA, will also extend to business-to-business direct debits. Furthermore, simply aiming to reduce days sales outstanding (DSO) without looking to time receipts as closely as possible with payables can also be detrimental, as cashflow ‘spikes’ result in higher working capital levels than may be required if cashflow was more evenly smoothed. [[[PAGE]]]

Another aspect of optimising receivables is to appreciate the commercial sensitivity of customer relationships. Like your own business, many of your customers will be global companies, and may frequently do business with different parts of your organisation. By maintaining a decentralised approach to receivables, you cannot have a global view of a customer’s outstanding position and therefore the overall level of risk to that customer. Furthermore, by looking at a customer’s business globally, you can look at implementing more strategic incentives which reward timely payment such as end-of-year bonuses.

Leverage

While ensuring prompt payment remains an objective, more important is the predictability of cashflow.

As we have said already, receivables are a major asset for any company. This brings us neatly on from simply looking at working capital, in which receivables play a vital role, to a broader view of the financial supply chain, extending from suppliers at one end to customers at the other (please see SEB’s Guide to Financial Supply Chain Optimisation, the centre section of this edition of TMI). Seeking to increase efficiency, push costs out of the financial supply chain (not simply moving costs to another part of it) and connect each step are all vital elements in achieving and maintaining a competitive position by protecting a company’s margin as well as allowing greater visibility over all of the factors which influence cashflow and working capital. Furthermore, in a credit-strapped market, treasurers should be seeking to identify assets which can be used to as collateral on which to obtain financing. This could be physical assets, such as property, machinery and inventory, but equally it could be financial assets such as invoices (receivables) or even purchase orders.

Tim Corbett, Head of Commercial Finance at Fortis Bank UK explains,

“During periods of economic uncertainty, the least attractive debt from a bank’s point of view is an unsecured loan. However, if a company uses its assets as part of an asset-backed working capital facility, the bank will often be far more willing to support its financing requirements.”

“We are seeing continued year-on-year growth in asset-backed financing and an increase in the size of companies looking to use these mechanisms. This has also led to an expansion in cross-border asset financing.”

Receivables securitisation is potentially an important way of obtaining finance, particularly for companies in the automotive, manufacturing, high-tech or retail sectors. As Phillip Kerle, Chief Executive Officer of Demica Ltd, provider of working capital solutions explains,

“Over the past five years, we have seen companies increasingly use three major balance sheet assets as a basis for financing: receivables, payables and inventory. Inventory financing is the most complex of these, particularly the associated legal issues. Supply chain financing is still in its infancy but provides a great opportunity for corporates.”

Although securitisation may still seem a dirty word after the problems with sub prime mortgage-backed investments in the United States, receivables securitisation should not be tarred with the same brush and both factoring and receivables securitisation are being used by larger companies. Phillip Kerle, Demica, continues,

“Trade receivables securitisation is an attractive proposition for the banks as under Basel II, they need less capital held against receivables than other types of asset. Therefore, there are advantages for both banks and corporates. This type of financing is particularly attractive to sub-investment grade corporations with a customer base more highly rated from a credit standpoint, in order to arbitrage the rating between the corporate and its customers.”

Protection

Finally, risk management remains a vital element when seeking to optimise the receivables process, whether or not these are used as a basis for financing. While treasurers will invariably have a policy for hedging interest rate and foreign exchange risk, credit risk needs to extend beyond monitoring counterparty exposures and include a level of risk protection. After all, if a customer with unpaid invoices of two million euros fails, 100% of the impact is felt on the balance sheet. Clearly, companies will want to avoid bad debts building up, and centralising, optimising and reporting on receivables are vital in providing an ‘early warning’ of a customer issue, but if a customer goes bankrupt, these measures will not help. Consequently, while credit insurance is never going to be a subject which causes treasurers’ pulses to race, it is an important element to consider in any receivables financing programme. [[[PAGE]]]

Return on investment

All credit and collections officers have oversight across all accounts, providing greater business continuity and customer service.

The payback period for a receivables optimisation project is frequently very much quicker than other financial initiatives, particularly those requiring a capital outlay in the form of new technology. While it is common to seek a payback period between one and three years for technology spend, it is realistic to seek a return on investment from three to six months when investing in receivables technology and best practice in receivables management. Bearing in mind the more strategic, qualitative benefits as well as tangible benefits, the speed with which a return on investment can be achieved should be a significant advantage in a business environment where budgets are more modest and may need to be fought for. For example, one US shared service centre of a European company had sought a 12-month return on investment for its receivables optimisation project which included centralisation, new business processes and technology, replacing 15 systems which were previously in use. The company achieved a return on investment in two months, reduced FTE by 45% and bad debt by 30%, with a project duration of a month for the system implementation.

Receivables are a vital area in which treasurers can become closer to the business and add value to it, by implementing technology and processes which are in line with industry best practice. While this area may not be part of the treasurers’ remit today, it is almost impossible to reduce working capital levels without the ability to influence the key components which contribute to it, particularly payables and receivables but potentially the broader financial supply chain. Due to the speed with which demonstrable benefits can be achieved, it can be a ‘quick win’ in the quest to improve working capital and seek competitive advantage.

In the next edition of TMI, Numico (now part of Danone) discusses its working capital optimisation project and some of the benefits it has achieved.


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Article Last Updated: May 07, 2024

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