Accounts Receivable: How Much Cash Is Trapped?

Many businesses have adapted to the impact of the pandemic by paying later. As a result, the average business has experienced a considerable rise in days sales outstanding (DSO). The average DSO now sits at 98 days, with a DSO increase for 94 percent of Western European businesses, according to Atradius.

Research from The Hackett Group‘s Working Capital Survey and Scorecard showed that the US hasn’t fared much better, with companies dramatically slowing payments to suppliers in 2020. The survey found that, on average, companies now take more than 62 days to pay suppliers, an all-time high.

With the immediate economic impact of the pandemic starting to recede for the developed world, many businesses expect their average DSO to drop, thereby liberating working capital that can be put to work in supporting business growth.

But how much of an impact will changes to DSO really yield? Should businesses really strive to drive down DSO in order to liberate working capital from the receivables ledger?

How much working capital can be freed up by driving down DSO?

Let’s consider an example of DSO reduction for a £100m turnover business. If this business experiences an average DSO of 57 days, it has an opportunity to reduce this and extract the equivalent value from the receivables ledger.

By dropping its DSO by just one day, the business could immediately liberate the equivalent of £274k.

However, imagine dropping 57 days DSO down to 15 days! Reducing DSO so significantly would liberate the equivalent of £11.5m in cash. Capital that would otherwise have been sitting in the receivables ledger, supporting customers by extending them an interest-free line of credit.

Dropping the length of DSO also improves liquidity, which has become an increasingly important focus for businesses navigating uncertain economic times.

Is high DSO always a bad thing?

Whilst cash tied up in the receivables ledger cannot be directly put to work, sometimes it may be impractical to shorten payment timeframes to drive this figure down. Different industries and different regions have different expectations of payment terms and businesses may find a need to extend payment terms in order to compete.

Days beyond terms (DBT) and bad debt may be more important metrics to track from the perspective of the bottom line. Increasing DSO may indicate payment challenges within your customer base, but every dollar outstanding still counts as an asset.

The biggest challenge from high DSO is how much working capital is held up in the receivables ledger and not being invested into profitable activities.

Converting Accounts Receivables into cash more quickly

Moving beyond the frustration of cash tied up in the accounts receivable ledger may be easier than you think. Various options exist to access this working capital more quickly.

Improvements in DSO can be made by delivering invoices more quickly, particularly if using e-invoicing, and even automating this as well as other aspects of the billing process, such as sending statements and dunnings, to encourage payments to come in on time.

Investing in improvements to the O2C process can drive down DSO and improve customer experience. But what about more dramatic alternatives to access working capital more quickly?

There are considerable business benefits to extracting working capital in this way. It presents a route to funding for growth without taking on extra liabilities or debt, as with a business loan, but rather using assets they already have.

There are three main approaches to extract working capital from the receivables ledger: invoice discounting, invoice factoring or Managed Accounts Receivables.

What is invoice discounting?

Invoice discounting enables sellers to get advances on cash they are due from buyers, rather than waiting for those customers to pay. Invoice discounting is borrowing that uses the receivable value as collateral. The main steps in this process are:

1. 1. The seller sells to and delivers invoices to buyers as usual.
   2. A copy of each invoice goes to the invoice finance provider.
   3. The invoice finance provider then provides the seller with a percentage of the invoice value within a short timeframe.
   4. The collections process operates as usual, with the seller responsible for bringing the payment in on time.
   5. When the debtor pays, the balance of the invoice is received by the seller, but a service fee is due to the invoice finance provider.

The simplicity of invoice discounting can be both a benefit and a drawback when evaluating this type of borrowing as a route to liberate working capital. Here are some of the main pros and cons:

Pros

• • Simple cash release, without taking on debt
  • Can be offered by existing bank, requiring little set-up time
  • Customers do not need to be aware that any finance has been provided to the seller

Cons

• • If invoices are not paid on time, extra charges may be due to the finance provider
  • There may be limitations and requirements as to the makeup of the invoices supplied for discounting
  • Does nothing to streamline, simplify, or support the accounts receivable process – it’s just a way of acquiring funding

Take accounts Receivable to the next level with automation

Automating accounts receivable

What is factoring?

