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Unlocking cashflow

To tackle cash flow, bridges must be built, writes Joe Kelly

20 Oct 2011

By Joe Kelly, PGRX

An unlocked safe

OF ALL the concerns that keep finance professionals awake at night, the issue that occupies the mind most is finding ways to improve working capital. The reality is that, with traditional sources of investment and credit capital having become far less accessible over the past three years, working capital represents a source of cash flow over which control can be exerted, according to a survey we conducted, which asked finance executives to rank their worries in order of importance.

One respondent to the survey, a senior finance official at a household name international retail group, confessed that in his efforts to gain an audience with the busy CEO or CFO, it was proposing a discussion about working capital improvement strategies that garnered the most generous allocation of time.

This particular individual was fortunate to be working within an organisation that had already adopted a strategic focus on improving cash flow. Unfortunately, that is not always the case, and some finance leaders will need to help promote a stronger ‘cash culture' across the business. This might require the development of a robust forecasting methodology and a structure for reviewing and reporting the cash position, as well as aligning management incentives with cash goals and setting key performance indicators around cash control.

When that culture is established, the question for finance leaders is which areas of working capital could deliver improvements to the cash flow position.

There are a number of medium-to-long-term solutions, including pursuit of a more tax efficient supply chain and postponement of non-essential capital expenditure. There are also a number of quick wins available, such as resetting inventory targets, reviewing short-term risk management, timely VAT reclaims and earlier commencement of proactive payment collection.

One area that is often under-exploited, yet has the potential to yield significant results, is the setting of payment terms. While many financial leaders are keenly aware of the impact that payment terms and days payable outstanding (DPO) can have on cash flow, they don't have the keys to unlock these items.

Instead, the details of payment terms and DPO tend to be in the hands of the procurement function or the buying organisation that controls relationships with suppliers. Furthermore, if the procurement function does not have incentives around payment terms and DPO, the potential gains remain untapped. The root cause is that historic gulf between finance and procurement. If neither can be accountable for DPO, then it inevitably slips between the two.

Typically, organisations that incorporate such silos are characterised by having hundreds of different sets of payment terms – with all the confusion and inconsistency that implies. As a rule, finance would not be involved in setting those payment terms, which often remain unchanged from the beginning of the supplier relationship. Put simply, a contract that was agreed in 2009 may no longer represent such a good deal in 2011. What's more, DPO and cash discounts may not be factoring into performance measurement for the procurement department. In other words, it's actually the suppliers who are setting payment terms.

What should be happening is that payment terms are concentrated into a handful of long and discounted options. There should also be cross-functionality and continuity in day-to-day procurement negotiations, as well as a commitment to applying identical terms to suppliers within the same purchasing category.

To help ensure ongoing value, it's useful to measure the performance of the procurement department with regard to payment terms. Benchmarks can be set and the figures can be used as key performance indicators for the business as a whole. With regular monitoring, it's easier to guard against slippage against the supplier baseline that has been set.

There's no doubt that achieving the above requires a significant investment of time and effort, so be prepared for a challenging period. Deep and sustainable accomplishments can be a drain on internal resources but the rewards can be considerable.

For those embarking on a DPO improvement initiative, it's vital to get the buy-in of as many internal stakeholders as possible. Aligning different functions under a common goal will help deliver sustainable improvement. When taking the lead, it's also important to proactively and clearly communicate the objectives and present a business case based on strong, fact-based analytics.

The bottom line is, of course, the most important of all. So what benefits can be realistically expected from a review of payment terms and the implementation of new measures? You might be surprised to learn that a typical DPO increase of six to seven days, applied on a permanent basis, could drive cash increases of hundreds of millions of pounds, depending on the size of company purchases.

The finance leader who can deliver results like that as part of an initiative to optimise cash flow will always find an open door into the CEO's office.

Joe Kelly is managing director of client services at global audit, analytics and advisory firm PRGX

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