Last year, CFO’s were under pressure. Many went into survival mode as recession swept across the commercial landscape. They scrutinised cash flow more frequently and moved into an invoice and collection frenzy. They also put credit checks, credit insurance and debt collection activities in place. But despite their best efforts, the outcome for many told a different story.
In 2020, credit manager Intrum revealed the average UK business-to-business invoice was paid in 64 days. But, on average, companies had agreed terms of 45 days. And in November, credit insurer Atradius said late payments had increased by 81 percent compared to pre-pandemic levels.
The crisis has certainly focused the minds of CFOs, particularly around receivables and late payments. The successful ones created taskforces and asked all of their colleagues for help. They remained responsible for working capital control, support and reporting, but the rest of the business heavily influenced the amount of money available.
The quality of contracts, for example, impacted their cash position when it mattered most.
Don’t overlook the contract
The order to cash process is important. When it works well, contracts are agreed, orders are processed and delivered, and money is collected in a timely way. But if the process stretches out, or becomes challenging, it can cost businesses money and stifle their progress.
‘Self-imposed’ complications usually result from poorly negotiated contracts that could be avoided with better collaboration between finance and commercial teams. Sales professionals don’t always understand the financial consequences of their agreements, and finance teams aren’t always informed about what’s happening.
Consider a ‘special invoice requirements’ clause, for example. This means client approval is needed before a final invoice can be issued. In essence, these translate to extended credit terms, often with no penalties or disincentives attached. Even on 30-day terms, clients may take 25 days to respond to the draft invoice. Payment times will often double as a result.
Other companies find that disputes can be raised by suppliers at any point, often at the end of their credit period – perhaps on day 59 of their 60-day term. These disputes can take 10 to 15 days to settle, and the clock gets put back to the start: the two-month period then begins all over again.
Contractual service levels can also force companies to produce goods quickly, putting pressure on their supply chain, which can lead to late payments if deadlines are missed. These clauses are usually overlooked by finance departments because they are typically managed by commercial colleagues. But they can have a significant impact on the finances of a company when they are broken.
It’s no surprise that good contracting and price management can vastly improve working capital if finance and commercial teams work together.
Start with three…
This is what CFOs can do to build on the lessons they’ve learned and raise awareness of working capital:
- Communicate the importance of cash and amplify the understanding of working capital and cash flow beyond the finance department. This will clarify the role everyone needs to play to reach a shared understanding of why working capital matters and how people can influence it. Working capital optimisation doesn’t achieve its objectives when it’s driven solely by finance, and other functions of the business are just informed of solutions, rather than invested in finding them.
- Visibility of performance is key. CFOs should abandon metrics such as day sales outstanding (DSO). These don’t provide clarity on the root causes of poor performance. Instead, CFOs should look at management reports and ask themselves: do I understand the hidden cost of overdue invoices, disputes management, write offs and commercial rebates? And, importantly, do my commercial colleagues understand these factors when they negotiate contracts?
- Align bonus structures to the overall performance of the business. If commercial teams have the right incentives, working capital will improve, as a result.
Unless companies communicate, measure and incentivise, it’s difficult to achieve a cultural shift.
Working capital is the best platform for investing
If companies can improve their working capital position, they could put their cash to better use. According to Intrum’s European Payment Report 2021, businesses said getting paid on time would help them fund innovation, sustainability, and new products. Quite simply, they would have more cash to invest on their strategic priorities.
Businesses that unlock the potential of their working capital are well placed to face the future. But it won’t happen unless everyone understands the part they can play. CFOs need to take steps to raise awareness, measure their progress, and incentivise change. Working capital might sound like a finance problem, but as we’ve learned, everyone must be part of the solution.