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7 steps to elevating working capital performance: the CEO of a software firm offers advice that companies should consider to free up cash locked in credit, receivables and payables by using business process improvements, technology and change management.

In this challenging economic climate, Global 2000 corporations are looking for new ways to stimulate growth, improve financial performance and reduce risk. Working capital tied up in cash flow is quickly being seen as a "hidden reservoir" of efficiencies that can be tapped to fund growth strategies, such as capital expansion. Cash flow locked in credit, receivables and payables can be freed up by using a recipe of business process improvements, specialized technology and effective change management.

According to a McKinsey & Co. study of the top 24 U.S. corporations, a total of $162 billion in cash flow can be freed by streamlining receivables and payables processes. This is equivalent to an additional 5 to 9 percent in net profits. Companies today face many barriers with achieving excellence in these finance processes. Key issues around this are disconnected global systems and processes, lack of best practices for finance functions, managing emerging markets, dealing with mergers and acquisitions, and complying with mandates like the Sarbanes-Oxley Act.

The following seven steps serve as an effective roadmap for corporations looking to squeeze the highest returns from global working capital management.

1 Concentrate on free cash flow as a performance metric to drive the organization forward.

In recent years, external investors and analysts have started to valuate corporations based on more than just revenues or earnings. Specifically, after debacles such as with Worldcom Inc. and Enron Corp., investors have realized that earnings statements can be misleading. Now, a tighter focus is being placed on cash flow from operations, along with other balance sheet metrics.

Free cash flow, a measure of how well corporations are generating cash after capital expenditures, is increasingly being seen as a signpost of corporate efficiency. As corporations improve their working capital management, their free cash flow also increases, potentially leading to higher valuations by investors and subsequent increases in shareholder value.

2 Integrate credit risk, receivables and payables management from a performance management, process automation and cross-enterprise collaboration standpoint.

These finance processes comprise the cash inflow and cash outflow portions of the working capital cycle. In order to effectively manage global working capital, the customer-to-cash (composed of credit risk and receivables management) and the procure-to-pay (composed of procurement and payables management) processes need to be streamlined.

Credit risk and receivables management functions have to be coordinated, with the front-end credit evaluation properly limiting risk of bad-debt write-offs, while the back end collections have to be automated to accelerate customer payments. A 360-degree view of this process is vital to ensure that credit risk scores and profiles for specific customers are used to drive the appropriate collections approach.

Similarly, customer payment history should be used to evaluate future orders. For example, a customer that scored as a higher-than-average credit risk may require proactive and aggressive collections methods, including advance reminder letters and dunning notices shortly after an invoice goes past due. Likewise, based on ongoing payment history, the customer may either have its credit score modified or suffer an increase in credit holds for subsequent orders.

The payables side of the equation needs to be strategically managed to take advantage of discounts where appropriate, while extending certain payments to non-strategic suppliers. In all cases, it is important to have a framework that strives to automate as many non-value-added processes as possible, while having a top-down performance management view that measures and monitors results against pre-determined metrics and goals.

3 Drive cost containment and standardization with finance shared services and outsourcing.

The pressure to improve margins and profitability has led many corporations to take a two-pronged approach to centralizing finance functions, along with leveraging third-party service providers. Credit, receivables and payables functions are no exceptions to this, and are prime candidates for shared services, where a smaller specialized team of professionals services global business units.

In many cases, the challenges of dealing with a global customer base and coordinating worldwide cash flow functions requires specialized business processes and technologies. Specifically, shared services--which span multiple operating units--often have to consolidate data across disconnected financial systems, which leads to decreased efficiency and lower-quality transactions. Finally, many corporations take an 80/20 approach to managing receivables and payables, where 20 percent of the customers, representing 80 percent of revenues, are managed by an in-house shared services team, while the 80 percent of customers representing 20 percent of revenues (usually smaller balance accounts) are outsourced to a third-party partner.

Balancing receivables and payables performance across both the in-house and outsourcing teams is critical to ensure financial success. This often requires a specialized technology platform with multi-language and multi-currency capabilities that both teams can use, while offering measurement and management capabilities to finance executives.

4 Take a holistic approach to cash flow forecasting and short-term liquidity management.

While the daily operational aspects of managing cash flow are done at the levels of credit, collections and payables departments, the job of optimizing short-term liquidity is often done by treasury and corporate finance departments. These personnel have the task of accurately forecasting cash from receivables and payables and managing any gaps in liquidity.

