Receivables May Offer Relief When Cash Is Tight

Many companies are experiencing a buildup of accounts receivable on their balance sheets as customers — especially large corporate buyers — are stretching out their payment terms. While these bills may eventually be paid, delays are causing a cash flow crunch across many supply chains.

Recent Study

The CFO/The Hackett Group 2021 Working Capital Scorecard provides some eye-opening statistics on working capital trends during the pandemic. Based on data from the 1,000 largest nonfinancial companies in the United States, days sales outstanding (DSO) deteriorated by 3.8% to 41.5 days in 2020, an all-time high.

Although the average DSO varies substantially from company to company, customers are generally taking longer to pay invoices in 34 out of 50 industries covered by the scorecard. Many large companies are hoarding cash to prepare for continued economic distress and inflationary pressures in 2022.

Some large companies responded by passing their cash flow delays down the supply chain. The 2021 scorecard found that days in payables (DPO) rose from 57.8 days in 2019 to an all-time high of 62.2 days in 2020 — an increase of 7.6%. This is the largest one-year jump in five years.

There’s a limit to how far businesses (especially small ones in a competitive supply chain) can push their suppliers. If you’ve pushed your company’s DPO ratio to the limit, where else can you look for cash to fund day-to-day business operations?

For many companies, the answer is found in accounts receivable. Here are some opportunities to help turn your receivables into fast cash.

Early Payment Incentives

Your company may be able to expedite collections if customers are given a financial incentive to pay their bills early. For example, you might offer a 3% discount to customers who pay within 14 days of receiving their invoices. Online and autopayment options often work in tandem with these discounts.

On the flip side, consider assessing fees on past-due payments. This might kickstart some customers to resolve their outstanding balances. For those who respond proactively to late fees, you could waive late charges as an act of goodwill — the point is to entice payment, not to punish them.

Reinforced Collections Drive

Some small companies haven’t historically needed to dedicate specific resources to collections, because customers have generally paid on time. However, if significant collection issues have built up during the pandemic, it may be time to pick a customer service representative to be in charge of making collections calls. For more serious issues, you might prefer hiring a seasoned, in-house collections professional or reaching out to an external commission-based collection agency.

Before you send letters threatening late fees or remit a bill to a collection agency, it’s usually prudent to call the customer to find out what’s going on. Sometimes you might be able to negotiate a lower amount or installment payments — which is better than a write-off.

Line of Credit

A line of credit can help reduce the cash conversion cycle (the time between making a sale and getting paid). Often, credit lines are collateralized by unpaid invoices, just like equipment and property are pledged for conventional term loans. Banks typically charge fees and interest for securitized receivables.

Each financial institution sets its own rates and conditions. Typically, these arrangements provide immediate loans for up to 90% of the value of an outstanding debt and are repaid as customers pay their bills.

Factoring

This option allows companies to monetize their unpaid — but not yet delinquent — receivables. Here, receivables are sold to a third-party factoring company for immediate cash.

Costs associated with receivables factoring can be much higher than those for collateral-based loans. And factoring companies are likely to scrutinize the creditworthiness of your customers. But selling receivables for upfront cash may be advantageous, especially for smaller businesses, because it reduces the burden on accounting staff and saves time.

Important: Before monetizing receivables, banks and factoring companies will ask for a receivables aging schedule — and most won’t touch any receivable that’s over 90 days outstanding.

We Can Help

In today’s unprecedented market conditions, cash flow shortages are common. Contact your financial advisor for help monitoring and improving your DSO and other working capital metrics. There may be some creative ways for you to monetize what’s outstanding on your balance sheet.

Contributing Advisors