Order-to-Cash Processes

TMI170 ING info pat 2:Info pat.qxt 01/12/2008 09:25 Page 1 Section Two: Order-to-Cash Processes Gregory Cronie, Head Saes, Payments and Cash Management, ING O rder-to-cash and purchase-topay processes are cosey aigned - after a, every company wi be both a buyer and seer of services. In this Guide, brought to you by ING, we focus first on order-to-cash. This is deiberate whie CFOs are rarey kept awake at night worrying whether a payment has been made, worrying whether money has been received is quite a different matter. Many cash management and financia suppy chain projects focus initiay on payments, particuary internationa payments, as these can be costy uness managed effectivey and there is a fear of frauduent payments, uness adequate contros are in pace. Athough payments is an important area on which to focus, it may be more vauabe to prioritise coections in many companies as the benefits are more tangibe, to ensure that cash is coected earier, creating cash fow to fund the company s activities. After a, for many firms, receivabes are the argest or second argest asset on their baance sheets. Fig 4 beow exempifies a possibe order-to-cash process, with the buyer to the eft and seer to the right. For the purposes of this order-to-cash section, Company A is the seer; however, as we wi see when we move on to purchaseto-pay, many of the techniques for automating order-to-cash processes are, of course, reevant when Company A becomes the buyer. Treasurers frequenty consider the description of order-to-cash to be synonymous with coections, but this does not take into account the compexity in the processes which precede cash receipt. From the perspective of Company A, the order-to-cash processes - and the chaenges surrounding them incude: A. Agree order detais, incuding pricing and payment terms. Depending on the scae of the order, type of customer and type of goods/services, companies may appy different payment terms to different customers eg. payment in advance; payment on receipt of goods; payment 30 days from invoice or 30 Fig 4: Order-to-Cash Process Athough payments is an important area on which to focus, it may be more vauabe to prioritise coections in many companies as the benefits are more tangibe Source: Asymmetric Soutions Ltd TMI ING Guide to Financia Suppy Chain Optimisation 1

TMI170 ING info pat 2:Info pat.qxt 01/12/2008 09:25 Page 2 Order-to-Cash Metrics Athough companies wi appy metrics at different stages of the order-to-cash process (eg. the number of days after order date/fufiment that the invoice is raised, proportion of invoices resuting in a query, speed of query resoution) the most significant metric from a iquidity and working capita perspective is Days Saes Outstanding or DSO. Accounts Receivabe x Number of Days (i.e. 360/365) Tota Credit Saes Or: Accounts Receivabe/Tota Credit Saes Number of Days DSO is the average number of days between point of sae and coection. Therefore, the ower the number of DSO, the fewer days it takes a company to coect revenue. DSO is cacuated as: Accounts Receivabe = Amount of Cash Owing to Company (i.e. invoiced and not received) Tota Credit Saes = Annua saes where amounts are payabe after order/order fufiment Number of Days = Number of Days in the year - i.e. 365 For exampe, assuming Tota Credit Saes = 1,000,000 and Accounts Receivabe is 100,000 1,000,000 / 365 = 2,739.70 DSO = 100,000 / 2,739.70 = 7.51 days DSO can vary from month to month, and over the course of a year with a company s seasona business cyce. If using DSO, it is important to anayse trends. For exampe, increasing DSO may be an indication of customer dissatisfaction or that extended payment terms are being offered (perhaps for competitive reasons or saes target pressures). It coud aso refect inefficiencies in credit or coection processes. However, DSO is not the most accurate indication of the efficiency of the coections process. Changes in saes voume infuence the outcome of the DSO cacuation. For exampe, even if the overdue baance stays the same, an increase of saes can resut in a ower DSO. A better way to measure coections effectiveness is to ook at the tota overdue baance in proportion of the tota accounts receivabe baance (tota AR = Current + Overdue), which is sometimes cacuated using the Days Deinquent Saes Outstanding (DDSO) formua. Metrics are avaiabe for best in cass DSO for different industries by companies such as The Hackett Group. days from receipt of goods. Appying different payment terms heps the company to manage risk but can aso make it more difficut to monitor and foow up on receipts. B. Orders can be received in a variety of ways depending on the industry and type of goods etc. but a frequent probem is transferring detais of the order into the company s systems to be passed on through finance for invoicing and production/services for order fufiment. Manua input of purchase orders can resut in errors and a great dea of resource. C. When receiving invoices, many customers wi require their origina purchase order number so they can reconcie the invoice with the origina order detais. As we as detais of the order, payment terms etc. this information therefore needs to be hed on the company s system to be passed through to the customer. Without this, a customer s reconciiation process, and therefore payment, can be deayed. Invoices are frequenty sent by post, which is expensive and, can ose a few days, which can resut in ate payment. On the other hand, often customers wi not accept invoices received uness in hard copy. D. With payment terms often extending to 30, 60 days or beyond, and payments frequenty received on a date other than the due date, depending on customers payment run etc. unpredictabiity of coection timing is a significant probem for companies, making it difficut to forecast accuratey. Furthermore, chasing ate payment is frequenty a timeconsuming but vita activity, made more difficut when different peope are invoved in coections, or the process is dispersed across different parts of the organisation. For exampe, the saes team (often distributed across many ocations) in many 2 TMI ING Guide to Financia Suppy Chain Optimisation

