The Credit and Financial Management Review

First Quarter 2005

Creating a World Class Accounts Receivable Process - Four Powerful Approaches

The role of Accounts Receivable departments, and finance as a whole, is rapidly transforming in today’s enterprise. Formerly thought of as a purely administrative role, A/R functions extending from credit and collections to cash management are now being viewed as a strategic cornerstone that can deliver unprecedented competitive advantage and greater profitability for leading corporations.

Recent surveys of forward thinking companies have cast a clearer light upon the forces which are currently driving A/R departments. As can be seen in Fig. 1, A/R departments are under pressure to provide strategic information around cash flow to CFOs and treasury groups, and at the same time to better manage the customer-to-cash cycle and improve transactional efficiencies. Mastering this three-part role of strategic financial guidance, revenue management, and low-cost efficiency is crucial to building high performance A/R departments. However, many companies face the challenge of fusing these three, often divergent, roles into one streamlined and effective organizational entity. This article discusses these challenges as well as four innovative approaches that world class companies have taken to drive their A/R performance to new heights.

The findings of the survey point out key challenges that confront today’s A/R departments. They are summarized into the following three categories and have their own unique requirements:

Pressures to deliver strategic cash flow insight to the CFO’s office – As many companies are emerging out of a previously harsh financial climate, they now place a sharper focus on improving profitability along with the “tone at the top”. This ranges from understanding the up-to-the-minute status of the balance sheet and operational cash flow to ensuring compliance to Sarbanes-Oxley (SOX) standards around A/R processes. More and more, A/R departments are now being asked to provide strategic guidance to the CFO and Treasury groups about current and future cash positions so as to enable better financial decision making and disclosures to Wall Street. In addition, CFOs are looking to A/R departments to establish, maintain and ensure certification of internal controls around receivables to meet SOX requirements. Finally, CFOs are also expecting that A/R departments serve as a financial “nerve-center” and provide forward looking guidance and warnings into changes in projected cash flows, thereby enabling companies to take corrective action earlier in the cycle.

Pressures to optimize cash flow and revenue management – Along with better and more timely financial reporting, A/R departments are also expected to continue to maximize cash flow for their companies, sometimes at an elevated pace in comparison to previous years. Improvements in working capital and cash flow management are being seen as important corporate initiatives and receivables are clearly a core element of achieving these objectives. A/R departments are being measured on the proper management of credit risk and efficiency in collections, thereby leading to reductions in DSO, revenue leakages and bad debt write-offs.

Pressures to reduce company-wide operational expenses – Last but not least, A/R departments are expected to achieve all of the aforementioned goals with a minimum of operational costs and a maximum of efficiency. A significant portion of the companies surveyed were moving to centralized finance models such as Shared Services Centers, where smaller, more specialized teams of A/R personnel were servicing multiple business units across the globe. In these centralized business models, having a focus on transactional efficiency and quality is the key to success. Along with the demands for cost efficiency is the challenge of putting in place best practices in receivables management that address the need for consistency in global processes along with placating local or country-specific business requirements.

The results of the survey indicate that A/R departments have varying objectives in each of the three categories. Of particular interest is the need to incorporate flexible and repeatable processes for A/R functions which are deemed best in class for their respective industries. Additionally, a high focus is also placed on gearing A/R processes to be more value added and customer-facing in nature, whereas a separate goal is to automate non-value added, oftentimes manual functions. The distribution of the many stated objectives can be seen in Figure 2. In general, they mark a clear movement towards the new three-pronged role of A/R in the current business environment. In turn, a new set of approaches to A/R processes need to be crafted to help companies cope with these demands on receivables management.

Achieving Financial Transparency & Predictability in A/R

The need to implement a process centered around providing real-time cash flow information to executive management places the burden on A/R departments to do the following:

An example of a company which successfully dealt with the pressures of creating top-down financial transparency in A/R is Syngenta Crop Protection Inc., a $3 billion agri-chemicals division of a $7 billion chemicals company. Syngenta faced daunting challenges after its spinoff from Astra Zeneca and Novartis, two global chemicals industry giants. Top priority was given to getting a better handle on cash flow and cash forecasting in order to enable Syngenta to quickly pay off $4 billion in post-spinoff debt. As a result, Syngenta’s CFO and treasury groups needed real-time visibility into cash flows from receivables in order to make better short-term investment and borrowing decisions. The task fell on Syngenta’s A/R department to quickly develop a high performance receivables management process.

