The Dash for Cash: Improving Accounts Receivable (AR) Management to Increase Liquidity

Companies must adopt a fundamentally different, comprehensive approach to accounts receivable (AR) management—whether to win market share or survive the economic spiral; to build sustainable cash positions. The approach must look across the entire order-to-cash process to root out payment problems early on and design flexible solutions that release more cash and permanently lower AR, according to a new report by Booz & Company.

Manage the Whole Order-to-cash Process

A year ago, companies with large reserves of cash were viewed as ripe for acquisition; leverage was rife and “leftover cash” went back to shareholders in the form of dividends or stock buybacks. Today, cash is king. Financing—when available—involves high premiums, compounded by a deepening recession that’s crimping cash flows and forcing cutbacks—in an effort to conserve incoming cash. “The survival of many corporations is under threat, but those with strong cash positions will have the financial means to move against weaker competitors and make market share gains,” explained Ahmed Youssef, Principal with Booz & Company.

Tap Hidden Cash on the Balance Sheet

Cash conservation is important to improve the quality and viability of a corporation’s cash flow statement. Most corporations focus on improving the P&L; and in addition, companies must better tap the hidden cash on their balance sheets, by preserving and enhancing a corporation’s cash position in relation to its current liabilities.

Not every asset can be converted into cash. To raise cash and boost liquidity, managers should turn to cash equivalents on the balance sheet, especially near-cash assets such as inventory and accounts receivable, instead of selling long term assets. Opportunities to mine cash varies between companies; in the chemicals industry, trade receivables as a percentage of sales have ranged between 15 and 25 percent for the last several years. Reducing these percentages by 5 to 10 percent can release tens of millions of dollars of cash.

Rethink the Basics of Measuring AR—What and How?

Many companies miss the liquidity potential by tolerating too many inefficiencies in the order to-cash process. Rather than managing each of the process’s five buckets, companies tend to ignore the earlier ones, and focus on the overdue problems at the end of each quarter. “Improving management so that AR is permanently reduced is critical for success in today’s environment,” said Ahmed.

The first step toward better AR management is to change what you measure. Many companies use “invoice to cash” or “dispatch to cash” to tally their AR numbers, which exclude critical pieces of information. Companies should take a broader view by measuring the entire order-to-cash process, to uncover the root causes of poor receivables. By taking a holistic approach; focusing on the root causes of payment problems and managing each bucket properly; companies can make AR reduction more sustainable. 

The second step is to change how you measure. Instead of using a typical point in time to measure receivables, companies should calculate an average AR, which gives a truer understanding of AR status. To calculate an average AR, a company must delve into individual orders and invoices over a period of time.

The Five Buckets in the Order and Cash Process

Once a company changes what and how it measures, the next step is to apply those measurements across the order-to-cash process, giving attention to all five buckets:

  • Order to dispatch: Working capital in this bucket is often calculated as part of inventory and does not show up in official AR numbers, yet often the causes of customer dissatisfaction and late payments are rooted here. “Attention to this area can speed up inventory turnaround and reduce late customer payments,” explained Ahmed.

  • Dispatch to invoice: Automated, dispatch-linked invoicing has improved the efficiencies in this bucket, but problems still occur such as batch invoicing, missing invoices, and poor invoice quality, that trap working capital and lead to problems later in the order-to-cash process.

  • Invoice to due (a.k.a., payment term): This bucket contains the most working capital and offers enormous potential to accelerate payments and unlock cash. It often receives little attention because the sales force and credit teams focus efforts on the overdue AR later in the process.

    The overarching philosophy is that payment terms should be simple, specific, and fit-for-purpose. Simplicity cuts and rationalizes the number of payment terms; reducing complexity, administrative burden, and the chance of errors. Specificity makes payment terms more uniform, and reduces staff workload. Fitness for purpose differentiates among customers, offering tailored payment terms for high value customers and more generic terms for less valuable ones.

    “Careful analysis of the current invoice-to-due situation helps quantify the potential working capital benefit of different payment terms -putting a dollar value on the difference between the current invoice-to-due situation and the ideal situation,” stated Ahmed. Solutions include the reduction of non-standard payment terms, moving from “end-of month” to “date-of-invoice” invoicing, aligning the payment terms of the customer to the sales and margin contributions, and identifying and resolving outliers.

  • Early payments: Most customers pay early only when incentivized. The challenge is to maximize the early payment potential without giving away too much. As part of the discount offer, companies should define discount-linked payment terms by offering two choices—e.g., one payment term for “short, with a discount” and one for “standard, with no discount”. Discounts are powerful tools for encouraging changes in payment terms, and over time price increases can reduce the effect of the discounts.

  • Overdues: This bucket receives much attention for AR reduction, especially at the end of reporting periods. However, tactics to unlock cash often leave the underlying causes of late payment unaddressed. There are better ways to manage and reduce AR; firms must prioritize the collection effort and then apply specific solutions for the two distinct categories, intentional and unintentional, each requiring a different approach.

Sustainable Change for Cash Strapped Times

The need for cash is apparent, and companies must conserve cash for tough times ahead. “By establishing procedures that push near-cash assets into actual cash, a company can create a more liquid balance sheet on a sustainable basis,” explained Ahmed.

This effort requires a new approach to AR management. By adopting a holistic approach to the order-to-cash process and focusing on average AR instead of point-in-time AR, companies can better identify payment problems earlier and design solutions. Thus a company can accelerate payments, reduce AR, and boost its cash position. For many companies, a sustainable 10 percent improvement in cash release during the order-to cash process is possible. We think of AR reduction like a spring-loaded starting block: an enviable advantage in management’s dash for cash.