The Strategic Value of Centralized Collections
Cash collection is critical to every business. In this respect, nothing has changed for centuries; without cash, a company cannot pay workers, invest in production or fulfill customer orders. With receivables such a fundamental driver for the business, it is in some ways surprising that a large proportion of companies have yet to centralize and optimize their collections management, in many cases choosing to focus first on accounts payable. After all, few CFOs are awake at night worrying about whether a payment has been made; the same cannot be said for collections, which has a major impact on the company.
Getting Paid on Time
What is required to collect cash on time? The answer is both simple and complex. To collect on time, a customer needs to pay on time; encouraging them to do so is rather more problematic. In the past, companies encouraged their customers to pay on time, or even early, using early payment discounts. While this may still be valid for some companies, every company is seeking to maximize its working capital, so early payment may be less attractive. So what processes should a collections manager prioritize to ensure that they get paid?
Firstly, companies are increasingly conscious of counterparty risk, and in many cases, the process of assessing potential customers and establishing appropriate exposure limits is being reviewed, resulting in more conservative policies and lower limits. One of the issues with a decentralized approach to credit and collections management is that it is difficult to ensure that a standardized approach to customer acquisition, monitoring and limit setting is being adopted across the business. Furthermore, if different sales departments or business entities are conducting business with the same customer groups, it may be almost impossible to identify and monitor overall group exposure.
Secondly, companies need to make it as easy as possible for their customers to pay. To enhance collections convenience, it may be desirable to insist that customers pay using electronic credit transfers or direct debits, but this policy may be detrimental to customer relationships and be at odds with local payment cultures in different countries of operation. A centralized approach to collections does not mean that local payment cultures cannot be respected; in fact, by using a solution such as AvantGard Receivables, invoices and customer correspondence can be produced in different languages with bespoke content according to the culture in each country or the nature of individual entities. Furthermore, by using a combination of processes, technology and banking services, companies can collect cash in a variety of ways, including manual forms of collection such as checks, without compromising efficiency.
Thirdly, companies need to be proactive in seeking prompt payment. Sending an invoice and expecting it to be paid is not enough. Invoice disputes and queries need to be dealt with quickly to avoid payment delays. In many companies, this is managed by the sales team, and there is no central visibility or accountability over the query resolution process. Making the use of technology that enables a single view of each customer, invoice and status, with automated follow-up actions facilitates the process, ensures personal accountability and central visibility. Another element of collections proactiveness is the ability to remind customers that an invoice is due. Often, particularly in a decentralized environment, this involves a call from the finance team to sales, who then chase payment. This often takes place long after the collection was due, and gives a negative impression to customers. In contrast, establishing a centralized, automated process for sending customized payment reminders before due date, as well as afterwards, can be an important way of ensuring that collections are on time. Furthermore, a professional impression is created with customers.
Identifying Collections Quickly
Achieving prompt payment is the first major task, but collections managers also have to know immediately that they have been paid. This requires consistent visibility across collection accounts, using bank proprietary or bank agnostic connectivity tools such as SWIFTNet, with information integrated with internal systems for prompt reconciliation and posting. This enables companies to make use of cash as quickly as possible and free up customer limits to permit new business. Nothing is more frustrating for a sales team than being unable to sell to a customer where limits appear fully utilized, even though the customer has actually paid. Achieving this level of automation and integration is very difficult if collections are conducted locally, as processes are frequently inconsistent and less rapid.
Enhancing working capital
Centralizing and optimizing credit and collections management delivers benefits that extend well beyond the immediate confines of the collections or sales departments. Achieving greater predictability of cash flow is vital for liquidity planning and enables borrowing and investment decisions to be taken with more confidence, with the potential to reduce borrowing cost and increase investment yield. In an environment where credit is more constrained, and more expensive than during pre-crisis days, with no guarantees of continuous market access, this can be a very important consideration.