The newly formed company looked at the entire Customer-to-Cash process and decided to build in process efficiencies and best practices from the very beginning. Syngenta’s cash flow challenges were compounded by the fact that it had a complex customer network comprised of dealers, agents and retailers, all of which could serve as collections entities for payments from end customers. Also, due to the fact that Syngenta was selling into agricultural markets, its cash receipts cycle was dependent on end customers paying invoices based on the outcomes of crop harvests in the year. This meant that Syngenta’s customer would typically pay invoices 6 to 9 months after being billed, leading to a high level of seasonality in the A/R portfolio. In order to counteract this uneven cash flow, Syngenta offered a series of variable cash discounts throughout the year to coax customers into paying earlier. The combination of early incentive discounts and complex dealer-agent-retailer relationships presented obstacles to gaining timely and accurate visibility into current and future cash receipts.

Syngenta first addressed these issues by instituting process changes in the A/R department. The team started by examining the type of performance metrics that needed improvement along with the specific requirements for information from the CFO and treasury organization. A/R performance metrics that were zeroed in on included DSO and average past due balances. Next, the A/R department looked at its credit and collections process with an eye towards optimizing revenue risk based on customer segmentation. A/R policies were put in place to tie actual collections and receivables activities to customer credit risk profiles. For example, customers specified as low risk were addressed with more lenient collections approaches (e.g. sending reminder letters when the invoice goes 30 days past due) while high risk accounts were dealt with more severely (e.g. sending dunning letters when the invoice is 7 days past due).

After this, the A/R department looked at the processes by which aged receivables were addressed, how specific accounts were chased, and also how promise-to-pay information from customers was recorded and used in portfolio analysis and cash forecasting. It turned out that a lot of these tasks were manual, paper-driven processes. Promise-to-pay information was received based on a verbal agreement by the customer with little recourse taken when promises were broken, provided the A/R department was alerted to these exceptions. Understandably, the lack of cohesive processes and automation was driving wild swings in cash forecasting accuracy and past due accounts, thereby hampering the A/R departments ability to give accurate guidance to the treasury group and CFO. Putting in place effective policies around these A/R processes was instrumental in achieving Syngenta’s corporate goals.

Finally, Syngenta chose to automate its many manual A/R processes and improve cash forecasting accuracy by utilizing a state of the art cash flow management solution. This solution offered flexible business rules in the form of collections strategies that would prioritize and automate many of the collectors’ tasks. This then drove the A/R team to better monitor and manage the cash collections and forecasting processes.

“We had previously been subject to a high degree of uncertainty in terms of when our cash receipts would come in,” stated Bert McCuiston, Syngenta’s head of credit, collections and cash management. “Now with the process changes and automation in place, our team is able to proactively deal with customer delinquencies and also quickly advise our treasury group about future changes in cash flow. This is now based on actual outstanding transactions and specific commitments from customers as opposed to general projections by the collector.”

The results of this concerted effort to improve receivables management were astounding. Syngenta’s average past due balance dropped by $29 million in comparison to the previous year while average deductions balance decreased from $2.9 million to $1.1 million. All of this translated to a DSO reduction of 4.5 days. Additionally, as shown in Fig. 3, Syngenta’s cash forecasting accuracy improved up to 35% in certain cases. The remarkable gains in cash flow and process improvements have contributed over an estimated $3 million annually in bottom line savings to Syngenta. Furthermore, having accurate visibility into cash flow trends armed Syngenta’s treasury group with the information needed to make better cash management decisions.

During this same time, Syngenta was also hurrying to meet its deadlines for SOX compliance. The A/R department instituted policies and procedures that ensured a full audit trail of all receivables transactions. Aging reports and cash forecasting functions were used to disclosure future changes in cash flow. Again, having a cash flow management solution was key to automating, testing and implementing this set of internal controls. The result at Syngenta was a “well controlled” rating for SOX compliance given by the Global Internal Audit group. The process changes and tools put Syngenta well on its way to meeting its compliance deadlines.