Factoring differs from invoicing discounting in that the process of invoicing and collections is still managed by the seller. Factoring allows businesses to fund cash flow by selling their invoices to a third party (a bank or independent finance provider) at a discount.

The main steps in this process are:

1. 1. The seller enters into an agreement with a factoring company, allowing them to manage their sales ledger and credit control for a fixed term (often 24 months).
   2. A percentage of the total invoice value is advanced to the seller each time an invoice is produced.
   3. Buyers adapt to changes in credit limits and collections process run by the factoring company.
   4. When the debtor pays the factoring company, the balance of the invoice is passed to the seller, minus a service fee.

Factoring is a far bigger commitment than invoice discounting but can significantly reduce the credit and collections workload and provide much needed access to working capital.

Pros

• • Simplifies the invoicing and collections process, which is owned by the factoring provider.
  • Provides a reliable cash advance on invoices, giving businesses access to working capital without the wait.

Cons

• • Loss of control over customer interaction; providers could be less sensitive to preserving customer relationships.
  • Long, fixed contracts can be costly and offer limited scope for change if customer relationships are negatively impacted by changes to credit and collections.
  • Not necessarily non-recourse, meaning that extra charges may be applied for late payments and bad debt.
  • Not necessarily the full ledger; providers may not take on the most challenging parts, which are the parts you most likely want to be covered!

What is Managed Accounts Receivables?

Managed Accounts Receivables (or Managed AR) provides many of the benefits of factoring and invoice discounting by guaranteeing payment of invoices within a specific timeframe. However, Managed AR goes beyond both factoring and invoice discounting in a number of important ways.

Firstly, Managed AR operates as an extension of your business, through a white-glove approach. What that means is that invoices and associated communications are sent as if they were from the business, ensuring that invoicing and collections proceed with the utmost care to preserve customer relationships.

Secondly, Managed AR provides a non-recourse guarantee that payments will be made within the specified timeframe. There is a guaranteed business outcome of on-time payment, DSO is set to a specific number of days, and bad debt is eliminated. Managing payments through this type of non-recourse service ensures that customer defaults are not borne by the original seller. Uncollected payments are absorbed in the risk calculation and service cost of Managed AR.

Pros

• • Non-recourse: there is no risk of extra charges for late payments or bad debt.
  • White-glove approach removes the risk of damage to customer relationships; invoicing and collections are done as an extension of the original business.
  • More working capital is released sooner. There is no split of initial payment and top-up after invoice payment.

Cons

• • Managed AR is new and not well understood by the market.
  • Can be wrongly associated with the negative press around supply chain finance in the last year.
  • Requires an experienced provider to support your customers with credit and collections processes on par with your own.

How Daimler achieved a fixed DSO of 15 days

Daimler’s National Accounts parts division was managing an expanding fleet parts business of hundreds of dealer operators that supported more than 15,000 customer locations nationwide. The complexity of maintaining more than 17,000 unique connections between Daimler dealers, buyer ERP, and point of sale (PoS) systems was immense and time-consuming.

Daimler sought a way to reduce complexity and drive down DSO, with a view to using the working capital (previously tied up in the receivables ledger) for business growth.

Daimler approached Corcentric to take on the challenge of managing the accounts receivable process, via the Managed AR solution. Corcentric was able to swiftly deploy Managed AR to the full customer base and assume the credit risk of Daimler’s customers by taking on the receivables and accelerating payment to Daimler dealers. Through the accelerated payment offering of Managed AR, Corcentric also eliminated the need for Daimler dealer locations to seek payment from delinquent purchasers.

By deploying Corcentric Managed AR, Daimler reduced its DSO from 37 days to 15. Less than two years after the Corcentric solution was implemented, Daimler saw a substantial increase in invoices processed, a double-digit growth in revenues realized, and an 86 percent decrease in disputes, with no additional overhead needed to accommodate its increased parts business.

To quote Richard Simons, General Manager of Parts Sales and Marketing for Daimler Trucks North America:

“Partnering with Corcentric to manage our billing has consistently enabled us to not only achieve significant processing efficiencies, but to have the visibility to identify customer trends, forecast spend, and develop strategic initiatives that actually improve our working capital.”

You can read more about our case study, Daimler Trucks North America drives growth with billing solution.

Interested in Managed AR?

Check out our webinar How to achieve a permanent DSO of 15 days, to find out more.