How do we know if receivables are well managed to credit terms? Are we performing at our best? What if we are the best in industry according to external benchmarks? How may we then do better or is it possible at all? Credit managers often face these questions in the never-ending quest to collect to terms and to drive down terms where possible. An analysis of the customer master is requisite to answering these questions as well as to enable one aspect of credit term optimisation.

Customer Master Analysis

As firms grow a variety of factors lead to an accumulation of ‘multiple’ customer line items. These items are found or logged in the customer master (or equivalent in an ERP or accounting system) are the details for each customer including entity name, billing details, terms and other notes that relate to the customer. We have found common errors in both paper and IT based systems of firms we have worked with and these include:

One customer listed multiple times due to spelling differences or billing/contact address differences

Multiple differing terms due to numerous customer listings from the point above though this results more often as a result of legacy resulting from personnel turnover

Both points above are found as a result of M&A activity where names, addresses and terms are inherited or grandfathered

Understanding this level of detail permits one to commence investigation into terms granted to a customer from the working capital management perspective. Conducted either together or apart from an aged trial balance for third party receivables this analysis allows the firm to ‘clean’ up administrative details such as multiple names for a single entity (see ‘client’ in table below). Sales is often involved in this project to enable an organisational understanding of where the client stands and should stand. A cross functional and cross-business unit project – customer analysis enables a common understanding among different business units that may be selling to the same client.

The optimisation that occurs upon analysis of the customer master is that of simplifying billing (to a single entity as opposed to multiple entities) and reducing the opportunity for disputes (spelling error, legal name error, billing address errors etc) that delay payment.

Terms Analysis (BPDSO)

A derivative of fields from both the customer master as well as current receivable data we are able to calculate what an appropriate Best Possible Days Sales Outstanding (BPDSO) would be.
This is performed by aggregating the receivables found listed across the differing ‘entities’ that represent one client or one segment.

Sample of Terms Analysis for a single customer

Table 1 demonstrates the receivable data put together with the customer master and ‘open’ or ‘uncollected’ receivables data. Adding all weighted terms (% AR * Real Terms) for this particular customer, represented by 7 recorded entities, yields a summed number of 36.94. BPDSO therefore represents in real terms that at this point in time there should be not more then 36.94 days worth of sales in terms of uncollected receivable for this customer – with the assumption that all receivables are paid on time and in full. This is despite that there are a variety of terms ranging from 15 days through 90 days.
BPDSO is far more accurate since there is a weightage assigned to the oustanding receivables, unlike a simple average terms analysis – 42.86 days outstanding in Table 1 – which many credit managers are prone to use as a measure of best possible performance when faced with a multi-credit term customer.

Term Optimisation

Combining the customer master file analysis reveals terms that a customer already finds acceptable. For sales conducted across multiple business units (supplier and customer) this information represents an optimal credit term which the customer finds acceptable. A Credit Terms Analysis yielding a BPDSO tightens overall credit terms and assists credit managers as well as sales persons to keep customers on a well defined credit scheme.

BPDSO is also a useful indicator for best possible internal performance (internal benchmark) especially when one may already be performing at relative industry ‘best.’
For several clients with whom we have performed Account Receivable projects for this portion of the project yields:

An overall tightening of terms by 10% to 35% resulting in and from simplified credit schemes for customers – resulting in quicker cash in and also lower operating costs as a result of less conflicts and confusion between sales and finance

An ability to forecast cash requirements resulting from open AR (a portion of cashflow forecasting)

Management’s ability for clearer insight into customer behavior and opportunity to formulate strategic sales deals utilizing credit as a facility responsibly

An ability to gauge AR and credit term performance particularly when external benchmarks are no longer applicable

Print

Supply chain strategies often take second or third place to operations in the growth and development phase of an organisation.  One of the unintended (though sometimes strategically intentional) operational consequences of aggressive growth, both organically as well as through M&As, is that of product or SKU proliferation. As a result, forecast to fulfill gets slowed down.

Working Capital Area: Forecast to Fulfill

SKU proliferation manifests itself as a hindrance to supply chain efficiencies in a variety of forms including:

• An ‘impressive’ range of product
• Dramatic levels of raw material or WIP, the latter held as a strategy of postponement
• Elaborate operational set ups that often challenges productivity and efficiency KPIs resulting in large production batches
• Loss of operational and commercial control as batched production produces a bull whip effect in finished goods inventory
• An inflated balance sheet where inventory is concerned and gradually thinner margins due to missed or short ships as a result of batch & efficiency metrics

Taken individually, these anomalies can be dealt with, and they frequently are, in a piecemeal fashion.  Slashing SKUs across the board delivers instant results but a trade off is that of falling efficiency levels measured at the plant level.  Inventory can be shifted onto a VMI strategy where costs are kept off as long as is possible though this eventually strains supplier relations.  Moth-balling entire plants are not uncommon once ‘demand’ is perceived to have dropped though this leaves much to be desired in terms of industrial relations.  Micro-management becomes the order of the day and a fairly immobilized organisation results.  Undue force is applied to ‘balance’ the balance sheet in an effort to improve margins.

Collectively however, addressing such a situation at the strategic level while selectively ‘leaning’ some operations yields results that are relatively more ‘stable’ to the organisation.

A multi-variate analysis of product selectively utilising Pareto principles ought to produce an SKU range that is manageable both from the marketing / margin perspective as well as the operational perspective.  Combined with some innovative product re-design resulting in ‘multi-use products’ as well as postponement, the results are appreciable.

Some of the variants to be considered are:

• Movement (traditional ABC)
• Value in dollar terms
• Margins
• Inter-operability
• Market positioning & share
• Ability of the product to be innovated upon
• Strategic position for consolidation

Forecast to Fulfill – Benefits of Managing SKU Proliferation

A diversified industrial client we worked with in this area managed to lower overall (RM, WIP & FG) SKU counts from some 5,500 to 4,200 over the duration of an 18 month long project.  A 22% reduction.

Project yields beyond SKU consolidation were:

• Overall decrease in inventory of 15%
• Short / missed shipments decreased by 60% resulting in less commercial and financial penalties
• Expedite (both for production and shipping) occurrences decreased from a monthly average of 370 to under 100

Less tangible benefits were an improved working relationship between the front and back ends of the firm and an improved understanding of how better sales and marketing could work together with production to ensure a lid on SKU proliferation.

Credit lines drying up are common phenomena these days. Past credit performance, even with a great history, seems to have no impact on the decisions of banks to lubricate the wheels of commerce. There is, however, a relatively cheap and available source of cash many firms have that may be tapped into now: Working Capital. Working Capital – or the cash flow of a firm – can broadly be categorised into:

1. Customer to Cash (Receivables Management)
2. Forecast to Fulfil (Inventory and Supply Chain Management)
3. Procure to Pay (Payables Management)

Often simply referred to as ‘cash flow,’ working capital resides on the balance sheet of a firm. Improvements in this firm-spanning area yield many returns including the reduced need for cash to keep operations running, a reduced requirement for finance facilities that attract interest payments (Weighted Average Cost of Capital or WACC), well tuned and simplified processes which often mean a reduction in operating expense and P&L impacts. All these are some of the critical fundamentals that every analyst looks for in all economic climates. Even more so today.
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