Finding the Quickest Path to Revenue Assurance

Taking a holistic approach to maximizing revenue from sales offers benefits in many different aspects of receivables management. By looking at the complete Customer-to-Cash process as depicted in Fig. 4, companies can see the specific chokepoints that delay or prevent customers from paying invoices on time. The critical components to examine are revenue assurance in the form of credit risk management at the beginning of the process and how tightly it is interwoven with complex collections and payment processing transactions at the back end. When this complete process works seamlessly, the A/R portfolio along with past due amounts and write-offs is greatly improved. Delving into this tightly woven Customer-to-Cash process highlights specific disconnects that bear further discussion.

One common pitfall in A/R management is to treat credit risk management and collections activities as two separate functions. In reality, the two processes are very much intertwined and influence each other greatly. Proper credit risk management acts as a critical gatekeeper during the customer qualification and order management processes to limit a company’s exposure to bad debt write offs and delinquent payments. The practice of customer segmentation offers leading companies a way of categorizing customer risk and then driving subsequent credit and collections activities.

Profiling and determining credit risk for specific customers has to take into consideration numerous factors, both from external as well as internal sources. External sources such as credit bureaus (e.g. D&B, Experian, etc…), financial filings and trade references need to be intelligently combined with internal payment history and A/R portfolio data during the credit review. Additional considerations need to be given to whether the customer in question is a brand new account or has a previously existing business relationship with the company.

The best approach that many successful companies have taken towards credit risk management is one that considers multiple factors and different business scenarios before determining a customers’ credit risk profile and limit. A superior cash flow management solution will offer companies the means to determine credit risk with what is known as a “Glass Box” approach rather than a “Black Box” approach. Many credit scoring systems are “Black Boxes” in that they simply calculate a credit score without giving the credit personnel any insight into how those calculations were carried out and what factors influenced the outcome. The “Glass Box” approach gives the credit analyst the capability to understand the calculations of credit scores, analyze past payment trends and modify different conditions to simulate exception scenarios. An exception scenario could entail predicting the revenue effects of a raising a particular account’s credit limit by 1% or 2% on a specific order. The many business levers that a credit analyst can manipulate allow for better and more informed credit granting decisions.

This all comes to a junction in the handoff process between credit risk analysis and collections activities. Here, companies have to be very careful to make certain that the collections department knows what the credit department is doing, and vice versa. Leading cash flow management systems will guide A/R personnel to address delinquencies in a manner suitable to an account’s credit risk and past payment history by using tailored collections strategies. By integrating the credit and collections aspects of the Customer-to-Cash process, companies can help assure that a higher level of revenues actually materializes based on sales.

The next set of disconnects is present in the invoicing through collections and payment processing cycle. Here, it is important to ensure accuracy of the generated invoices with respect to originating customer purchase orders, sales orders and shipping documents. Typical reconciliation issues that prevent or delay payment include wrong pricing, wrong part numbers and incorrect quantities displayed on the invoice. Having proper procedures to ensure the monitoring and alerting of these discrepancies is critical to establishing a clean process from quotes through invoicing. A cash flow management solution can help automate much of the reconciliation activities and provide a host of reporting functions to pinpoint erroneous transactions within the Customer-to-Cash process.

Deductions (short payments) and disputes are also frequent cause of unrealized revenues. Customers oftentimes either mistakenly or purposely short-pay invoices, causing adverse effects on cash flow for the supplying company. The company then has to enter into a protracted dispute resolution process to clear up any erroneous deductions. All of this takes up valuable time and resources and more often than not, ends up in write-offs of the disputed amounts.

Deductions typically occur due to the following reasons:

Maximizing revenue was first and foremost on the minds of executives at Leiner Health Products, a leading $800 million supplier of vitamins to retailers such as Wal-Mart and Long’s Drugs. Revenue leakages from deductions taken by these retailers were piling up to 40% of sales in certain months. With this type of drain on the bottom line, Leiner knew it had to act quickly to plug its cash flow losses and redirect itself towards profitability.

