Tag Archive for: Working Capital management

Trading places – is big tech the real threat to banks?

| 01-11-2017 | Lionel Pavey |

 

Reading yesterday’s article about Fintech banks reminded me that, in the last few weeks, I had seen articles in the news about the growing interest in providing banking services by so-called Bigtech companies. Bigtech is defined as established “platform” players such as Amazon, Google, Alibaba and Paypal. These companies are already providing finance to small businesses – Amazon has already lent USD 3 billion to online merchants.


Whereas Fintech startups are trying to find funding for their ideas, they do not have a large supply of capital to truly offer large scale lending facilities. They are well suited to participate in peer-to-peer lending initiatives and can certainly show established banks how to do things in a new way, but they do not have the true scale to compete against banks. Bigtech companies, with their vast cash reserves and huge databases, present a very serious problem for existing banks.

Bigtech already collect and analyse data from all their clients. This gives them a unique insight in how to review and redesign the processes for banking, allowing for faster services, reduced costs and reaching a critical mass for trading on an electronic platform.

According to research from consultants McKinsey & Company “Seventy-three percent of U.S. millennials say they would be more excited about a new offering in financial services from Google, Amazon, Paypal or Square than from their bank — and one in three believe they will not need a bank at all”. Platform companies therefore appear to have a very strong and loyal relationship with their customers.

Japan’s largest online retail marketplace – Rakuten Ichiba – offer their customers:

  • Loyalty points and e-money usable at hundreds of thousands of stores, virtual and real.
  • Credit cards issuance to tens of millions of members.
  • Financial products and services that range from mortgages to securities brokerage.
  • Run one of Japan’s largest online travel portals.
  • Instant-messaging app, Viber, which has some 800 million users worldwide.

This is a very comprehensive list of what are, basically, supporting services to their main function as a marketplace. Banks offer traditional services with little or no additional services.

Where can Bigtech make a difference in the current banking model?

All online marketplaces bring both buyers and sellers together. Most sellers are companies that can be classed as SME (Small and medium-sized enterprises). In the current market SME’s are experiencing difficulties arranging finance. A survey conducted by the Asian Development Bank (ADB) concluded that there is a gap in trade finance – based on bank rejections on applications for trade finance – of about USD 1.5 trillion. SME’s make up around 75 per cent of that total. Furthermore, 60 per cent of companies that responded, stated that rejection led to losing trade. Realistically, if 10 per cent of those rejections had been financed, that would lead to an increase of 1 per cent in staffing levels for SME’s worldwide.

Trade finance is a special form of banking. It provides finance for a relatively short time – the average tenor is less than 180 days. It is a crucial form of finance as shipping goods around the world places a great strain on working capital – all the costs are upfront and the goods are only paid for after receipt. Any form of lending entails risks and for trade finance a good source of information can be obtained at the International Chamber of Commerce (ICC). This organisation is responsible for the business conduct codes for international trade. They analysed data between 2007-2014 with an exposure of USD 7.6 trillion. Defaults for short-term finance for import/export stood at 0.06%.

Providing trade finance is complimentary to online marketplaces and certainly an area where Bigtech firms can increase their presence in the financial industry. With all their data, they are better equipped than a bank to analyse the financial health of an export company. They can see how many orders have taken place, their geographical distribution, their trade value etc. They are also able to offer finance to buyers – their data is also available to Bigtech fims.

Bigtech companies have the means to take on banks; they have the data; knowledge of the marketplace; work completely in an online environment; are open 24/7 and are better known and regarded by young people. The opportunities are there – the question is how much of the supply chain do they want to influence?

When I first started in banking I worked in import and export departments. It provided a good insight into how an economy really works. I was raised on the South coast of England and, as a child, regularly played around the local commercial harbour. I still recall the smell of fresh timber and casks of Sherry and Port. The harbour was the gateway to the world; it was where adventures started. I still live on the coast – some things never change.

