accounts receivable management best...

John Wiley & Sons, Inc.

Accounts ReceivableManagement Best Practices

John G. Salek

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John Wiley & Sons, Inc.


John G. Salek

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This book is printed on acid-free paper.

Copyright 2005 by John Wiley & Sons, Inc. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system, or transmit-ted in any form or by any means, electronic, mechanical, photocopying, recording, scan-ning, or otherwise, except as permitted under Section 107 or 108 of the 1976 UnitedStates Copyright Act, without either the prior written permission of the Publisher, orauthorization through payment of the appropriate per-copy fee to the Copyright Clear-ance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, 978-750-8400, fax 978-646-8600, or on the web at www.copyright.com. Requests to the Publisher for permissionshould be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 RiverStreet, Hoboken, NJ 07030, 201-748-6011, fax 201-748-6008.

Limit of Liability/Disclaimer of Warranty: While the publisher and author have usedtheir best efforts in preparing this book, they make no representations or warrantieswith respect to the accuracy or completeness of the contents of this book and specifi-cally disclaim any implied warranties of merchantability or fitness for a particular pur-pose. No warranty may be created or extended by sales representatives or written salesmaterials. The advice and strategies contained herein may not be suitable for your situ-ation. You should consult with a professional where appropriate. Neither the publishernor author shall be liable for any loss of profit or any other commercial damages, in-cluding but not limited to special, incidental, consequential, or other damages.

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Library of Congress Cataloging-in-Publication Data:

Salek, John G.Accounts receivable management best practices / John G. Salek.

p. cm.Includes index.ISBN-10: 0-471-71654-5 (cloth)ISBN-13: 978-0-471-71654-9

1. Accounts receivable. I. Title. HF5681.A3S23 2005658.15'224dc22

2005003023

Printed in the United States of America

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www.wiley.com

This book is dedicated to the people and institutions who havehelped me immeasurably through the years.

My parents, who persevered in their lives through the GreatDepression and World War II to provide a wonderful childhood

environment for my brothers and I to grow up and be happy in our chosen endeavors.

My brothers, who walked beside me during the early years and whohave since prospered in their chosen professions.

Linda, the love of my life and my wife of 27 years, who has been at myside the majority of my adult life, providing support and stability.

Our two children, Michael and Stephanie, who have been an unendingsource of joy and pride.

The teachers, professors, and coaches at Ramapo High School in FranklinLakes, New Jersey; The University of Connecticut; and The Amos

Tuck School of Business Administration at Dartmouth College; whoprovided the educational foundation to succeed.

Bob Troisio, my mentor at International Paper Company, whointroduced me into the field of receivables management over a

quarter of a century ago.

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C O N T E N T S

Preface ix

Chapter 1 Introduction 1Why Is Receivables Management Important? 1If It Was Easy, Everyone Would Do It (Well) 2Influences Outside the Control of the Responsible

Manager 5Conflicting Priorities 6

Chapter 2 Receivables Antecedents 9Quotation 10Contract Administration 12Pricing Administration 16Credit Controls 20Order Processing 38Invoicing 40

Chapter 3 Receivables Asset Management 53Introduction 53Portfolio Strategy 54Collection Process 66Special Collection Efforts 83Deductions Processing 92Late Payment Fees and Prompt Payment Discounts 103Dispute Management 109Account Maintenance 117Payment Processing 121

Chapter 4 Technology 131Overview 131Receivables Applications 132Best Practices 134

vii

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Cost versus Benefit 138Key Points 138

Chapter 5 Organizational Structure 139Overview 139Best Practices 141Key Points 148

Chapter 6 Metrics, Reporting, and Incentives 149Overview 149Reporting-Driven Downward Spiral 150Best Practices 152Incentives 158Incentives Best Practices 159Key Points 164

Chapter 7 Acquisition Integrations and ERP Implementations 165

Overview 165Best Practices 170Key Points 175

Chapter 8 Outsourcing 177Overview 177Best Practices 180Key Points 185

Chapter 9 Selected Topics 187Introduction 187Policy and Procedures 187Internal Controls 188Financing of the Receivables Asset 189Payment Term Changes 192