Leiner examined its Customer-to-Cash processes and realized that there were multiple reasons for deductions from customers. First, a high amount of unauthorized deductions were incorrectly taken by customers for reasons such as those related to trade promotions. The second group of deductions taken were those that were seen as being preventable – many of them related to non-compliance and erroneous shipping, freight handling, etc… These deductions needed to be not only resolved, but also examined with eye towards removing any root causes in terms of process defects. Finally, the last set of deductions were those which were pre-authorized and simply needed to be quickly identified and accounted for in Leiner’s budget.

The company embarked on a process redesign initiative that spanned across multiple departments within Leiner and extended to its customers. Leiner’s management team realized that reducing deductions required a collaborative approach between the A/R, sales, trade planning and logistics departments. In many cases, simplification of the way Leiner conducted business with retailers – such as reducing the number of SKUs and trade promotions programs offered – made the occurrence of deductions less likely. However, in a majority of the cases, Leiner had to support its process changes with a workflow-enabled cash flow management solution. This solution was able to automatically identify different deductions, route them through the company for rapid resolution and also offer up detailed reports that allowed Leiner to address the root causes for short payments. Here again, automation in conjunction with A/R process changes was key to improving revenues.

The results at Leiner came almost immediately. Backlogs of deductions that had not been addressed in a timely fashion were driven down by 75%, boosting annual revenues by over $12 million. The average time required to identify, route and resolve deductions dropped dramatically from 50 days to less than 5 days, and within the same day in many cases. The value of deductions taken decreased from an average of $8 - $10 million per month to negligible amounts under $100,000. This initiative was truly an antidote to Leiner’s cash flow problems.

On top of all this, Leiner’s process changes and tools offered more control over the types of deductions that were ultimately experienced by the company. As can be seen in Fig 5., Leiner’s revenue leakages before the receivables management initiative were comprised of a startlingly high percentage of unauthorized and preventable deductions. Furthermore, a large majority of the pre-automation deductions were made up on pricing and non-compliance errors such as wrong SKUs and packaging/labeling mistakes. After automating the deductions management process, Leiner saw a remarkable drop in unauthorized short payments as well as a better spread in the types of deductions taken. Gaining this tight control over deductions in Leiner’s case was a big step towards achieving superior financial performance.

Building Quality Into the Cash Flow Process

Companies that have a large number of transactions in A/R can gain considerable efficiencies by placing a high priority on process. Measuring quality in receivables management has many facets that a leading company should consider:

A common trend in many companies is to utilize a proven methodology like Six Sigma to drive receivables management processes. Six Sigma is a business philosophy that drives a process to operate at near perfection. This is typically stated in the terms of producing only 3.4 process defects per 1 million opportunities. For example, a billing process operating at Six Sigma levels would be producing 3.4 invoicing errors per every million invoice transactions. Business processes that are developed with Six Sigma in mind have proven to deliver long lasting benefits including lowered costs, improved customer satisfaction and ongoing improvements in business performance.

The starting place for many Six Sigma initiatives is to take current phenomenon, such as a high percent of A/R being past due, and dive into the root causes. Then, new processes can be shaped that either eliminate or counteract the casual factors. A common tool that is used to perform root cause-and-effect analysis in many process improvement methodologies such as Six Sigma is the fishbone diagram as shown in Fig. 6. This tool has multiple components – the “head” is typically the “Critical to Quality” parameter which is being examined, the “bones” which are the various input categories that drive that parameter, and the smaller bones are the actual inputs for each category. The fishbone is created in a collaborative manner by the various process “experts” in the A/R department. The final output of this brainstorming session is a targeted list of quality drivers which need to be incorporated into the new A/R process. In the example shown, these key variables have been boldfaced. These insights can then be a springboard for a high quality process redesign at many companies.

Staring face to face with a massive 150,000 invoices a month, $2 billion staffing services provider Volt Information Sciences Inc. realized its company-wide commitment to Six Sigma level transaction quality could easily be applied to its A/R department. Realizing that the best way to produce a high quality process lies in building it up from scratch, Volt embarked on a Design for Six Sigma initiative centered around its receivables.

“The philosophy of Six Sigma is very much ingrained within all aspects of Volt’s business,” stated Terry Jordan, senior credit manager and Six Sigma black belt at Volt. “In the A/R department, we successfully used Six Sigma to design a new receivables management process which fostered superior customer satisfaction and operational efficiencies.”