TMI170 ING info pat 2:Info pat.qxt 01/12/2008 09:25 Page 3 Fig 5: Exampe Chaenges & Remedies in the Order-to-Cash Process Chaenge Remedy Payment Terms Ensuring payment terms are appropriate to the risk profie. Monitoring coections when different orders have different payment terms Customer management system (CMS) and credit process to appy appropriate payment terms. Training of saes staff and processes to ensure that payment terms refect credit risk whist being attractive to customers. Suppy chain finance soutions, such as receivabes financing (pease see Part Two of this Guide). Automated coections soution which incudes this capabiity. Purchase Order Recording order detais accuratey in company s systems with imited resources Eectronic order processes such as order scanning and automated data dissemination. Remote order input by customers directy to company s order management/erp system eg: data originating from customers systems. Invoicing Postage can be expensive and deay payment. Invoices need to incude customers purchase order reference. Eectronic invoicing (einvoicing) incuding coaborative approach with customers. For exampe, einvoices abe to be imported directy into customers systems. Coection Late payment is damaging to suppiers party due to the unpredictabiity of cashfow. Chasing payments is not aways systematic when conducted on a distributed basis and/or by individuas with other responsibiities, so cash may be received ater than necessary. Modification of ERP or order management system to record this information and aow it to be reproduced on invoices. Eary payment discounting encourages timey or eary payment and increases predictabiity of coection. Centraised coections process, either through shared service centre or dedicated coections factory. Reconciiation & Working Capita Difficuties in identifying when cash has been received into different accounts etc. Impact on customer reationships and iquidity/ working capita Work with banking partners to ensure that invoice number is shown on bank statement for reconciiation. Cash centraisation to aow greater visibiity of coections and contro over iquidity. Payment under Export Letter of Credit Errors in trade documentation deay receipt of cash. Review and tighten interna processes, incuding seeking advice from trade banking partners. companies is responsibe for chasing coections but saes professionas are generay incentivized to generate revenue, so these other priorities frequenty prevent coections from being managed systematicay. E. Receiving payments in different banks, accounts, ocations and via different payment methods means that finance managers do not aways know when payment has been received, particuary if reconciiation is a decentraised activity. This can cause probems with customer reationships - for exampe, a company appears unprofessiona if chasing invoices, which have aready been paid, or incorrecty stops future orders. Furthermore, unidentified or unpredictabe coections restrict a company s efforts to manage iquidity and working capita. In theory, the timing of cash received under the terms of an export etter of credit shoud be more predictabe. However, with a arge proportion of trade documentation being submitted to the bank with errors, often repeatedy, which need to be remedied before payment can be made, companies are often unnecessariy deaying infows of cash which coud be essentia for iquidity management purposes. TMI ING Guide to Financia Suppy Chain Optimisation 3

TMI170 ING info pat 2:Info pat.qxt 01/12/2008 09:25 Page 4 Remedies to Order-to-Cash Chaenges Addressing the chaenges above can be achieved in various ways, incuding a combination of interna initiatives, potentiay with soution vendors and/or banks, and externa projects working with banking partners. Whie every company s order-to-cash process wi differ, some of the most important soutions incude: Purchase order services Purchase order services are cosey aied with einvoicing. By connecting these processes, buyers and seers can share a common view of data with data imported and exported eectronicay from/to the respective companies systems. Typicay, systems supporting purchase order deivery aow copies to be printed and/or the reevant data imported into the seer s systems in the appropriate format. This avoids the need to manuay input data from the purchase order and both buyer and seer record the same reference information. Some systems provide automatic notification to buyers of purchase order receipt. einvoicing Purchase order services can be (athough is not aways) inked to einvoicing by automaticay creating the invoice based on the purchase order information. Data from the origina purchase order is suppemented with additiona information from the seer s systems, such as payment terms, and transmitted back to the buyer. Like purchase orders, these can then be printed by the buyer, or imported in the reevant format into its interna systems. einvoicing is used as quite a generic expression to incude different types of eectronic invoicing. For exampe, EIPP (eectronic invoice presentment and payment) and EBPP (eectronic bi presentment and payment) are both acronyms frequenty used to describe different types of einvoicing soutions. EIPP is typicay Reducing the quantity and vaue of overdue coections shoud be a priority for every CFO, now more than ever. einvoicing techniques are deveoping momentum and many companies are seeing the benefits of both B2C and B2B einvoicing. The cost benefits in terms of reduction in paper, printing and postage is cear, but einvoicing brings major benefits to both suppiers and their customers by enabing straight-through-processing as invoices can be processed automaticay without the need for data reinput. einvoicing is an exampe of a coaborative approach to financia suppy chain optimisation in which both buyers and suppiers benefit, strengthening reationships and making it easier to do business Ad van der Poe, Head of E-Business, Payments & Cash Management, ING Fig 6: Advantages of Centraising Coections Reduce Days Saes Outstanding (DSO) Leverage technoogy and personne more effectivey More strategic goba customer reationships/support saes function Increase Predictabiity of Cashfow Infuence Timing of Cashfow Potentia source of financing used to describe business-to-business (B2B) invoicing, whereas EBPP is used to refer to business-to-consumer (B2C) biing such as utiity and teecoms bis. Athough more reevant to purchase-topay, some einvoicing soutions aso incude automated purchase order and invoice reconciiation, as we as invoice approva. One trend, which has emerged in recent years, is a purchase order/invoice exchange, such as OB10, which effectivey provides an intermediary mechanism for distributing, receiving, matching and converting purchase order and invoice data. Centraised Coections Reducing the quantity and vaue of overdue coections shoud be a priority for every CFO, now more than ever. Ceary, the earier payment is received, the sooner that cash fow is avaiabe to the business. Furthermore, during difficut economic conditions, many firms are scrutinizing their credit risk in more detai, resuting in shorter payment terms, ower credit imits and more stringent imitations on re-order in the event of outstanding coections. In many companies, the accounts receivabe function is distributed geographicay and by business ine, often aigned with the saes organization. As saes departments are primariy focused 4 TMI ING Guide to Financia Suppy Chain Optimisation