Appendix Receivables Management Success Stories 193

Index 207

viii Contents

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P R E FA C E

In todays global marketplace, competitive pressure and industry prac-tice mandate that products and services be sold on a credit vs. cash-on-delivery basis. This practice often produces a receivables asset that isone of the largest tangible assets on a companys balance sheet. A re-view of the 2004 Fortune 500 certainly reveals this truth. Receivablesranked among the top three tangible assets for 75% of the top 100 com-panies. Surprisingly, management of this multi-million (or multi-bil-lion) dollar asset rarely receives much senior management attention,except when a serious problem develops. The custodians of the receiv-ables asset are similar to umpires of a baseball game; they are not no-ticed unless they do a bad job.

This book discusses the importance of managing accounts receiv-able, and provides proven principles for achieving benefits such as in-creased cash flow, higher margins, and a reduction in bad debt loss. Thefocus is primarily on commercial (business to business) receivablesmanagement. It excludes the specifics of managing retail (business toconsumer), healthcare provider (third party reimbursement), and inter-company receivables. The principles described apply to all business-to-business commerce, but will often need to be tailored to industry-specific practices.

The Best Practices in this book are real-world, field-tested practices.They were developed, refined, and improved by the author over a 16year period while working with over 100 companies in a wide range ofindustries to generate tangible, measurable improvements in the man-agement of customer receivables. Examples drawn from those engage-ments will be used throughout the book to illustrate real-worldproblems and solutions that drive measurable results.

This book is designed for all managers who are responsible for man-aging the receivables asset, either directly, such as directors of customer

ix

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financial services and credit managers or indirectly, such as controllers,treasurers, and CFOs. Reading this book will enable readers to betterunderstand how to manage this important asset while learning numer-ous practical techniques that can be implemented immediately to driveimprovement.

x Preface

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Introduction

WHY IS RECEIVABLES MANAGEMENT IMPORTANT?

It can be argued that revenue generation is the most critical function ofa company. Dot-com companies that created exciting new products butfailed to generate significant revenue burned through their cash andceased operating. Every company expends substantial resources togenerate increasing levels of revenue.

However, that revenue must be converted into cash. Cash is thelifeblood of any company. Every dollar of a companys revenue be-comes a receivable that must be managed and collected.

Therefore, the staff and processes that manage your receivablesasset:

Manage 100% of your companys revenue.

Serve as a service touch point for virtually all your customers.(Only Sales and Customer Service speak more with your cus-tomers.)

Can incur or save millions of dollars of bad debt and interest ex-pense.

Can injure or enhance customer service and satisfaction, leadingto increases or decreases in revenue.

1

C H A P T E R 1

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If increasing revenue, enhancing customer satisfaction, and reduc-ing expenses are important to you, read on.

The benefits of effectively managing the receivables asset are:

Increased cash flow

Higher credit sales and margins

Reduced bad debt loss

Lower administrative cost in the entire revenue cycle

Decreased deductions and concessions losses

Enhanced customer service

Decreased administrative burden on sales force

These benefits can easily total millions in profit and tens of millionsof cash flow in a year.

IF IT WAS EASY, EVERYONE WOULD DO IT (WELL)

Management of the receivables asset is a demanding task. The vast ma-jority of companies expect that over 99.9% of all billings will be col-lected. Collecting ninety five percent of revenue is not good enough.Companies will tolerate bad debt expense of several tenths of a percentof revenue, but not much more. Which other departments are expectedto perform at 99 plus percent effectiveness?

It is generally expected that a high percentage of invoices will bepaid on time and over 90% within 30 days of the due date. Manage-ment expects that the asset will be managed to promote sales and thatall customers will be served promptly, courteously, and professionally.Astoundingly, most firms also expect this all to be accomplished for acost equal to about two to three tenths of a percent of revenue. Quite a bar-gain!