Volt followed a very well planned out strategy to bringing superior levels of quality into its A/R department. First, the team mapped out all A/R processes as if they were manufacturing operations, indicating supplying departments, data inputs, data outputs and internal and external customers of the process. The last element of this is important because it defines what is known as the Voice of the Customer (VOC) in Six Sigma projects. The VOC sets the stage in terms of how requirements for processes are defined and how solutions are measured and evaluated.

The next step was to look at each of the processes and determine which were value-added steps and which were non-value add steps. The non-value add steps were easy candidates for automation while the value-added steps required supporting tools to enable the A/R team to operate more effectively. In this manner, Volt looked at everything from credit management, billing, collections follow up activities, dispute resolution and performance monitoring. The final result was a newly defined process map where all A/R functions were streamlined and geared towards better business performance.

A cash flow management solution was then implemented at Volt to serve as the underpinning for the newly defined processes. All of the non-value added activities, such as prioritizing collector’s calls, emailing, faxing invoices, etc were automated with the solution. The value add activities such as making contact with customers, analyzing the A/R portfolio, etc… were supported by the new system which empowered Volt’s collections team to focus on dealing with customers and better manage the portfolio. The selection of the cash flow management solution was also done using the Six Sigma methodology, thereby ensuring that the Voice of the Customer was being heeded.

Using a structured, quality driven approach to A/R has paid off for Volt. DSO has been kept in check for critical customer accounts and bad debt write offs have been substantially reduced by $750,000. The process improvements and cash flow management solution have brought in extensive improvements in cash flow and current savings of nearly $1 million, with additional ongoing savings projected for the future.

Leveraging Shared Services to Do More With Less

Under pressure to cut costs in every aspect of their business, Fortune 2000 companies have also begun to use centralized operating models for cash flow processes such as receivables management. The move towards Shared Services typical comes about for multiple reasons:

With Shared Services for A/R functions, corporations can utilize a combination of experienced personnel, global best practices and cash flow management technology to bring about long lasting improvements in cash flow.

No stranger to building a leaner and meaner enterprise, Solectron, a $12 billion electronics contract manufacturer, set its sights on establishing specialized A/R Shared Services Centers to service its global business units at a low cost of operations. The company was going through turbulent times and had to look at new ways to leverage its resources. An additional twist presented itself in the form of disconnected ERP systems that were resident in its many global operating units, thereby obstructing the ability to gain an accurate global view of receivables.

By establishing its Shared Services centers in North America, Europe and Asia, along with a cash flow management solution to serve as much needed infrastructure, Solectron was able to effectively service global operating units. A/R processes were streamlined and best practices were replicated across all regions. This powerful centralized operating model also allowed Solectron to address regional issues such as local language and documentation requirements while running a global organization at full speed.

The employment of a cash flow management solution was also critical to Solectron’s success in this endeavor. This web-based solution not only integrated disparate financial systems, but it also provided built-in receivables automation and best practices. Many of the time consuming tasks that the decentralized A/R departments had to perform, such as researching invoices, transmitting documents and generating dunning letters, were fully automated by the system. In this manner, Solectron’s smaller team could easily handle customers spread across the globe.

Solectron reaped massive returns from its Shared Services initiative. With better visibility into A/R, improved cash forecasting and automation, Solectron was able to deliver $14 million in bottom line savings based on interest expense savings alone. As an added bonus, this initiative brought the company an additional $1 million reduction in direct expenses. As the high technology manufacturing industry continues to improve, Solectron has a solid foundation of cost control and transactional efficiency to rely on for the future.

Blueprinting The A/R Department of the Future

In all of the aforementioned case studies, the companies were able to achieve positive financial returns by employing a powerful recipe of experienced A/R personnel, receivables management processes with embedded best practices and leading edge cash flow management technology. All three components of the solution were necessary in order to achieve the corporate objectives. The final ingredient is to leverage a strong change management philosophy to implement and manage new processes and solutions on an ongoing basis.

Companies seeking to achieve improvements in Accounts Receivable by redefining their processes would do well to keep in mind the following points:

Lou Mohanty is the Director of Marketing at Emagia Corporation, the leading provider of Enterprise Cash Flow Management software solutions and managed services. Additional information on Emagia can be found at www.emagia.com.