Cash Is King—The Relevance of Cash in Today’s World

Due to increasing uncertainty and risk levels, our business environments have become more like the perfect storm for the adventurer.

Enterprises prefer stable and low risk environments, so they expect from stakeholders some level of stability, especially from their own support organizations. Business services and support functions need to be agile to respond to changes and deliver stable operations.

In this environment, we need to clarify what exactly is the positioning and relevance of O2C activities and working capital:

• What is the relevance and role of cash?

• How do we optimize an O2C process in this environment?

• Is it about technology or talent?

• What changes to the GBS and business model are needed for it to survive?

A recent OTC research report from SSON Research & Analytics revealed that the relevance of working capital has risen, with 94% of companies believing it is very important or “their life depends on it.” Again, 94% of companies said Days Sales Outstanding (DSO) has the most impact on their total working capital (TWC), the other 6% being Days Payable Outstanding (DPO) and Days Inventory Outstanding (DIO). The DSO relevance was up from 84% before the pandemic.

The change is mainly the increased focus on DSO in times of crisis and reduced focus on the DPO side. Approximately 20% of companies struggled to stay alive during the pandemic due to cash shortage. Other companies swim in cash and cannot be bothered with this discussion. To conclude on what the relevance of cash is: it depends. It depends on the sector, company, timing, etc., but in general—the relevance is high.

In terms of measuring working capital, most people focus on the cash conversion cycle (CCC) and its components (DSO, DPO, DIO). There are reports displaying TWC/CCC for sectors, geographies, or even individual companies. These are “nice to know” and can be used for high level external comparisons, but for internal improvement efforts, they provide little insight.

In a ranking of the most popular metrics (in above mentioned SSON report), 78% of companies say they use DSO, 75% use “best possible DSO,” and 37% use average days delinquent (ADD). For internal improvement efforts, ADD or similar metrics are more realistic and helpful. ADD currently stands at 7 days, with a very large range of deviating results, so this could be a good starting point to understand the speed of the organization. Since organizations are required to be agile in general, a much shorter ADD could be expected as a result, especially as it actually costs money.

If working capital is important, then what are the reasons for ADD at 7 days and DSO being stretched? You could argue the reasons are multiple and they can be found in basically every part of the process.

Granted, it depends on circumstance. But when you analyze in detail, there are huge differences between organizations in similar environments. Maybe they neglect some of these findings, thinking they cannot be better due to their type of business, but others have proven the opposite.

A topic of much debate is the so-called best practice around segmentation strategies. The background logic is simple: it’s all about knowing your customer. And if you know them all, then why wouldn’t you use this knowledge to optimize your process and approach to yield the best possible results? So yes, segmentation strategies make sense.

They should be used, and they should be formally defined, standardized, and automated, like anything else in support functions and GBS. The SSON research finds 13% of companies are not using segmentation strategies in collections. While that isn’t great, at least the rest use it to some extent to define the approach to collections, although only 35% have a clearly defined strategy. The others only manage elements of this best practice.

The same companies state that only 44% have a clearly defined strategy in terms of a process (including timing) for contacting customers for collections, while 6% have no process. Since 56% in total do not have a clearly defined strategy, it’s starting to become clearer why DSO is stretched.

Ultimately, to know your customer, you must talk to them, based on a well-defined strategy telling you why you talk to who and when. And the people participating in customer communications need to be skilled for exactly that task. It’s wise to align skills with role requirements, in O2C as elsewhere. A professional in charge of collections management likely needs to be a good communicator, with O2C training including technology supported assessments of exactly what to say and how to say it.

On the other hand, the person analyzing the results of dispute management might be an Excel and data guru, but not suited for customer contact. In addition to having segmentation strategy produce a defined approach, it requires proper staffing. If skills are missing, staff need training or upskilling.

Based on the questions list from the beginning, we have talked about relevance, some optimization ideas, and talent. What about technology? You could argue technology availability is abundant nowadays, and not the limiting factor. But is that so? SSON Research & Analytics highlighted which capabilities the order-to-cash/cash/working capital technology provides. The surprising result is that current systems in use provide somewhat limited visibility. As an example, for collections and disputes:

• 68% of companies get a measure on how much/what portion was collected successfully

• 61% of companies get a measure on how much/what portion is being disputed

The rest of the companies do not have this insight, but at least the majority of companies has transparency. Some of the other system capabilities are even worse:

• 65% cannot perform cash pooling

• 71% cannot compare forecast to actuals

• 77% do not have transparency about pending orders moving into AR soon

• 87% cannot calculate the cost of borrowing.