 

 

Lionel Pavey

Cash Management and Treasury Specialist

 

How long is your money tied up in stock?

| 7-7-2017 | François de Witte |

You might visit this site, being a treasury professional with years of experience in the field. However you could also be a student or a businessman wanting to know more details on the subject, or a reader in general, eager to learn something new. The ‘Treasury for non-treasurers’ series is for readers who want to understand what treasury is all about. Our expert François de Witte explains the cash conversion cycle and working capital managment.

Background

One of the main tasks of the treasurer is to ensure that the company has the required funds to operate. The treasurer will usually contact the banks for this funding. However, he can also finance the activities of the company by working on cash conversion cycle and the working capital management.

Cash Conversion Cycle

The cash conversion cycle (CCC) is the length of time required for a company to convert cash invested in its operations to cash collected as a result of its operations. A company’s operating cycle is the time it takes from the moment the company pays the invoices to its suppliers until cash is collected from product sales. In other words, it is the difference between when you pay for things and when you get paid.  Here is a simplified example:

When you build an equipment, you need to purchase parts. Let’s assume that you pay them 25  days after the receipt of goods and of the invoice. 10 days following on the invoice for the parts, the equipment is ready to be sold.  It takes another 20 days to sell the equipment to a customer. Let’s assume that the clients pay on average after 30 days. In this case, the cash conversion cycle is 35 days.  Hence, the business needs to have enough “working capital” to fund this transaction until it gets paid.

The following drawing illustrates the cash conversion cycle:

 

The real challenge for a company is to shorten cash conversion cycle, so as to free up cash, which can be reinvested in business or to reduce debt and interest.

If a company wishes to reduce its cash conversion cycle, and hence its working capital requirement, it can work on the following parameters:

  • Order to cash cycle: this is the time it takes from the moment of the receipt of a sales order, until the moment of the effective payment of the order.
  • Purchase to pay cycle: this is the time it takes from the moment that you issue a purchase order, until the effective payment of the order
  • Inventory management: aiming at reducing as much as possible the inventory levels

You can reduce your Order to Cash Cycle by e.g. :

  • Reducing time between delivery of goods and services, and the invoicing.
  • Optimizing the collection processes, by managing the payment delays and ensuring an active monitoring of overdue invoices
  • Using the right Payment instruments, e.g. by replacing cheques by direct debits
  • Automation of the reconciliation

You can optimize your Purchase to Pay cycle by e.g.:

  • Reducing manual and paper-based processes, duplication of data entries, reconciliation and matching processes
  • Automating the processes by moving to digital documents through OCR or other techniques
  • Aligning of the supplier terms and early payment discounts.

Working Capital Management Metrics

If you wish to monitor your performance in this area, it is important to have the right metrics. The most use measurement instruments for the working capital management are the following :

Days Sales Outstanding (DSO) :

This is the average number of days it takes for a company to collects its invoices. It is computed by dividing the commercial account receivables by the annual sales and multiplying this number with 365.

Example: A company with EUR 100 million turnover has end 2016 outstanding accounts receivable of EUR 15 million.

DSO = (EUR 15 million / EUR 100 million) * 365 =  54,75 days

The challenge for a company is to try to reduce the DSO as much as possible, hence shortening the cash conversion cycle. This can be done by reducing the payment terms and actively managing the overdue account receivable (credit control).

The DSO can vary from sector to sector, but as  rule of thumb, when this figure exceeds 60 days, this is an alert that there is an improvement potential.

 Days Inventory outstanding (DIO):

This is the average number of days of inventory a company has. I suggest to compute this by dividing the inventory  by the annual sales and multiplying this number with 365.

Example: a company with 100 million turnover has end-2016 EUR 12 million in inventory.

DIO = (EUR 12 million / EUR 100 million) * 365 = 43,8 days

Here also, the aim is to keep the inventory very low. This is not always possible, because for some sectors, there can be a lengthy production process. In addition, the company needs to ensure that it has in its shops the most used products, in order to avoid losing clients. However by putting an place a good production planning and inventory management, the inventory levels  can be further decreased.

