Date : March 2016 Platform/Online Media: CFO Connect Magazine Source
Efficiency of collections – the role of CFO in DSO management
CFO's are the most anxious people when it comes to reducing the number of Days Sales Outstanding (DSO) from customers. After all, they are well aware that if the cash runs, out, one goes out of business! Clearly, there is a growing expectations form CFO's to play a critical role here, and finance organisation are being empowered, even restructured, to make high impact decisions in this area.
CFO's believe that a 'Sale is not complete till all dues are collected', and they have the responsibility of impressing this maximum upon the entire customer-facing team. In this maxim upon the entire customer-facing team. In this respect, they must play a lead role in several ways, from setting the right Key performance Indicators(KPIs) and establishing a credit facility, to improving process efficiencies (including automation), follow-ups and dispute management.
Start with defining the right KPIs. There are a multitude of useful performance indicators, including DSO, Best possible DSO(BPDSO), Receivable Aging, AR turnover, Collection Effectiveness Index(CEI), and so on. What is essential, though, is to identify and consistently use measures that work for the business over time, and not just in certain situations. Also crucial is to use KPIs that measure the efficiency and effectiveness of receivables management, and that provide timely and relevant information to measure, monitor and manage progress toward achieving key strategic objectives.
As a KPI, the DSO is a measure of time: how long it takes to collect an invoice once is sent. This provides insight into the efficiency of collections at a point in time. Meanwhile, the Collection Effectiveness Index (CEI) compares how much money was owed to the company, and how much of that money was actually collected, in a given time period. This helps assess the strength of the firm's collections policies and procedures over a period of time.
Credit management starts with the objective of extending credit only to those customers who prove credit-worthy. Organising and running a professional credit department can be tricky: it calls for the types of skills and administrative abilities required credit in bank. This works well only if the right policies are set from the beginning. All of the parties involved, including the customer, must have the required information, and know the rules of the game from the start. These 'rules' might include what parameters are used, what triggers a credit block, and how it might be released or enhanced. A step-by-step process should be developed, in which customers are awarded terms on the basis of figures and data they provide. In today's world, everything is transparent, and systems that extend credit should use tangible figures, credit scores, trade and bank reference checks, and credit history, among other factors. One might start a relationship, for instance, with only cash-on-delivery as an option, and then gradually increase the amount of credit extended as it gets earned. There must be sufficient incentives for the customers to work towards better terms.
The 3Ds: Documentation, Dispute Resolution, Dunning
Nothing upsets a customer more that getting a wrong invoice. It makes all the difference, then, to get the basics right: data accuracy, minimum time-to-invoice post sale, transparency on cost, taxes, discounts, and vendors compliance. Also important, in this regard, is to have the option to send invoices to customers not just manually, but through electronic platforms that allow for presentation and payments in one goes.
It is impossible to get customers to pay if you cannot get through to them, and the practice of sending payment reminder letters- i.e. the dunning process- is common today. A polite reminder a few days after the due date lets the customers respond, and to resolve any errors dispute. Quick action on reconciliation, matching already-on-account credit/debit, and unapplied payments or adjustments, is all essential. These help the customer establish the correct amounts payable. The next two levels of reminders might then become progressively severe, escalating to a threat of legal action, but keeping in mind the importance of the relationship. A carrot-and-stick approach, such as early payments discounts and late payment penalties, do work. More advanced measures, such as the use of credit insurance, factoring, receivable exchanges, collection lawyers, and reporting late-paying customers to the credit bureaus, can be considered on a selective basis.
Ultimately, policies and procedures are what lay the foundations for strong account receivables. Evaluating a customer for credit demands a robust system that tracks receivable and the collections process is about the art of knowing the customer. A psychological understanding provides insights into what buttons to push in collecting the account. Traditional ratios such as turnover will measure how many times you were able to convert receivables over into cash. Using the right measures- ones that are relevant to the business- is another vital aspect of managing accounts receivable.
Receivables management is not just a transactional issue, but a strategic one. During periods of both growth and economy uncertainty, CFO's must drive the effective management of receivables. Efforts to control receivables directly help improve cash flows, reduce transaction and operating costs, save time, and eventually, feed into sales and revenue. It is therefore crucial to both short- term survival and long -term growth.