Become the Cash King


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How the credit department can effect working capital management.

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Become the Cash King

  1. 1. Becoming The Cash Flow King or Queen © 2006, Michael C. Dennis. All Rights Reserved Presented by Michael C. Dennis, M.B.A, C.B.F., L.C.M. November 7, 2006
  2. 2. Disclaimer The opinions presented in this program are those of the instructor, Michael Dennis. His opinions and recommendations do not necessarily reflect the views of CMA Business Credit Services or its Employees, Officers and Directors
  3. 3. Introduction <ul><li>For most companies, accounts receivable is the largest single asset on the balance sheet </li></ul><ul><li>Even if fixed assets are higher value, account receivable is usually the largest current asset </li></ul><ul><li>For most companies, accounts receivable is the single largest source of cash </li></ul><ul><li>The ability to manage cash flow can be the difference between success and bankruptcy </li></ul><ul><li>There are numerous examples of companies that failed not because their products were unsuccessful, but because management was unable to manage working capital to ensure that there was cash on hand when it was needed </li></ul>
  4. 4. Introduction <ul><li>The goal of working capital management is to ensure that a company is able to pay operational expenses and other debts as they come due </li></ul><ul><li>With this in mind, it is easy to see the critical role that the credit and collection function play in a company’s working capital management program </li></ul><ul><li>Working capital management is not simply the process of collecting past due balances, it is the process of balancing cash inflows and outflows </li></ul><ul><li>An effective credit department will monitor and manage credit limit and terms to control both the risk of default and the risk of serious payment delinquencies </li></ul>
  5. 5. How Companies Typically View their Credit Department <ul><li>Many companies view the credit function as primarily involving debt collection </li></ul><ul><li>It is true that most employees of the credit department spend the majority of their time collecting past due balances and resolving customer deductions, but this is not the most important task the credit department performs -- the most important tasks involve managing the risks of payment default and payment delinquency </li></ul><ul><li>No matter how efficiently collectors chase past due balances, the department will be fighting a losing battle if the credit department cannot or does not proactively control credit risk </li></ul>
  6. 6. How the Credit Department Can be Used More Effectively in Working Capital Management <ul><li>The credit manager and his or her subordinates must be given the authority and the autonomy necessary to manage risk </li></ul><ul><li>This implies that the credit department will be given the resources required to proactively manage credit risk </li></ul><ul><li>Resources would include but is not limited to the personnel needed to evaluate credit risk, and the budget necessary to purchase an adequate number of credit reports on customers </li></ul><ul><li>To be effective, the credit department must be given the authority to hold orders and/or to refuse to extend credit when this is necessary to manage credit risk – since risk management is integral to managing collections </li></ul>
  7. 7. How the Credit Department can be Used More Effectively in Working Capital Management <ul><li>There are two basic elements associated with a decision about whether to offer extended dating to a customer </li></ul><ul><li>The first is the additional risk that this poses to the creditor company, and the second is the impact on cash inflows and on the company’s working capital management function </li></ul><ul><li>For the credit department to help manage working capital, it must have final authority when customers request extended dating but in many companies, the sales department can approve extended dating terms without prior approval </li></ul><ul><li>The credit department cannot help manage cash inflows unless it manages extended dating requests </li></ul>
  8. 8. How the Credit Department can be Used More Effectively in Working Capital Management <ul><li>The cash conversion cycle can be considered to begin with the purchase of inventory </li></ul><ul><li>This cycle continues when inventory is sold, and accounts receivable are created </li></ul><ul><li>As accounts receivable are collected, cash is deposited into the creditor’s bank account. Cash is used for a variety of purposes. One of those purposes is to purchase additional inventory </li></ul><ul><li>That new inventory eventually becomes accounts receivable, and the cash conversion cycle continues </li></ul><ul><li>Working capital management is concerned with shortening the cash conversion cycle, as well as managing cash outflows to ensure that there is cash available when it is needed </li></ul>
  9. 9. How the Credit Department can be Used More Effectively in Working Capital Management <ul><li>Working capital management involves balancing cash inflows and cash outflows </li></ul><ul><li>In order to accomplish this, creditor companies must accurately forecast cash inflows </li></ul><ul><li>In some companies, the credit department is not involved in forecasting cash inflows. This can be likened to developing a sales forecast without speaking with sales department. </li></ul><ul><li>The credit department should be directly involved in forecasting cash inflows involving accounts receivable </li></ul>
  10. 10. Cash Forecasting <ul><li>Cash forecasting is an inexact process, and it is difficult to consistently do well </li></ul><ul><li>Nevertheless, the credit manager and the credit department staff have specific information which can make cash forecasts more reliable </li></ul><ul><li>If the 80/20 rule applies to your accounts receivable - meaning that 80% of total A/R is owed by 20% of your customers - then even if your involvement is limited to forecasting collections from the largest 20% of customers – doing so will result in more accurate forecasts of cash inflows </li></ul><ul><li>Other methods used typically involve formulas and mathematical models, but without data from your customers these other methods can generate flawed forecasts of cash inflows </li></ul>
