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Accounts receivable is typically viewed as something the accountants control somewhere in the back office. If the day’s sales outstanding (accounts receivable cycle time) is high, the focus is directed toward the collection process and billing. The reality of the situation is that the receipt of cash on a timely basis from a customer is the ultimate test of virtually all the processes of the company from the design of the product; the manner in which the product is positioned by the salesman, the taking and entering of the order, the manufacturing and shipment of the product, the installation of the product and the billing and collection process. Accounts receivable is the end of the funnel for all the processes in the company. If all the processes were performed in a timely seamless manner with good customer communication, the bill gets paid. On the other hand if the process or communication is not crisp, the payment will be delayed. To significantly impact accounts receivable cycle time or Days Sales Outstanding (DSO) most of the effort must be focused outside the accounting department to fix the root cause problems of late collections. Operational management must be an integral part of the collection process and have measurements and incentives that are focused on cash collection. As long as management views accounts receivable cycle time as an accounting issue, excellence will not be achieved.
Achievement of improved days sales outstanding represents a significant cash opportunity to most companies. An additional payoff is improved customer relations. The accounts receivable team must focus on the revenue cycle process which is depicted in Figure 1. This is the process from the point the salesman takes the order until the payment for the goods or service is received by the accounting department.
The revenue cycle consists of six sub processes which need to be individually mapped in the barrier identification phase of the program. These sub processes are as follows:
Each of these processes should be mapped and the key policies and process metrics understood. The key processes to improving accounts receivable typically are the order entry process and the collection process.
In analyzing collection problems, the root cause of approximately 50% of the problems will occur in the order entry system. The first pass yield data (FPY) for the revenue process will look something like Figure 2.
The first pass yield in the front of system (order entry) will be low, driving a number of collection problems. The purchase order number was not entered correctly, the wrong freight carrier was used, the wrong part was ordered or the pricing was not what the salesman quoted. Thus the order entry process from the salesman preparing the order to entry into the system must be mapped in detail and appropriate measurements established. The more subtle aspects of the order entry process or what can be termed customer communication system should also be understood during this mapping. What is the customer communication system to handle conflicts with customer requested ship dates, requested change orders and late shipments. Managing customer expectations often times will impact collections as much as actual performance.
The collection process is the second key process. The key to world class collection processes is consistency. The process has to react to the same set of circumstances in the same manner and in the same timeframe every month. The system must be consistent from month to month to month. Collection systems vary from company to company, however, some of the attributes of a good collection system are as follows:
The computerized order entry/billing systems have resulted in the billing process itself being an automatic process triggered by the product shipment with a very short cycle time in most companies. A typical cycle time of the accounts receivable process is generally hours for high volume manufacturing company to a matter of weeks in a contract-driven company like an accounting firm. The industry can drive the billing cycle time and therefore accounts receivable cycle time. A sharp reduction in the cycle time of the billing process typically will not have an impact on the day’s sales outstanding performance measurement. The billing process needs to be mapped, as there are situations in which the billing process is extremely complex such as government project work or the process is broken to such an extent that a major opportunity exists in the billing process.
The performance measures to determine the progress being made are:
The mapping and analysis of the revenue sub processes will identify barriers. The team should prioritize the barriers identified and begin working the high impact barriers. However, data collection activity should be started in parallel to confirm the barriers identified to date, discover additional barriers and define more clearly the root cause of barriers identified. Some of the best theories are blown out of the water by a little data.
The data collection should generally result in a Pareto analysis of root cause collection problems. Sources for this data are:
The optimal team structure to reach entitlement in accounts receivable is to view the underlying process as the revenue cycle which starts at order acceptance by the salesperson and is complete upon collection of the cash (Figure 1). The team focus should be the entire revenue process and include representatives from order entry, credit/collection and accounting. In addition the team must reflect the true cross functional nature of receivables and include representation from sales, fulfillment and service. Additional barrier removal teams would be added as root cause barrier identification progresses.
If a revenue cycle team approach is not feasible a very close working relationship must be established with the order entry team as a substantial portion of the accounts receivable barriers will be solved in the order entry department.
The majority of collection problems are not collection problems. The customers that do not pay their bills due to cash flow problems range from 20-30% of the overdue accounts. The vast majority of accounts that are past due are not yet satisfied with the execution of their order. The credit department is simply a facilitator in solving customer’s problems so that they achieve their collection goals. The road to accounts receivable entitlement is taking those same customer problems and instead of fixing the problem, fixing the root cause process that is creating the problem. Examples are:
The following are a number of generic problems that result in increased accounts receivable cycle time. This list is not intended to be all inclusive, but can be used as a mind jogger. The barriers encountered at a specific client are always somewhat unique and can only be identified by doing your homework. Here are some generic barriers:
Accounts receivable performance is a window to the effectiveness of the total revenue process of a company. Mediocre day’s sales outstanding indicate that the company’s revenue process, from the point the salesman takes the order to cash collection, does not function as an effective seamless process.
As a number of the root cause issues that create collection problems are outside the credit department, a cross functional team including sales, order entry, manufacturing and accounting is required to identify and solve the problems to drive improvements. Because of all the different functional areas involved, an experienced process consultant is useful to drive a company’s accounts receivable improvement program. Initially there will be some finger pointing by the functional team members; however, as data collection removes the emotion from the discussion and actions begin to drive results, the team’s momentum will build and day’s sales outstanding will begin to come down. The power of an aligned team will become apparent.