Management of the receivables asset is a complex task. It addressesthe ramifications of practices and processes usually outside the span ofcontrol of the responsible manager. It requires balancing of opposing

2 Accounts Receivable Management Best Practices

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Introduction 3

How Improved Receivables Management Can Revitalize an Organization

A high-technology firm whose products were well regarded by themarketplace was experiencing an especially serious receivables man-agement problem. Bad debt exposure and the investment in receiv-ables were high (days sales outstanding [DSO] was just over 100days). Millions of dollars in disputed amounts were being concededannually, not in response to valid customer disputes, but simply as afunction of age. In addition, the companys stock price was de-pressed because of the high DSO. Wall Street analysts interpretedthe elevated DSO as an indication that:

Their new products did not work properly, or Products were delivered on a trial basis, were not valid sales,

and therefore were not true receivables.Clearly, this firm was feeling tremendous pain from failure to

manage its receivables.Over an 18-month period, this firm completely redesigned its re-

ceivables management process, tools, staff skills, and managementculture, implementing most of the principles and techniques de-scribed later in this book. The benefits from the companys improve-ment in its receivables, illustrated in Exhibit 1.1, include:

A huge increase in the stock price, and An increase in cash on hand equivalent to four months of

sales.In addition to the increase in stock price and cash on hand, bad

debt and concession expenses decreased by several million dollarsannually.

CASE HISTORY

priorities. It is affected by the state of the domestic and global economy,interest rates, foreign exchange rates, banking regulations and prac-tices, business law, and other factors. Excellence in receivables man-agement is a combination of art as well as science; it involves businessprocess, technology tools, staff skills, motivation, company culture,changing behavior of both customers and coworkers, the right organi-zation structure and metrics, incentives, and flexibility to deal withchanging external influences.

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Exhibit 1.1 Benefits of Improved Receivables Management

120

100

80

60

40

20

3/31

/200

1

6/30

/200

1

9/30

/200

1

12/3

1/20

01

3/31

/200

2

3/31

/200

3

6/30

/200

2

9/30

/200

2

12/3

1/20

02

DSO Cash Balance $million

0

450

400

350

300

250

200

150

50

100

0

Software Firm DSO versus Cash Balance

DSOCash Balance $M

120

100

80

60

40

20

Dec-00 Mar-01

101105

101

93

8074

61

6237

5754

38

263030

32

Dec-01 Mar-02Jun-01 Sep-01 Sep-02 12/31/02

DSO Stock Price

0

65

55

45

35

25

15

5

Software Solutions Provider

DSOStock Price

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Exhibit 1.2 illustrates the determinants or drivers of receivablesmanagement. Most of them are outside the direct control of the man-ager with responsibility for receivables.

INFLUENCES OUTSIDE THE CONTROL OF THERESPONSIBLE MANAGER

The receivables asset is sometimes called the garbage can of the com-pany. This is because the receivables asset reflects the quality of the en-tire revenue cycle operation. If an error is made in taking an order,fulfilling it, invoicing it, applying the customer payment, or if the cus-tomer is dissatisfied with the product or service, it will manifest itselfas a past due or short payment in the receivables ledger. The quality ofthe receivables asset is an excellent barometer of customer service. It isfeedback the customer willingly and quickly gives. It is tempting to callit a free quality control measurement system, except it is not free. Thefirm does not have to pay customers for the feedback, but it does incurcosts in remediating the problems.

Introduction 5

Exhibit 1.2 Drivers of Improved Receivables Management

Front-End OperationsOrder Processing and Contract AdministrationCredit Verification and ControlsBilling

ReceivablesCollectionAccount Reconciliation

Dispute and DeductionManagement

Cash Application

Terms and ConditionsPrepaymentsDue Dates

Past Due

Current

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In most companies the sales strategy and/or the front-end opera-tions (i.e., order processing and fulfillment, etc.) are outside the directmanagement control of the person responsible for receivables manage-ment results. In such cases, the manager is measured on the results of aprocess that he or she does not fully control. In response to this, en-lightened companies will place the entire revenue cycle (order to cashcycle) under the control of a single executive, as a process owner.This arrangement has numerous advantages, the primary one being thematching of authority with responsibility. Even then the executive doesnot have total control over all the determinants, specifically the salesstrategy and the need to make the numbers at the end of a month orquarter.

