Crisis basics: Managing cash

The maxim “turnover is vanity, profit sanity, and cash flow reality” couldn’t be more pertinent at this time. Working capital typically must be monitored monthly, but in times of financial stress, it may be necessary to do so weekly and, in some cases, daily.

Debtors/receivables are the first component of working capital I want to consider here, using the common measure of days sales outstanding (DSO). A good starting point for identifying the underlying reason for your debtor days result is to analyse the proportion of your revenue attributable to those customers on the longest payment terms.

The first question I ask when working with clients is, “Do you need to sell on credit?” If the answer is “yes”, then the next question is, “Do you need to sell on credit to every customer that currently takes it?” Clearly this depends on the type of product or service they sell and to whom. A useful activity is to review the credit terms offered by an existing or new customer to their own customers. It should be possible to extract this information from their published accounts. An approach taken to amend credit terms is to adjust standard terms for new customers first and then harmonise terms across existing customers over time. When an organisation is under financial pressure, it may be necessary to prioritise sales to the customers that pay more quickly.

Monitoring payment against credit terms involves identifying invoices that are overdue using debt ageing buckets, eg, invoices past their payment date more than 1 day, more than 30 days, more than 60 days, etc. Ideally, your credit control activities should ensure that the value and number of overdue invoices decline over time. It is important to measure the weekly movement of each bucket by value. Prioritising the highest value overdue invoices is key. Equally important is to identify consistent late payment offenders, monitoring all invoices, overdue or not, with “problem” customers and getting a commitment to pay, even if an invoice is not yet overdue.

Unresolved invoice queries are a key reason for invoice nonpayment. Analysing the reasons for credit notes issued over the last few months can be illuminating, as it may highlight issues throughout the organisation, from contract terms and price and discount discrepancies to product quality or delivery issues. Any credit control or shared service can undertake this valuable function for a business.

I recently worked with a client in the facilities management sector who had a significant ageing debt problem and was also handing back 10% or more of annual sales revenue in the form of credit notes. The client had multiple separate businesses — each able to sell to the same customer base. What became apparent was that although different contract terms were agreed by each of these businesses, its largest customers only recognised them as a single supplier and held one set of contract terms on their system, using the most favourable. This led to confusion in the financial shared service tasked with collecting payment. Its customer questioned discount rates and didn’t believe payment was overdue, or if the customer had paid, the payment had not been allocated to the correct account. The eventual negotiated resolution was to move to a consolidated key customer account management process across each business unit with harmonised contract terms.

Business health indicator

Stock/inventory is one of the clearest visible indicators of the health of any business. Buying and making stock available, however, can be a problem if you’re cash strapped. One possible solution is to enter into sale or return (consignment stock) agreements with your suppliers where you hold their items as stock and pay for them when sold.

It is imperative to turn stock into cash by expediting orders that have not been shipped. It’s equally important to unpack stock and get it on the shelf or into the system as quickly as possible. You should ensure that all stock is made available for sale. This also applies to stock held for a long time. Try to find a way to sell this, even at a loss or significant discount. It’s better as cash now even though it impacts profitability later.

A practical technique I encountered was used by one of the UK’s major retailers. As with many companies in this sector, a substantial proportion of sales were offered through some form of promotion. This resulted in sudden spikes in stock levels. The retailer in question asked that each promotion proposal include an estimate of the overall increase in promotional stock and movement over the campaign period. The individual estimates were aggregated every week to ensure the retailer kept within their stock and working capital targets and timed promotional activity accordingly. The promotion stock requirements were adjusted when matched to actual sales, enabling reorder frequencies and quantities to be amended. Its objective was to purchase smaller quantities more frequently, smoothing the working capital impact of promotions with negligible stock levels remaining — and it worked.

Treating creditors fairly

Creditors/payables can have a significant impact on your business if not managed effectively. These are not the people you want to exploit but rather treat fairly and maintain good working relationships with, as they too need to stay in business.

A useful calculation is to divide your trade creditors balance by your stock balance. If the result is a number greater than 1, then your suppliers are funding your stock, which is good news. Another is to analyse your suppliers’ balance sheets to calculate their debtor days. If there is an unfavourable discrepancy between the terms you have and those offered to their other customers, you may have grounds to renegotiate longer payment terms.

As with stock, measurement and forecasting is the key activity, with particular attention given to any payment incentives offered by creditors, eg, early-payment discounts. You need to fully understand the value and timing of cash outflows to ensure there is enough cash available to cover these payments. It is especially important to plan for the payment of large invoices, as it may be necessary to negotiate a separate credit arrangement to cover these, possibly with the creditor itself. The most important point is to communicate regularly with key creditors and avoid shocks.

Automation has improved the accuracy of supplier payments but can also contribute to delays. The reason for this is usually with invoice matching approval, often due to a price discrepancy or availability of authorised supporting documents. These issues tend to build very quickly, especially when processed through a shared-service facility. The payment delays usually emerge as a “bow wave” with multiple invoice payment delays becoming apparent in a short time. This can be very disruptive to the business whose people invariably are the only ones with the knowledge to understand and resolve the root causes.

Practical approaches

An example of a practical approach to resolving price discrepancies is buyers’ producing a list of products and prices from their procurement system and sharing these with their suppliers for corroboration and updating. This very manual process worked in a situation I observed, although it took some time to complete. It was, however, an improvement on the alternative suggestion: to relax the price discrepancy tolerances on accounts payable, especially where the gross margin of the products in question was around 3% to 4%.

A manufacturing client I worked with had a significant number of ageing unpaid supplier invoices. The problem was serious, with some key suppliers threatening to cease supply. The cause of the problem appeared to be that the users had not comprehensively adopted the goods receipt and service delivery confirmation requirements of a new procurement system. This impacted the invoice matching and payment process. The course taken to expedite payment was to print off a list of supplier invoices due for payment the following week and for the finance manager or controller to approve these payments on the report with a signature. This process was cumbersome but provided greater scrutiny of what was being bought, by whom, and from which suppliers. The result was a significant reduction in expenditure that directly benefited margin and profitability.

Managing cash is a fundamental activity for any business, and there is no magic wand. What is needed is continuous monitoring and measurement of the areas where companies know problems arise, eg, payment delays from particular customers, slow-moving higher-value stock, or certain suppliers that generate the majority of payment queries. There’s nearly always a Pareto effect whereby a minority cause most problems and another minority are the most valuable. So, it is important to understand the story behind the numbers, as some relationships are valuable to the business and some are not. Segmentation analysis can be used to identify those customers (debtors) the business can afford to take issue with and which to accommodate; which suppliers to press and which to keep sweet; and which stock lines are slow-moving and which are important to stock anyway.

It is usually management accountants working within the finance department or shared service that have access to the data and the skills needed for improvement. There is a wealth of information to be garnered from the daily transactions being processed. The key point is to know what to look for, set up simple processes to analyse data using staff with appropriate skills, and then to take action.

For more news and reporting on the coronavirus and how management accountants can handle challenges related to the pandemic, visit FM’s coronavirus resources page.

— Mark Gault, ACMA, CGMA, is a UK-based business architect at Gault & Co. Ltd. To comment on this article or to suggest an idea for another article, contact Oliver Rowe, an FM magazine senior editor, at Oliver.Rowe@aicpa-cima.com.