Benefits of centralizing collections
- Improve operational efficiency and reduce costs
- Enhance credit analysis and establish common policies
- Reduce days sales outstanding (DSO) and bad debt
- Leverage technology investment
- Free up customer limits more quickly
- Establish transparency/ reporting at regional/ global level
- Manage business change, such as mergers and acquisitions more easily
- Establish center of excellence for collections to improve the quality of service to subsidiaries and to customers
The business case for centralizing collections can be compelling: to reduce days sales outstanding and bad debt; increase efficiency, control and standardization of business processes, and enhance both internal and external customer relationships. However, the challenges can often seem insurmountable, and frequently thwart plans to centralize collections. Some of the most common include the following:
Lack of management support
In companies where decision-making is divested to local management, major business change requires senior management sponsorship to help clear internal roadblocks and incentivize local management to co-operate and assist in centralization. The benefits of centralized collections are often not apparent to local management and sales teams until the new arrangements are in place, so strong sponsorship and commitment is essential.
High initial investment
The cost of establishing a new SSC or migrating major activities into it can be considerable, and companies with budget constraints may find it difficult to justify major upfront investment. However, the potential advantages in reducing DSO and bad debt, and enhancing the company’s liquidity position can be considerable, and the payback period for such a period is frequently less than 6 months.
Frequent business change
Companies which frequently undertake M&A activities tend to believe that the ongoing costs of migrating new businesses into a centralized credit and collections unit may be not be justifiable. However, in reality, companies that have introduced shared services for collections have found that by introducing a structured approach to migration of new businesses, particularly when using a specialist collections system as opposed to an ERP, where the implications of migration are typically greater. Furthermore, companies that divest businesses have found that the value of divested assets is increased when collections are centralized, as potential purchasers have full visibility over the debtor position and confidence in credit procedures that are undertaken.
Differences in payment culture, methods and formats
Multinational companies in particular face the challenge that collection processes in each country can differ considerably. For example, paper-based instruments such as checks remain popular in the United States, Spain and to a reducing extent, the United Kingdom, while these instruments are growing in popularity in countries such as India. In contrast, countries such as the Netherlands and the Nordic countries have highly efficient, electronic payment mechanisms. Furthermore, the clearing systems and formats required in each country differ substantially, and the business culture for collecting cash can vary. Maintaining a decentralized approach to collections may initially appear beneficial to address local regulatory, clearing and cultural requirements. However, with costs replicated across each collection location, and the lack of control and automation that typically results, disparate collection methods can be managed in a single system whilst successfully addressing the diversity of local needs. In some cases, it makes sense to retain some functions locally, such as invoicing in the case of highly specialist companies with complex orders; however, centralization does not always require all individuals engaged in the process to be in a single location. Instead, we are seeing a growing trend towards virtual, as well as physical SSCs, facilitated using central technology to ensure that global processes, controls and reporting are achieved, whilst still respecting the culture of the company.
Diverse banking services
One of the outcomes of the financial crisis, and in particular the reduction in credit availability, is the changing relationship between treasurers and finance managers and their banking partners. While there has been an overall trend to rationalize the number of banks, it is increasingly expected that if a bank offers credit, they will be invited to participate in other banking services, such as transaction banking, as a way of offsetting their risk and enhancing the value of the relationship. This means that many corporates are working with a panel of banks for cash management, often on a regional basis, which would appear to hinder efforts at centralization. Once again, this should not be the case. Using multibank, bank-neutral connectivity channels, such as SWIFTNet (or multi-banking electronic banking systems provided by individual banks, although these are proprietary) enables information from multiple banks to be channeled through a single ‘pipe’. Furthermore, by leveraging new standards such as XML-based ISO 20022, information transmitted to and from banking systems can be standardized.
To summarize, therefore, given the geographic, cultural and business differences between clients, there is no standard approach to centralizing collections. Rather, use of a single technology platform can facilitate a centralization strategy that is specific to each company, that could involve one SSC, but equally could include regional or country centers, a ‘virtual’ approach or a combination. Furthermore, a collections platform such as AvantGard Receivables enables diverse language, cultural and business requirements to be accommodated within a standardized process. The importance of senior management support cannot be underestimated; similarly, treasurers and finance managers need a bank, or group of banks, that support their clients’ choice of communication channels, formats and can assist in delivering information that facilitates automated processes such as straight-through processing.