Based on these findings, it’s fair to say that the possibilities today’s technology provides are not in place in many organizations.

It is possible that the numbers are slightly inflated due to the respondents of the research being from GBS/shared services, i.e., they might only answer for themselves instead of the company. The questions were holistic, so a slightly less dramatic option is that the OTC people in GBS simply do not know what other departments, such as Treasury and Sales, are doing. Obviously, it will be a struggle to implement best practices, train people, and hit KPI targets without proper technology support. Contrary to common belief, technology implementation gaps are still significant.

Another problem area causing potential working capital effects is the missing focus on details in regulatory changes, taxation, and delivery terms—commonly known as Incoterms.

For example, the most used Incoterm (according to Trade Technologies) is Cost, Insurance, Freight (CIF). This may only be used for bulk (non-containerized) sea-freight shipment. However, this is not the most common form of transport, as most are containerized. When something happens (delay, damage, etc.), a dispute is likely to take place, as the agreed terms are “unclear.”

Some companies use EXW (Ex Works) even when exporting. This produces a situation where the buyer needs to produce the customs declaration for export and import, and the seller needs to charge VAT, which would not be the case within the EU using another term.

This can produce issues (such as a missing customs declaration) that delays delivery and payment. Many companies nowadays use the legal transfer of ownership moment as the time to recognize revenue, which logically makes sense.

In the context of Incoterms, it’s relevant to mention that Letters of Credit (LOC) have increased in use as they are the best security vehicle for both sides. The issue here is the missing knowledge in many companies about how to hand in correct applications at banks. This leads to 50-70% of LOC applications initially being declined, often due to small formal issues. Increased knowledge and focus could help avoid this rework and delay. Some technologies help with this, and there are also outsourcers supporting the process.

In terms of discussing total working capital KPIs, naturally there are more areas to cover. It is always good to run forecasts, like sales and revenue forecasts. After all, the key purpose of OTC/TWC-support work and measurement is to support the business!

Depending on the type of business, this could be metrics on sales revenue forecast, sales pipeline, and sales backlog. During the year, the forecast combines the “as-is-numbers” for past periods with the existing budget for the remaining year. We then generate an estimate (forecast) of what we will end the year with. We should keep in mind in this context that mathematical calculations are only part of the truth. We must still analyze the content, trends, and reasons to truly understand the forecast, not just extrapolate based on algorithms.

The final question in terms of working capital relevance, optimization, and impact would be about the external trends impacting companies, support functions, GBS, and OTC as a process or team.

Do we need to change something in OTC, GBS, or elsewhere to provide reliable service in the future? We don’t know what we don’t know, especially the future, but we do know we are in a VUCA (volatility, uncertainty, complexity, ambiguity) world defined by permanent change as the only constant. Hence, we must stay alert, agile, and be willing to change. Since this is not always the case, a good idea is to finally move from change projects to a permanent, structural, defined change setup with structural factors, roles, teams, strategies, and continuous improvement activities in place.

A constant change approach also means you should measure regularly and run health checks and strategy reviews and stay updated on trends and best practice solutions from the market. Pro-active behavior is key to survive out there!

To summarize, here are some key takeaways:

• The relevance of working capital/cash is high in the current environment

• Working capital measurements need be both more comprehensive and more specific

• Cycle times and productivities are improving slowly or not at all

• Best practices (e.g., segmentation strategies) are not yet standard for all

• The right skills and talent are required to make use of available technology and process designs

• Technology utilization metrics are poor and much more is possible

• Certain, previously overlooked, areas (Incoterms, LOCs) can have significant impact on cash

• Foreseeing the future is not possible, but improving forecasting still offers opportunities

Learn more about how BlackLine's Accounts Receivable Automation can help your organization optimize accounts receivable performance, create team capacity by removing manual processes, and gain critical decision intelligence to drive value.