Cash is King - Now More Than Ever
As you may possibly have gleaned from the daily bombardment from all sections of the media, we are in midst of the worst global economic crisis for anything from the last 20 to 80 years, depending on
your source of information. It is also pretty obvious that very few prosper in times of economic downturn. After all, that’s the whole point of a recession — is it not?
But alongside those who traditionally buck the trend and prosper during times of economic strife — pawnbrokers, tranquilizer salesmen, and funeral directors being amongst the select few — for my own august profession of credit management the world’s current problems present an ideal opportunity to demonstrate the very real "value add" that the credit and collections team within a shared services organization can offer.
"Cash is King " is the mantra of the credit management profession, and whatever the size of an organization, effective cash management is traditionally a key component of a successful operation. No matter how good your products or services, if your customer defaults on payment, or worse, goes out of business before paying you, then the impact on your own bottom line is at best significant, and at worst terminal.
The recent past has — bar the odd blip — seen a sustained period of general economic stability and growth throughout global markets. We will all by now have a view on how real and sustainable a lot of this growth was, but for many the seemingly inevitable economic cycle of boom and bust has been broken. Banks and financial institutions speculated in a variety of ways and helped fund the growth.
For many companies, this meant easier access to finance and less reliance on the traditional aspects of cash management. Business failures remained at a low level for many years so fewer bad debts were incurred. The combination of these factors explains why stringent cash and credit management practices were not necessarily at the top of operating agendas. The banking crisis of the past two years — and now the wider economic downturn — has totally changed this landscape.
So what exactly are the challenges facing credit management teams in particular and shared services organizations in general — and how should we be positioned to react to them? As a starting point, banks are obviously reducing debt at all levels. One of the easiest ways of doing this is via restrictions on lending at all levels. This means that credit lines, financing, and overdraft facilities previously available to companies are being reduced, placing strain on operating cash.
As a result, most companies are now facing a real requirement to generate cash quicker from clients — that is, get paid promptly when an invoice falls due. At the same time, the clients are probably experiencing cash flow restrictions on their own and are actually looking to extend the payment time by delaying payment. As companies seek to protect their cash flow we are seeing an increase in requests for extended credit terms. More and more companies are being asked to comply with requests for 60 and 90-day payment terms, rather than the 30 days terms that have been the norm in the past.
We are also bound to see an increase in company failures. An unusual feature of this crisis is the nature and size of the organizations that have already collapsed or been close to collapse — financial institutions, car manufactures, high street retailers, etc. Sectors and organizations which were generally seen as low risk — and therefore worthy of generous credit lines from suppliers — are now experiencing real financial discomfort. However, many of these organizations are major "clients" to others, in terms of revenue. In a recessionary environment, how many companies can afford to walk away from a major revenue stream, no matter how precarious? Many of the organizations currently suffering financial distress would typically also make up the top 20% of a supplier’s client base, which in turn usually represents 80% or more of total revenue.
Furthermore, as the recession bites, it is inevitable that more and more companies of all sizes and across all sectors of the economy will suffer financial distress and become a potential "bad debt." It is financially impractical for governments to continue to bail out private organizations, whatever the political pressures may be.
All very worrying. But every problem presents an opportunity, and as I said earlier, I believe that these extremely challenging times do present a real opportunity for the SSO community and credit management teams to demonstrate their "value add" services in a very tangible way. Avoidance of bad debt due to effective credit management processes can save organizations millions of dollars. A bad debt of $1m — sold at, say, a margin of 10% — would require additional sales of $10m from other clients just to recoup that loss; not an easy task in turbulent markets. It becomes obvious just how costly a succession of bad debt write-offs can be to both bottom line profit and company cash flow.
At the time of the last recession — roughly 20 years ago — the shared services model was still emerging and most companies’ credit management functions would have been at country level. This time around, most organizations have a regional or global structure, allowing for centralized command and control with a consistency of approach best suited to tackling a global problem.
Taking Positive Action
So, what actions should the credit management and cash collection teams be taking right now? Credit risk and exposure will have to be managed and monitored ever more closely and a vigilant eye kept on warning signs for company failure amongst your client base. All organizations should be reviewing their credit risk process and asking if it still meets the requirements of these turbulent times. The ultimate decision on whether to supply a client will depend on many factors — length of contract, nature of goods or services supplied, margin and security available — as well as financial data. But if you are engaging with marginal clients, the terms of trading should be clearly established and performance monitored closely with a view to minimizing exposure at all times.
For existing clients, there should be a real-time monitoring process, which should quickly identify any deterioration in their financial circumstances. Past performance is no guarantee of future behavior, and the fact that you may have traded with a company for the past ten years does not in itself guarantee their survival for another ten. Be alert to any warning signs and be prepared to take swift and decisive action.
There should also be effective reporting, which shows, quickly and easily, total debt owed across all geographies by an organization and its subsidiary companies. Very often it is only after financial distress is diagnosed within a client that an analysis of total group exposure is undertaken. And by then it could be too late.
A lot will obviously rely on interpreting formal financial reports and information in the public domain, but just as important is the day-to-day feedback the cash collection teams will be getting from their dealings with clients. They are at the frontline of the battle against bad debt and slow payment. A sudden slowdown or suspension in payments in clients should always be taken as a warning sign and investigated. Is it a sign of financial distress or a sign that the client wants to ease their cash flow at the expense of yours?
Which brings us to the subject of delayed payment. Most of the actions above are focussed mainly on the doomsday scenario of insolvency write-off and the successful avoidance of bad debt which can save your organization millions and really demonstrate the credit management team’s value-add.
At the same time, we should not overlook the cost of slow payment by clients who may be staying profitable at your expense. Even in these days of artificially superlow interest rates, extended credit is a significant drain on bottom line profit. And this is before we factor in the additional resource time and cost of following up delayed payment or of increased borrowing as a result of the gap in your cash flow. Additionally, once a client has established a practice of delayed payment it can be very difficult to move them back again.
Whatever actions you take against delinquent payers — and, again, this may vary from organization to organization depending on factors such as market share, marketing strategy, and profit margin — there should be processes which enable these clients to be identified and reported internally for management purposes.
Speed of response, consistency of approach, and the ability to take a global view will be crucial for organizations to weather the approaching storm. Given their ability to see across the totality of both geographies and processes, shared services organizations and their credit management teams are ideally placed to deal with these challenges.
About the Author
Ian Chambers is currently Global AR Process Owner for Unisys, and has more than 20 years experience in senior roles within credit, commercial and financial management across a number of major organizations. Since 1992 he has held a succession of international roles with Unisys Inc, including recent major involvement in SOX compliance programs and Six Sigma Lean projects. More recently, he has been responsible for the development of worldwide best practices within the credit and collections environment and for implementing global transformation initiatives within the SSC organization.