Receivables – Enhancing Receivables for Improved Business Performance

by Mohammad-Ali Faruqi, Receivables Product Manager, EMEA, Citi

Since the start of the financial crisis, working capital management has become a dominant theme for corporate treasurers. In a constrained credit market with a high cost of borrowing through overdrafts or the capital markets, corporates are forced to look internally for ways to address costly inefficiencies in the financial supply chain, unlock working capital from within the business and make savings through operational efficiencies.

Today’s Limitations in Working Capital

According to a recent CFO.com working capital survey, there is €550bn of trapped liquidity in the top 1,000 companies in Europe, and more than $750bn amongst the top 1,000 in the United States. To understand this further, Citi performed an analysis of 20 of our top 3000 customers worldwide. We found that these customers lag behind the median for their industry for days sales outstanding (DSO) by between 1 and 20 days, and have an average of $1.3bn in trapped liquidity.

Improving operational efficiency and cash management processes to release trapped liquidity has an impact beyond working capital metrics. Companies that are more liquid and have a high degree of organic funding have generated, on average, 15-18% in incremental returns over the past 18 months. Stock price performance of more liquid companies is 27% higher than their peers with a greater reliance on external borrowing.

Working Capital Potential

Industries with complex supply chains and global operations typically have the greatest potential for working capital improvements. By adopting best in class practises, we estimate that the typical multinational corporation (MNC) could reduce working capital financing requirements by up to 30% and boost earnings per share (EPS) by 2-3%.

It is in every firm's interest to maintain a robust supply chain in which their suppliers' as well as their own interests are protected.

As treasurers are well aware, working capital improvements arise by reducing days sales outstanding (DSO) and increasing days payables outstanding (DPO). However, while it may appear beneficial to pay suppliers later, this behaviour damages trust with suppliers, discourages favourable pricing and affects suppliers’ working capital, making them more vulnerable. It could be harmful to the company if key suppliers were no longer in a position to play their part in a company’s supply chain, so it is in every firm’s interest to maintain a robust supply chain in which their suppliers’ as well as their own interests are protected.

So if working capital improvements cannot be made by extending DPO, the focus should be on collecting cash as rapidly and efficiently as possible. While many people are aware of the opportunities for optimising accounts payable, there is less familiarity with receivables management techniques. Receivables are fundamental to every company’s financial supply chain; every treasurer wants to improve the collection of cash and reduce the value locked in inventory and receivables processes.

For example, enhancing the degree of automation in the reconciliation process allows timely updating of customer accounts so that overdue amounts can be followed up quickly; increasing transparency over the order and invoice and collections processes minimises invoice disputes and enables timely resolution. The benefits of an efficient collections process extend to customers too. For example, without rapid reconciliation and a timely invoice dispute process, buyers may be prevented from placing orders or receiving goods if credit lines are not promptly updated. [[[PAGE]]]

Striving for Straight-Through Processing

Measures of straight-through processing (STP) of collections include the ease with which customers can make payment, the speed with which the company is alerted to incoming payments, the quality of remittance information and the degree of automation in the reconciliation process. There are a variety of factors which can hinder STP today, as illustrated in fig 1, but which include:

• Companies which operate internationally, particularly when dealing with retail customers, often need to support local collection methods, such as paper-based payment instruments. This makes it challenging to centralise receivables into a shared service centre (SSC) or collections factory. In addition to diverse payment methods, diverse clearing processes, large customer networks and lack of remittance information can all hinder centralisation and automation of receivables.

• As payments pass through multiple systems and institutions before appearing on a company’s bank statement, remittance information on the original payment is often lost, truncated or held inconsistently. This makes it difficult to apply automated reconciliation rules, increasing the number of exceptions and need for manual reconciliation. This is expensive, time consuming and prone to error.

• Companies with multiple banking relationships often need to support different systems and data formats when bringing together account information. This is costly and it can be challenging to maintain each interface and process data formats consistently.