 Days Purchase Outstanding (DPO):

This is the average number of days it takes for a company to pay its suppliers. It is computed by dividing the commercial account payables by the annual costs of purchases (goods and  external services) and multiplying this number with 365.

A company with EUR 100 million turnover, EUR 50 million of external purchases has end-2016 EUR 8 million in accounts payable.

DPO = (EUR 8 million / EUR 50 million) * 365 = 58,4 days

Traditionally, it has been recommended to try to increase the DPO much as possible, hence shortening the cash conversion cycle. This can be done by e.g. increasing the payment terms. However, when a company is cash rich or has an easy access to credits, it can be beneficial to decrease the payment terms by negotiating discounts.

The DPO will also vary from sector to sector.

Length of the Cash Conversion Cycle (CCC):  

This can be computed as follows:

CCC = Days Inventory Outstanding + Days Sales Outstanding – Days Payables Outstanding.

Example:

  • Average receivables collection period = 54 days
  • Inventory conversion period = 43  days
  • Average payable deferral period = 50 days
  • CCC = 54 days + 43 days – 50 days = 47 days

Cash Conversion Cycle (CCC) in absolute amount:

I recommend to also look at the overall figure of the CCC:

CCC in absolute amount  = Accounts payable + Inventory – Accounts Payable

Example :

  • Accounts Receivable = EUR 15 million
  • Inventory = EUR 12 million
  • Accounts Payable = EUR 8 million
  • CCC in absolute amount = EUR (15 MM + 12 MM – 8 MM) = EUR 19 million

Why active working capital management is important

Working capital management is a cheap source of financing, because, except in the case of early payment discounts, there is no financing cost.

The following example illustrates the gains a company can generate by improving its cash conversion cycle.

  • Turnover : EUR 100 million
  • Accounts receivable: EUR 15 million or 54,75 days
  • Inventory : EUR 10 million or 43,8 days
  • Accounts Payable : EUR 8 million or 58,4 days
  • Average financing cost : 3 %

By reducing the DSO from 54,75 to 45 days, and the inventory from 43,8 to 40 days, the company can reduce its financing needs as follows:

  • Accounts receivables: from EUR 15 million to 12,33 million (or EUR 2,65 million)
  • Inventory: from EUR 10 million to 10,96 million (or EUR 1,04 million)
  • Reduction of the CCC: from 40,15 days to 26,6 days
  • Reduction in financing needs: EUR 2,65 million + 1,04 million = EUR 3,69 million
  • Financing cost savings: EUR 3,69 million * 3% = EUR 110.700

Hence, when making up your financial plan, make to also focus on optimizing your cash conversion cycle, as this enables to realize easy gains. In reality this is not always easy, but it is worth the effort.

François de Witte – Founder & Senior Consultant at FDW Consult

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Working capital management : Some practical advice on the optimization of the Order to Cash Cycle

| 27-2-2017 | François de Witte |

 

As mentioned in my article “Treasury : proposed “to do” list for 2017”, working capital management will remain a hot topic throughout the year. The first priority is to reduce the working capital needs and financial expenses by optimizing the Order to Cash cycle. In this article, we will develop a plan of approach and propose some concrete actions enabling to generate tangible savings.


Background

The purpose of the Order to Cash optimization is to improve the whole cycle from the moment of the ordering of the goods or services, until the final payment, with the aim to:

  • reduce operational inefficiencies and risks such as delays between goods or service delivery and invoicing, credit management issues, unapproved discounts and deductions, data quality issues, etc.).
  • improve a number of processes such as the invoicing, the dispute management, the credit management and credit control
  • assess the current the tools, build business case for the improvement thereof, and implement them.

Plan of Approach

When starting such a project, I recommend to have at first a quick scan of the overall Order to Cash process so as to identify the critical areas and to assess the business case. Based hereupon, one can then subdivide the project in a number of streams.

