Working Capital Management: A Shared Responsibility

Eric Ospina
Eric Ospina

Everyone talks about cash and how much cash matters.  “Cash is King” … “Cash is Everything” … We’ve all heard this before.  Over the last 18 months, because of the pandemic, cash collection has been at an even greater premium as businesses have struggled to pay and collect.  Numerous articles have been written emphasizing how to manage working capital during the crisis, all with the same result. Plan ahead, emphasize collections, delay capex, stretch out payment terms, identify critical spending and keep a sharp eye on items that are more discretionary in nature.  Simple, right?  The concept really is not that complicated.  Its more an execution issue, and that is the realm of the CFO.  Well … no … at least not entirely.

The revenue and cash collection cycle is commonly referred to as the “Order to Cash” cycle and is part of the asset side of the working capital equation.  Which covers the process whereby you identify a lead/prospect/potential sale to the moment when you convert that potential to actual cash in your bank account.  This cycle touches almost all sections of a company’s operations.  Sales teams necessarily identify the opportunity, interface with the customer/client and eventually seal the deal.  Operations delivers the product or service and ultimately the finance team bills the customer and collects on the invoice. 

We are all familiar with the role of the finance department in terms of invoicing, collections, dispute management and cash application and that is where most efforts are focused when we tackle working capital issues.  However, long term management of the collections portion of working capital management starts much earlier than when we invoice.  This process starts with the expectations that are built during the sales process and the terms that are agreed. In both cases, this is the realm of the sales or business development department.

Below a very summarized depiction of the Order to Cash Process:

Working Capital Management: A Shared Responsibility 1
  • The allure of more revenue is something that is hard to resist, especially for teams whose compensation depends on the sale. However, it is critically important to ensure that we are selling to creditworthy enterprises or clients.  If not, we could be expending a great deal of working capital resources that may take a great deal of time and effort to recover or worse yet, may never be recovered. 
  • Are the billing terms clearly spelled out at the outset of the relationship? Remember that agreeing to 60 to 90 day terms means that the enterprise will have to front the working capital for two or three months before getting paid.  Unless we are the Federal Reserve, there is a cost to that money, and we can bet that our customer or client’s CFO has already thought about it and is likely pushing to extend payment terms.  This is where knowing where we stand in terms of your customer or client’s supply/delivery process is important as it gives leverage in that negotiation.
  • What/when are the billing events that are agreed?  Who acknowledges service or product delivery and what are the time frames and conditions to do so?  During the sales process the tendency is to close the sale and therefore be flexible in this process, however if this is not clear, then this can have significant repercussions in terms of billing down the road which in turn impact ability to collect.

The point is that collections begin well before the invoice is sent.  Collections and therefore the revenue side of working capital management begins with the vetting of an opportunity and the negotiation of terms.  Best practice is that there is some CFO involvement early on in the process to ensure a set of guidelines are in place for the sales or business development teams as they pursue revenue opportunities.

Similarly, when there are issues with collections, they tend to fall into one of the following categories: unsatisfied customer, client issues with the invoicing terms, or plain vanilla inability to pay.  If a customer or a client is unhappy with the service or product, who is responsible?  Usually, the department delivering has not met the expectation.  If the invoicing terms are incorrect, then why are they incorrect?  What was agreed upfront?  In all cases the issue needs to be resolved and the customer or client facing part of the business needs to get involved.  This means the involvement of the operations and sales/business development in the collections and therefore the working capital management process.

Purchase to Pay Cycle is exactly what it sounds like and is the liability side of the working capital equation.  Like the above premise, this cycle involves several aspects of the company before finance takes over. 

Procurement should not be thought of as just procurement but rather “Strategic Procurement”, and this thinking is not just for the large and sophisticated companies.  It should also be happening even in the mom & pop stores.  Simplistically speaking it is a review and categorization of all providers into large mission-critical, small mission-critical, large non-mission-critical and small non-mission-critical providers.  This categorization then gives visibility as to how much leverage a provider has over the business and potentially how much leverage the business has over the provider. 

Below a very summarized depiction of the Purchase to Pay process:

Working Capital Management: A Shared Responsibility 2
  • It is the operations role to determine what the demand for products is. However, it is a joint responsibility as to how product is acquired in light of where the provider falls in the mission-critical or non-mission-critical categorization.   This determination necessarily impacts the far end of the process “Payment” as we will have less leverage and treat our mission-critical providers more kindly than we would our non-mission-critical providers.
  • Similarly, when to buy is almost as critical to the working capital management process. Again, this is a very close collaboration between procurement, finance and operations.  Where a product lies in terms of criticality to service delivery also governs when it is bought and how much is kept in inventory. 

The objective is the balance of cash inflows from the revenue cycle with the cash outflows from the purchase to pay cycle.  Loosely speaking your Days Sales Outstanding (DSO), which is a measure of the health of your receivables, should not be greater than your Days Payable Outstanding (DPO), a measure of how quickly you pay.  An imbalance over time will result in an unpleasant discussion with investors or the bank to increase financing which results in added costs and headache for all.   

It turns out that working capital management involves the entire enterprise and is not the sole responsibility of the CFO, yet very few non finance executives’ variable compensation has an aspect of working capital management tied to it.  If we want to see real change, try including a collections metric as part of the sales and operations teams’ performance measures.  Try including speed and accuracy of invoicing as part of the operations performance metrics.  Team goals achieve team results!

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