  11. 11. Tools for Controlling Delinquencies <ul><li>A record of all payment commitments should be kept by each collector </li></ul><ul><li>All payment commitments should be confirmed before the collection call ends </li></ul><ul><li>Commitments should be confirmed in writing if the customer has a history of breaking payment commitments </li></ul><ul><li>A follow up call should be made if payment is not received when it was promised </li></ul><ul><li>Following a broken commitment, the debtor should be asked and expected to send payment by overnight delivery </li></ul>
  12. 12. Tools for Controlling Delinquencies <ul><li>Remember that any grace period before collection calls begin benefits only the debtor. Therefore, grace periods should be eliminated </li></ul><ul><li>Whenever a customer is past due, the collector should confirm that the debtor has your company’s payment terms listed correctly. </li></ul><ul><li>Your terms and conditions of sale should appear on your credit application and your invoices. All applicants should be required to sign the credit application acknowledging they have read and agree to your terms </li></ul><ul><li>Purchase orders should be reviewed for terms of sale – not just for price and delivery dates. If the PO includes incorrect terms, it should not be processed until a written amendment is received </li></ul>
  13. 13. Tools for Controlling Delinquencies <ul><li>If you offer a cash discount for early payment, enforce your discount policy. If you do not push back when customers take unearned discounts, chances are that the problem will worsen until you do </li></ul><ul><li>Charge back unearned discounts, but don’t simply send a debit – send a cover letter. Follow up for payment just as you would for payment on a past due invoice </li></ul><ul><li>Be prepared to hold orders if necessary to force customers to repay discounts </li></ul><ul><li>If customers are not taking advantage of your discount program, chances are that it is because the customer’s A/P department is not making discounts a priority </li></ul>
  14. 14. Tools for Controlling Delinquencies <ul><li>Encourage customers not taking discounts to do so </li></ul><ul><li>Don’t spend too much time trying to convince A/P to take discounts. Instead, contact the customer’s controller or CFO in writing to notify them that discounts are being missed </li></ul><ul><li>As a general rule, discounts are an excellent way to control delinquencies because they represent a significant economic benefit to the customer/buyer. </li></ul>
  15. 15. Factors Beyond Your Control <ul><li>The credit department is often criticized for not generating sufficient cash inflows resulting in a cash crisis. Often, slow payment or higher DSO results from factors beyond the control of the credit department </li></ul><ul><li>For example, if the sales department has the authority to offer extended dating to customers, this will lengthen the cash conversion cycle, result in higher DSO and may result in a cash crisis </li></ul><ul><li>If errors made by the creditor result in withheld payments or customer deductions, this can affect cash forecasts and cash inflows </li></ul><ul><li>The credit manager must be able to quantify the impact of factors beyond the control of the credit department to maintain credibility with senior management. Failure to do so can be a CLM! </li></ul>
  16. 16. Factors Beyond Your Control <ul><li>Remember that disputes and deductions may represent only 5% or 10% of your A/R, but may require as much as half of your collector’s time to resolve </li></ul><ul><li>Your documentation could include the number of deductions taken each month, the total number that remain open, their cumulative dollar value, and what percent of the time the customer was correct in taking the deduction </li></ul><ul><li>Remind management that time your department spends correcting the mistakes made by other departments is time taken from collection and from risk management responsibilities </li></ul><ul><li>The less time your team spends collecting, the bigger the impact on debt collection, cash flow, and working capital </li></ul>
  17. 17. The Pros and Cons of Cash Discounts <ul><li>Pro - Discounts are an incentive for customers to pay sooner and shorten your cash conversion cycle </li></ul><ul><li>Con – If the discount you offer is not large enough or is not comparable to the discount offered by your competitors, customers will pay other creditors first </li></ul><ul><li>Pro – Discounts are a way to differentiate your invoices from other suppliers, in effect ensuring that your invoices receive priority handling </li></ul><ul><li>Con - Some customers take discounts whether they are earned or not and [in effect] challenge creditors to force them to repay the unearned discounts </li></ul>
  18. 18. The Pros and Cons of Cash Discounts <ul><li>Pro – For some creditor companies, the advantage of receiving cash sooner rather than later more than offsets the cost of offering a discount </li></ul><ul><li>Con – When customers take unearned discounts, there is often a significant amount of research required before the creditor is ready to demand repayment </li></ul><ul><li>Con – Customers can often present credible reasons why discounts that appear to be unearned should be allowed and these reasons cannot be dismissed without a thorough evaluation of the facts </li></ul>
  19. 19. Free White Papers <ul><li>Essays on the following subjects are available to attendees free of charge: </li></ul><ul><ul><li>The Pros and Cons of Credit Insurance </li></ul></ul><ul><ul><li>Financial Ratios for the Credit Function </li></ul></ul><ul><ul><li>What You Should Know about Export Credit Management </li></ul></ul><ul><ul><li>How to Handle and Dispute Bankruptcy Preferences </li></ul></ul><ul><ul><li>How to Measure Credit Department Performance </li></ul></ul><ul><li>To request any or all of these papers at no cost or obligation, please contact me by email at: </li></ul><ul><li> </li></ul>