In such a project, typically the following processes should be covered:

Ordering processes:
It is important to have a client acceptance process (for me a must in the B2B) and a clear policy on the way orders are accepted. I recommend to only accept written orders. For nonstandard goods, we also need to examine if a prepayment is required before an order is accepted, so mitigate the risk in case that the client does not execute this obligations. It is also useful to check beforehand if the exposure on the client will not exceed the existing credit limits.

Current invoicing processes:
Ideally the sending of the invoice should coincides with the delivery of the goods or services. Furthermore it is important to have the invoices sent timely. These actions enable to reduce the “hidden DSO”. Quite a lot of companies lose several days of easy working capital by neglecting this.
A good customer database is key, and in combination with the ERP, this  enables an automation of the invoicing process.  I recommend to use as much as possible e-invoicing, so as to reduce the costs and the postal delays.

Current credit management processes:
A formalized credit policy is a prerequisite. A number of solution providers offer solutions for the scorings of your clients, so as enable you  to define the credit limits in function hereof. In some sectors this information can be enriched by market information. Of course, one need to ensure that sales staff comply with this and check beforehand that the  credit terms have been duly approved. The credit manager needs to work hand in hand with the sales staff.

Current dispute management processes:
Prevention is important. For this reason, when ordering nonstandard goods, it is recommended to check beforehand the availability of the goods and the timing of the delivery, so as to manage the expectations of your clients. Throughout the process (from the order acceptance to the delivery and the invoicing) one should apply thee “first time right” so as to avoid disputes and litigation afterwards. Check also if some services and repairs are to be done under a maintenance contract or warranty, in which case they should be invoiced to other parties.

Current collection and credit control processes
It is important to have a well-organized credit control process enabling to send reminders quite soon after the due date (if possible the first reminder after 15 days). It can help to send to send to your clients some days before a gentle reminder of the forthcoming due invoices. Once the 2nd reminder has been sent, and provided that there is no dispute, it can be useful to block the delivery of goods and services to your client, so as to have an additional leverage, and to have  the credit collectors should calling the clients to see why they do not pay, and agree with them on an action plan.
When the classic reminder and call actions do not succeed, involve also the sales department and consider first a final call  by another person, before sending your clients to the debt recovery service or to the debt collection agency.
It is important to also ensure an automation of the processes, in particular if one has to address high volumes. If you cannot do it with your current systems, there exist good solutions in the market.

Reconciliation and allocation of incoming payments:
This is a big challenge for many companies. Make sure that your clients use the right payment instruments and payment messages, so as to facilitate the reconciliation process. Within the accounting department, incoming payments are not always allocated promptly, distorting the real accounts receivable outstanding. As a result, reminders can be sent unduly, leading to client dissatisfaction.

KPI’s and Dashboards:
It is important to foresee KPI’s for all the involved stakeholders, as well as incentives to ensure that everybody play the game. Dashboards should enable to remain in control and to monitor regularly a number of key indicators. An area of attention are the overdue receivables. A too high percentage of overdue receivables/total portfolio might be an indicator of possible uncollectable receivables and the need for write-offs.

Attention points

An Order to Cash optimization program is complex and we need to address a number of issues such as :

  • The resistance to change: people will come up with several reasons to keep on with the current processes. Overwork or client dissatisfaction will be used as excuse for deviations with the processes. Hence involve all the stakeholders, take time to listen to them and to make sure that they buy in the change. If the change is well explained, people will tend to accept the changed processes. The support of the senior management is key to address this resistance.
  • The limitation of the systems such as e.g. the ERP or the accounting package: Quite a lot of companies miss opportunities because they do not understand the capacities of their ERP. Involve from the start system experts and examine with them possible workarounds.
  • The standardization of processes throughout the organization : This can be an issue, in particular when working on multiple locations. Processes should be well documented. Once this is done, one can look for the automation.
  • The information and training of the stakeholders: Make sure that process documentation is easily accessible, and consider organizing training sessions for the involved staff.
  • The time and effort needed to implement external solutions: This requires a good business case, including all the aspects. Do not underestimate the cost, the effort and time to implement the tool.
  • The determination of the KPI’s and incentives: this should not only involve finance, but also other Sales, sales administration, the production department and the other involved stakeholders. Build in incentives to ensure that everybody play the game. Make sure that the KPI’s are monitored regularly so as to be able to take corrective action in case of divergences