• Lack of visibility over the invoice, order and collection cycle can extend the time taken to resolve invoice disputes, which ties up working capital.

• Many companies do not have the necessary receivables and reconciliation technology in-house for sophisticated reconciliation, dispute resolution, customer credit and chasing collections.

These issues slow down the receipt and allocation of cash, and make flows less predictable, therefore increasing the working capital levels that a business requires.

Centralisation

The move towards standardisation, and the increasing consistency of payment and collection methods through SEPA means that it is becoming easier for companies to centralise their receivables, allowing them to reduce costs, standardise processes and implement key performance indicators (KPI’s) more effectively, and establish a single channel with the bank.

The Move Towards Standardisation

While some of the challenges above are internal to the organisation, one of the primary issues is the need to obtain more detailed and standardised information from the banks. To support this, the clearing houses too need to facilitate the exchange of enhanced information. With the introduction of SEPA, this is becoming a reality as SEPA Credit Transfers uses formats based on ISO 20022 standards for financial messaging, based on XML (eXtensible mark-up language) which allows greater interoperability and standardised information exchange between different parties and systems. Unlike previous attempts at standardisation in the past, widespread support for XML amongst regulators, banks, vendors and corporates is driving consistent adoption. [[[PAGE]]]

Citi Response

In addition to standardised data formats, banks and clearing houses need to present more detailed and usable information to their corporate clients. Citi was one of the first banks to support SEPA Credit Transfers and XML formats, and is committed to using standardised transaction codes globally, allowing clients to categorise transactions on their Citi accounts more easily and invoke the correct process workflow. In addition, we pass on the complete set of remittance data on a payment/collection throughout its lifecycle to enable more automated reconciliation.

Companies which operate internationally, particularly when dealing with retail customers, often need to support local collection methods...

Many companies will use an ERP, such as SAP or Oracle to support all or part of their receivables process. To assist these companies, Citi has developed a unique Return Message Integration tool (RMI). This enables companies to handle all information from Citi and other banks more efficiently, improving overall payment and reconciliation processes. Vendors such as SAP, Oracle, SunGard and PeopleSoft have also invested in their solutions to process remittance data automatically.

Standardisation is only part of the equation, particularly as it takes time and effort to implement new interfaces and formats, which must be balanced against other priorities. To successfully address working capital inefficiencies, companies need to align their physical and financial supply chain and see where these processes are connected. For example, an order number and buyer ID is key information for inclusion on the invoice which in turn fuels the reconciliation process. Consequently, e-Invoicing, for example, can be a valuable contributor to a more automated financial supply chain. At Citi, we have developed a structured, systematic approach to reviewing our clients’ financial processes, including identifying and addressing areas for improvement. This approach to receivables management is known as receivables vision.

[[[PAGE]]]

By making a diagnostic analysis of each element of the receivables process, companies gain a better understanding of their customers’ behaviour and the risks inherent in their receivables cycle. We analyse the impact on DSO of each receivable method and look at how these can be improved, by changes in processes, technology or arrangements with customers (fig 2).

Conclusion

2009 will continue to pose challenges for companies as the reality of recession continues for many industries. Companies best positioned to withstand these difficult times will be those which are able to harness their internal working capital by accelerating cash conversion and extracting a larger portion of their group liquidity from the operating units. The benefits are not only internal; the markets will continue to reward companies that hold more cash than their peers.

Consequently, this is the time for companies to focus on the centralisation and optimisation of their accounts receivable. Citi’s receivables vision will make a substantial impact on our customers’ order-to-cash cycle helping them to move to best-in-class performance for their industry. Many of the traditional obstacles to centralisation have reduced through a combination of technology developments, the emergence of XML message standards, increasing adoption of electronic invoicing, digitisation of paper-based payment instruments and the launch of SEPA. These are all opportunities to enable companies to re-engineer their processes and account structures to drive standardisation and rationalisation.