The value of an integrated approach
While centralizing collections and reducing DSO and bad debt is a very positive development for every company, the wider value in working capital terms should not be underestimated. Increasing the predictability of cash flow is essential, which requires payables and receivables to be aligned closely. Furthermore, while the situation will differ by industry, reducing volatility of cash flow is another important consideration to allow greater control of working capital and reduce funding requirements. SSCs have a major role to play in both optimizing and aligning financial processes to allow greater visibility, control and use of cash.
Implementing shared services at a global employment services provider
The company had experienced rapid growth and business processes had become more fragmented with a loss of control and central visibility. Processes were not fully documented, which created business continuity risks, and internal audit was concerned that financial processes did not meet internal and external regulatory requirements, such as Sarbanes Oxley.
A new SSC was established at the company’s US-based headquarters, which has since been supplemented by a regional centre in the UK covering the company’s European activities. Initially, payroll, expenses management, accounts payable, accounts receivable and accounting were incorporated into the SSC, but as the success of a shared services approach has become more apparent, the range of services the centre provides has increased. In order to encourage internal support, the aim was to introduce a strong service culture, delivering benefits to employees and business units, and using quantifiable metrics to demonstrate performance improvement. While an ERP solution was used for the majority of SSC functions, AvantGard Receivables was introduced for credit and collections management.
From a collections standpoint, dispute resolution has been accelerated by 59%. DSO has been reduced by 3 days and aged debt has fallen by 75%, equivalent of $300,000 per year. There have been other positive outcomes too. As a company that regularly engages in both acquisitions and dispersals, business change can be managed more easily. Potential acquirers of divested assets have greater confidence, leading to an average increase of $2 million in the value of divested businesses. Credit insurance costs have also fallen considerably as a result of more visible, standardized and controlled credit and collection processes.
Case Study II: Enhancing the customer experience at a leading provider of industrial productivity solutions
Although a SSC was already in place, the credit and collections management process was predominantly manual. As each process was time-consuming, the company had to prioritize which invoices to chase, so inevitably, the focus was only on receivables with the highest value, and many smaller amounts were not chased routinely, affecting working capital and DSO considerably.
Invoice disputes were managed by the sales team, but there was no traceability of follow-up actions. Consequently, collections were often not received for a long time after the invoice date, and processes were highly dependent on manual processes, subsystems and key individuals.
The SSC introduced AvantGard Receivables, which was already used successfully in another part of the group. The implementation project took only 2-3 weeks, at which stage the solution was in live operations.
Although the sales team were initially reticent about introducing a new system and process, they quickly became accustomed to the new approach and recognized the advantages. In particular, people recognize the value of the solution in accelerating payment and improving customer satisfaction, whilst clarifying the tasks for each individual. The company now has a central point of information, with comprehensive visibility over the status of each account.
DSO quickly fell by 6 days, although this varies during the year due to the cyclical nature of the business. In particular, the company saw a major reduction in outstanding receivables relating to the service business, which fell by 10 – 15 days, the result of a major acceleration in the resolution of invoice disputes.
One of the most significant advantages of the new system is visibility over the source of problems, so that processes have been refined to reduce disputes and avoid issues falling between individuals’ responsibilities. High quality management reporting can now be produced, which is used extensively by the business lines, and by senior management, with a single, real-time view of data as opposed to using fragmented and inconsistent information held in different spreadsheets.
Points of Discussion
1. Cash collection is critical to every business – Some organisations offer early payment discounts to customers to get cash in. Can you offer any other tips with the SSON community to encourage customers to pay on time?
2. Many obstacles lie in the way of optimizing cash collections, including lack of management support – have you come across similar challenges and how did you overcome them?
Helen Sanders is Director of Asymmetric Solutions Ltd, which provides treasury and finance-related editorial, research and consultancy services to corporations and banks.