April 18, 2024
Cash and Cash Equivalents

Compressing The Order-To-Cash Cycle

Chief Accounting Officer at BlackLine, providing finance and accounting automation solutions.

Money makes the world go ’round and U.S. companies have plenty on hand for rainy days ahead. The Federal Reserve’s benchmark interest rates made it easy last year for companies to borrow. With interest rates approaching zero and at historic lows, the cheap cash helped fund capital projects, refinance existing debt and survive the impact of a lingering pandemic.

Corporate pockets also were stuffed last year with capital from investment-grade bonds and high-risk, high-yield bonds, issued at a near-record pace in advance of the expected easing of the Fed’s support. Added up, outstanding nonfinancial sector corporate debt in 2021 was around $11.2 trillion, roughly half the size of the U.S. economy.

Ah, the good old days! Growing leery of rapid inflation and hoping to cool the economy without freezing it over into a recession, the Fed issued the steepest interest rate hike since 1994 on June 14 and is expected to follow suit with another increase this September meeting.

In the meantime, American companies have tucked all that cheap money under the mattress. According to S&P Market Intelligence, S&P 500 companies held about $8.3 trillion at the end of the first quarter in cash, cash equivalents and short-term investments, up 42% from the fourth quarter of 2019. Sleeping on all those greenbacks makes investors fret and fuss, however. They’d prefer a more productive use of their capital, strategically investing it across a multiyear horizon.

Left with few alternatives to relieve shareholder angst, many publicly traded companies are buying back their own shares. In 2021, a record $880 billion was invested in stock buybacks by S&P 500 companies. Another $1 trillion is on track to go the same way in 2022, according to Goldman Sachs, possibly breaking the record.

If stock prices continue to flatten and stock buybacks remain on trend, the reduction in overall share count will result in higher earnings per share, S&P Global Ratings projected in March. That’s good news for investors, but most would rather see actual strategic plans put forth to increase revenue and earnings.

That’s difficult when so much is uncertain. For example, with inflation rising faster than wages, will it slow relatively robust consumer spending trends? With conflict in Eastern Europe at the half-year mark, will it further increase oil and food prices? With the broken supply chain still in need of mending and China going back-and-forth on Covid-19 lockdowns, will inflation accelerate next month, possibly beyond the recent 8.5% rise, just below the biggest yearly increase since 1981 that was reported in June? And if the Fed goes too far with its tough medicine, will it cause a recession?

In this perilous environment, companies must consider liquidity, which is impinged by the need to pay off all those accumulated debts from the last couple of years. They must account for the possibility of additional hikes in energy and material costs and higher salaries to retain skill sets at a time of labor shortages. And they must assess how much will be left over to fund ongoing operations coupled with the burden of higher inventory carrying costs due to supply chain issues.

In sum, the key challenge for all companies is cash flow forecasting—predicting both anticipated payments and cash receipts. Knowing how much cash will be on hand can help secure more advantageous terms from lenders and investors, fund a new initiative, buy up rivals and increase working capital, to the delight of shareholders. Without adequate cash on hand, assets may need to be sold or debt acquired at higher interest rates, to the consternation of investors.

Historically, projecting cash inflows has been unpredictable, due to erratic customer payment behaviors. At present, predicting cash outflows is equally if not more challenging, given that CFOs cannot control the global economy. To increase cash on hand, a better way to predict cash inflows is needed.

Know Thy Cash Flow

Aside from issuing more debt at higher interest rates or liquidating assets, a more efficient and operationally palatable means to increase cash on hand is to compress the order-to-cash (OTC) cycle. The OTC process initiates with a customer order and progresses through invoicing, inventory fulfillment, and concludes with a collection of the customer payment (accounts receivable). By reducing the length of time consumed in this cycle, companies can effectively convert inventory into cash quicker. In turn, this strengthens the balance sheet, improves financial ratios and reduces collection risk.

Put another way, the shorter the days of sales outstanding (DSO)—the number of days that elapse before payment is collected—the more cash on hand. For example, if a company with $12 billion in revenue can reduce its DSO by 30 days by instituting a more efficient order-to-cash process, this equates to pulling forward $1 billion per month in cash collections that otherwise would not be the case.

In many companies, the order-to-cash process is gummed up by manual processing. This is especially the case with accounts receivable, where most companies still dedicate significant resources to manually apply a cash receipt to an unpaid invoice. The manual processes fail to yield historical customer behavioral data to manage outstanding receivables or construct accurate cash flow forecasts.

To speed up the order-to-cash process, a diligent first step is to acquire a deep understanding of all the steps entailed. This can start with the customer order and go through credit management, order fulfillment, order shipment, customer invoicing, payment collection and cash reconciliation/ledger management. In this examination, look for points of friction related to manual processing, as well as evidence of possible disparate and inaccurate data.

Assuming these actions are taken to improve overall data hygiene, consider if there are ways to upgrade the order-to-cash process without having to increase head count or make incremental technological investments. These varied steps will reveal how much the process can be furthered with existing resources.

Now, perform the same evaluation again to determine if any points of friction remain. If this is the case, an automated accounts receivable solution can overlay the order-to-cash process at a cost justifying the value, by converting inventory to cash quickly to reinvest this capital in the business more efficiently. In a world of unpredictable macroeconomic variables making it harder to manage cash outflows, companies can find refuge in process changes and technologies to better predict cash inflows.

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