TMI170 ING info pat 2:Info pat.qxt 01/12/2008 09:25 Page 5 on signing new orders, monitoring coections is often a secondary activity or acks a systematic approach. It is very difficut to ensure that coections are rigorousy managed uness there is dedicated resourcing, consistent processes and management visibiity over coection status. Centraising the coections function can be physica or virtua - i.e. with coections staff based in a singe office or ocated in different sites but with a common systems infrastructure to automate processes, ensure consistency and produce standard management reporting. There are a variety of benefits in centraising the coections function, as summarized in fig 6. However, in addition to the operationa and working capita advantages, one aspect, which shoud be emphasized, is the abiity for companies to work more effectivey with their goba customers. A company may engage with a customer in a variety of different ocations with various payment terms, credit ines and payment currencies. By centraising the management of coections, companies can estabish goba credit ines, track customer activity gobay and provide consistent payment terms. This avoids mutipe accounts receivabe communications with the same cient and enabes companies to give better service. Dynamic discounting is an attractive way of increasing the predictabiity of cash fow and creating working capita without the need to obtain third party financing. However, ike suppier financing, trading partner reationships can be enhanced by introducing dynamic discounting. Furthermore, dynamic discounting is based on a buyer s credit rating instead of being pegged to the suppier s risk, further strengthening these reationships. Robert Dekker, Goba Head of Saes Corporate & Institutiona Cients, Payments and Cash Management, ING Eary Payment Discounting Eary Payment Discounting or Dynamic Payabes Discounting is a process which suppiers can use to encourage buyers to pay eary based on a siding discount scae. The discount amount is cacuated dynamicay based on the number of days remaining unti the due date. Discounting is a more economic means of financing than factoring or assetbased ending, and by creating greater certainty around payment timing, improving cashfow forecasting. Automated Coections Soution Whether coections are centraised physicay or virtuay, using a coections soution to provide systematic receivabes management is essentia. It is aso worth noting in anticipation of Part Two of this Guide that the more discipine in this process, the greater the proportion of receivabes that can be financed. Furthermore, credit insurance is often cheaper and better pricing for receivabes financing can be achieved. Centraised Cash Management Even if interna processes have been centraised, it is very difficut to manage coections if incoming cash is fragmented across different accounts and different regions. As we wi see in more detai in Part Three of this Guide, estabishing a regiona approach to cash management can address many of the difficuties of achieving visibiity, reconciiation and managing iquidity across different countries. Furthermore, with the Singe Euro Payments Area (SEPA) payment methods now avaiabe, in which ING has estabished itsef as an industry eader, companies can make it easier for their customers to pay them quicky and cost-effectivey, wherever they are in the Eurozone. n Case Study: Improving Coections in a Major Internationa Service Company We have focused on increasing the accountabiity of the Accounts Receivabe operation to the business, impementing SunGard s AvantGard Receivabes to deiver exceence in business processes, provide metrics back to the business and ensure that the coections process remains integra to our focus on customer service. We aso have cose connections with the saes teams and incude them in dispute processes at an eary stage to ensure that customer reationships are managed effectivey. We can aso og disputes and create reports by reason and time to resove the dispute and add notes to each customer account. This has heped us improve coaboration with the customer service departments and coect on outstanding invoices more quicky whist ensuring that customer reationships remain a centra focus. We have achieved significant benefits in doing so, incuding: Improved our dispute resoution time by 59% over a 12 month period, together with reporting back to customer services; Coected past due cash an average of 3 days earier 75% reduction in our advanced accounts receivabe past due aging, deivering cost savings of more than $300K in bad debt expense across the year despite >30% revenue growth. TMI ING Guide to Financia Suppy Chain Optimisation 5