CONFLICTING PRIORITIES

Excellence in receivables management requires trade-offs between con-flicting goals. The trade-offs are best balanced in accordance with thecompanys overriding strategic objectives. To optimize the trade-off,the relative ranking of these strategic objectives must be understood:

Sales growth

Profitability

Cash generation

Market share

Risk tolerance

The conflicting objectives are to:

Loosen credit acceptance criteria and controls to boost sales ver-sus tightening credit controls to minimize the investment in re-ceivables and the exposure to bad debt loss

Achieve strong receivables management results and provide ex-cellent financial service to your customers versus minimizingthe cost of the function


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The Best Practices described in this book, when tailored to a com-panys strategic objectives, culture, and industry, will enable excellencein receivables management in all of its dimensions. This excellence willdeliver the profit and cash benefits available to your company.1

NOTE

1. Fortune, Special Issue, vol. 149, no. 7 (April 5, 2004), pp. F1F20.

Introduction 7

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Receivables Antecedents

Receivables antecedents are defined as all the up-front operations re-quired to create a receivable. They include:

Quotation

Contract and pricing administration

Order processing

Credit control

Invoicing

This chapter addresses these receivables antecedent functions onlyas they affect receivables management. Naturally, there is a great dealmore information and detail about these functions, but we will limit thediscussion as noted.

The antecedents are absolutely critical to the management of the re-ceivables asset. They directly impact the quality and collectability ofthe asset and are the key driver of the cost to manage a companys rev-enue stream. A simple formula to illustrate this point is:

High customer satisfaction + Accurate invoice = Excellent receivables results

This formula holds true even if the core receivables managementfunctions (i.e., credit control and collections) are lacking. Excellent

9

C H A P T E R 2

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order fulfillment drives high customer satisfaction. In combinationwith accurate invoicing, the cost of delinquency, concessions, and man-agement of the receivables asset can be dramatically reduced. Whencompetent credit control and collections are added, the total receivablesmanagement benefits are maximized.

QUOTATION

Overview

Quotation is the process of extending a formal offer for a product orservice to a prospective or existing customer. A clear, complete quota-tion lays the foundation for excellent fulfillment of a customer orderand accurate invoicing.

The two key attributes of a quotation that promote excellent receiv-ables results are:

1. Feasibility/deliverability of offering. Do not quote somethingyou cannot deliver. The product or service quoted must be ableto be delivered by your firm and perform as sold. If not, the cus-tomer will be dissatisfied with the product/service and with-hold payment of your invoice

2. Clear commercial terms and conditions agreed by both parties.The six elements of a quotation that affect receivables results are:

1. The unit and total price (clearly stated including all dis-counts)

2. Applicable sales or use tax

3. Freight/delivery (actual versus allowance, who pays it)

4. Payment terms (when is payment due?)

5. The timing of issuing the invoice (upon shipment, at thestart or completion of a project, on reaching a milestone)

6. Description of product or service offered (product number,laymans description, proper or trademarked productname).


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Receivables Antecedents 11

Make Sure Receivables Management Is the Problem

A European supplier of turnkey computer systems that includedhardware, software, and training was experiencing poor cash flowand seriously delinquent receivables. After speaking with collections,customer service staff, and customers, it was apparent that many ofthe systems were not working as promised. This company did nothave poor receivables management processes or practices; it had aproduct that did not work. Improvement in receivables results couldnot be achieved without first improving product performance.

CASE HISTORY

Improved Product Performance Leads to Improved DSO

A New England manufacturer of big-ticket production equipmentrushed a new product into the marketplace before it was completelydebugged. Performance problems developed, customers withheldpayments, and DSO approached the 200 level. The manufacturerdevised a solution and methodically retrofitted the installed base ofthe new product. Customers were pleased but insisted on runningthe fixed equipment for 30 days before accepting and paying forit. The retrofit program required six months to complete, but it wassuccessful. The firms DSO dropped as much as 10 to 20 days permonth once the retrofit program progressed, returning to normallevels after approximately eight months. No improvement in receiv-ables management practices was made; the improvement resultedentirely from improvement in product performance.

CASE HISTORY

Best Practices

Limit quotations to offerings in the approved sales catalog orother official product listing.

Utilize an automatic product configurator tool. Doing thisprevents offering a combination of products, options, and/or ac-cessories that are not compatible. An example of incompatibility

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