Forecasting cash receipts and disbursements is challenging because of limited access to real-time transactional data, consolidating multiple forecast spreadsheet models from various divisions and getting accurate inputs from across the organization. By tying together transactional data from receivables and payables, along with the ability to perform "what-if?" simulations of differing business conditions, treasury and finance groups can make optimal investment and borrowing strategies. By having better visibility into variances in expected and actual cash receipts, for example, companies can decide how much cash to re-deploy to higher-yielding instruments or when to pay down debt.

A specialized cash flow performance solution that ties together transactional data from multiple systems with a forecast simulation engine can offer corporations this insight into future cash flows. The complexities of modeling factors such as discounts, seasonality, past payment trends, projected customer payment schedules, etc. can easily be incorporated, and variances tracked against projections.

5 Understand that risk management is a critical part of cash flow processes, and take steps to mitigate it.

With bankruptcies rising in certain industry segments, corporations need to have better forward-looking visibility into receivables risk. Extending trade credit properly when first deciding to conduct business with a prospective customer is critical to limit risk of non-payment or default.

Leading corporations have established a highly effective approach, where a customer's credit risk is assessed using multiple criteria based on both external data and internal history. Third-party credit bureaus like Dun & Bradstreet and Experian offer credit scores that can be combined with actual payment performance data to get better insight into customer credit risk.

A specialized cash flow performance solution enables corporations to create flexible credit scorecards that combine all these factors and also explain the reasons for certain credit scoring results. In this manner, companies can set the appropriate credit policies to best manage overall credit risk and reduce bad-debt expense.

6 Close the gap between customers, credit and receivables, sales and treasury.

Cross-departmental functions like dispute resolution, forecasting and credit management often require close coordination among many different parts of the organization. Resolving disputes, for example, may require the involvement of customer service or sales for pricing issues, logistics for freight handling issues, etc.

By establishing a collaborative environment, corporations can ensure that the correct functions required to resolve a dispute are properly engaged. Similarly, during the forecasting function, collaboration is required between treasury, corporate finance and division managers. By closely communicating on the inputs, a consensus forecast can be derived that is far more accurate than one generated from within organizational silos.

It is important to employ business processes that span multiple departments and support these processes with specialized workflow-based technologies that enable collaboration. A cash flow performance management solution identifies and track disputes, routes them to different departments and monitors any deviation to drive speedy resolution. For cash flow forecasting, multiple forecast revisions can be shared and modified by different divisions, with the final forecast derived from a collaborative effort that includes real-time inputs.

7 Leverage specialized technology to reap sustainable benefits.

Having a cash flow performance management platform serves multiple purposes for corporations seeking to achieve working capital excellence.

First is the ability to apply proven best practices in credit, receivables and payables automation on a worldwide basis. Second, a flexible and collaborative platform will enable multiple departments to streamline cash flow and dispute resolution processes. Finally, having performance management capabilities, including predictive analytics and reporting, allows senior executives to gain insight into overall cash flow management and develop higher working capital efficiencies.

By employing a combination of personnel training, best practices and specialized cash flow performance management technology, Global 2000 corporations like Solectron Corp., Syngenta AG, Vivendi Universal Games Inc., Hyperion Corp. and Zebra Technologies Corp. have been able to quickly reduce day sales outstanding by as much as 25 percent, minimize millions of dollars of bad-debt expense, improve cash flow forecasting accuracy by up to 35 percent and reduce worldwide operational expenses.

Veena Gundavelli is CEO of Emagia Corp. of Santa Clara, Calif., a producer of software that helps larger corporations maximize working capital. She can be reached at 408.492.8800.


* A McKinsey & Co. study of the top 24 U.S. corporations found that streamlining receivables and payables processes has the potential to boost net profits by 5 to 9 percent.

* Free cash flow is a key metric. As corporations improve their working capital management, their free cash flow also increases, potentially leading to higher valuations by investors and subsequent stock price increases.

* By following a program of seven steps, companies can discern an effective roadmap for squeezing the highest returns from global working capital management.
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Title Annotation:treasury: working capital
Author:Gundavelli, Veena
Publication:Financial Executive
Geographic Code:1USA
Date:May 1, 2006
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