Conclusion

By managing better the order to Cash Cycle, you can generate a lot of savings. This requires a global approach involving all the stakeholders. To be successful, an optimization requires a number of concrete process improvements, but also the buy-in of all parties involved. A good change management should ensure that the improvements are embedded in the organization, and smart dashboards will enable to monitor that one remains on track.
Technology can help to automate the processes, but do build first a business case and to not underestimate the effort.

It can be a long journey, but in the end, it is worth the effort.

 

 

François de Witte

Senior Consultant at FDW Consult

 

 

More articles of the author:

PSD 2: A lot of opportunities but also big challenges (Part I)

PSD 2: The implementation of PSD 2: A lot of opportunities but also big challenges (Part II)

Treasury: Proposed “to do” list for 2017

Working capital management – not just a finance issue

 

Working Capital Management – not just a finance issue

|14-12-2016 | François de Witte |

money-iii

 

When looking at the sales, conversion and procurement cycle, we should not only focus on the stated DSO, but also at the hidden DSO. In order to identify this, we must go much further to a complete analysis of the order to cash cycle, as illustrated by the following  6 examples:

 

 

  • Several companies do not manage their inventory efficiently
  • Quite a lot of companies still have a time lag between the moment that the goods and the services are delivered, and the moment that the invoice is issued
  • Several  companies still issue paper based invoices. The postal delay will also increase the collection time. For this reason, I recommend to my clients to move to e-invoicing
  • When I worked with a car dealer, I realised that between the moment that the cars were delivered by the importer, and the moment that they were sold, there was a huge time lag
  • A marketing company struggled with the process of offers, leading to purchase orders, because the various participating units did not provide their time sheet and cost estimation in time.
  • On the inventory side, purchase of spare parts were done, even without having a duly executed purchase order of the client, and clients were not reminded in time to take delivery of the goods, resulting in higher stocks

Hence, when starting an assignment on the working capital management optimisation, one should not only look at the processes within finance, but at the overall processes.in the company. By analysing the detailed processes on the floor, you can better understand the drivers of the cash conversion cycle, and take some actions, such as:

  • Ensuring that procurement only purchase spare parts when they have a duly executed purchase order, with then required the advance payment
  • Making staff aware of the need to ensure a quick invoicing process
  • Understanding the possible resistance to new concepts such as e-invoicing and automated incoming document scanning
  • Identifying the triggers, which will make that the staff cooperates to reduce the order to cash cycle
  • Having a better alignment between the finance staff and the sales department on e.g. the credit risk and the payment terms
  • Make procurement more sensitive to treasury aspects. I have seen several cash risk companies who left aside the possibility of supply chain financing of discounting schemes, because the KPIs of both procurement and treasury were not aligned;

But overall, if you wish to succeed in optimising the cash conversion cycle, you need to ensure that the changes are embedded in the organisation by:

  • Explaining to all the participants the importance of working capital management and their contribution to it
  • Providing to the various participants KPIs in this area, which are monitored on a regular basis. In my recent assignment, we have put joint KPIs for the Sales Administration in prompt invoicing and in DSO terms
  • Ensuring also that there is an internal control on the procedures
  • Ensure that you have the correct tooling (e.g. e-invoicing, credit management, credit collection, etc.)
  • Having a regular review of the processes

We can conclude that an efficient working capital management is a matter for the whole company. Beside hard skills, you also need soft skills and KPIs to ensure that the processes are really embedded in the organisation.

francois-de-witte

 

François de Witte

Senior Consultant at FDW Consult