Working capital management focuses on three factors that affect a company's free cash flow: the pace at which the company pays what it owes its suppliers, how quickly it collects what it's owed by its customers, and the amount it has invested in inventories.

REL, a working capital consultancy that's a unit of the Hackett Group, reported last year that research involving almost 1,000 of the largest U.S. public companies showed they had more than $1 trillion tied up in working capital.

Alberto Casas, North American head of receivables at Citibank, said working capital is likely to take on even more significance for corporate treasurers when the Federal Reserve starts to tighten policy.

As interest rates begin heading higher, "external sources of funding will become more expensive, and treasurers will seek opportunities to creatively explore other working capital strategies," Mr. Casas said. "We fully expect that working capital optimization will be top of mind."

Payables

Companies exercise considerable control over their payables, since they're the ones writing the checks. As the recession hit, many big companies took longer to pay their suppliers, pushing out their days payables outstanding (DPO).

Greg Person, vice president of global presales at Kyriba, noted that there has been a considerable amount of news coverage about the negative effects of big companies' delaying their payments to small and midsize suppliers.

In fact, the Obama administration took notice of the plight of smaller suppliers last year when it launched an initiative called SupplierPay. Companies that sign on to the program commit to paying their small suppliers more promptly or helping them access lower-cost capital. To date, 46 major corporations have signed on, including 3M, Apple, Coca-Cola, Intel, Johnson & Johnson, Lockheed Martin, Walgreens, and Xerox.

Person, pictured at left, pointed to supply chain finance programs as a method that large corporates can use to extend their payables in a responsible way, while at the same time giving suppliers more control over when they're paid. In supply chain finance, a bank serves as a middleman to offer a company's vendors earlier payment at a discounted rate, with the bank's willingness to advance payment to the supplier linked to the creditworthiness of their large corporate customer.

Kyriba has a supply chain finance product that companies and banks can use to implement such programs, and Person said the company sees a lot of interest in this area. The next evolution in supply chain finance programs will involve solutions that can work with multiple ERP systems and multiple banks, he said.

"Introducing a supply chain finance program in conjunction with a project to extend payment terms (increase/improve DPOs) helps mitigate some of the challenges associated with adjusting supplier payment terms and keeps the supply chain healthy," Volkwein said, adding that regulatory changes such as Basel III are making it more difficult for companies with lower credit ratings to access financing.

"A supply chain finance program is a synergetic way to extend financing to suppliers by leveraging the buyer's credit rating, where suppliers are able to reduce their DSO and buyers are able to extend their DPO; it's a win-win-win solution for the buyer, supplier and the bank involved in the financing," Person said.

Analisa DeHaro, an associate principal at REL, cited another approach: companies' use of early-payment discounts and dynamic discounting programs. While early-pay discounts involve offering to pay a supplier earlier than the standard terms if the supplier accepts a discount, companies that use dynamic discounting allow suppliers to choose from a range of dates and discounts, DeHaro said. "The sooner you pay, the bigger the discount you get."

Dynamic discounting doesn't involve financing from a bank or other third party, but it does involve software from vendors such as Ariba and Kyriba, she said.

Focus on Receivables

As companies consider how to make headway on working capital, they're likely to target the receivables area, said Citi's Casas, pictured at right, since many have already wrung out most of the gains possible on the payables side.

And as interest rates rise, float will become a bigger consideration, Casas said, adding to the impetus for improved management of receivables. "You need to look at this across the entire spectrum," he said. "If you're collecting from a large percentage of your customers via paper, and a customer is paying on day 30 and mailing a check, the lost income around that lost float will become more and more significant."

But the receivables area poses a number of hurdles.

While companies have control over when and how to pay their suppliers, "on receivables, you have very little control over how your customers are paying you or when they choose to pay you," Casas said. "So it's more difficult to unlock opportunity than on the payments side of the equation.

"And on the receivables side, there's still a significant amount of paper in the system from a check and invoice perspective," he said.

Casas noted the disparity that exists between the way that consumers pay businesses and the way businesses pay other businesses, with 60% of consumers' payments to businesses now occurring electronically, while the majority of business-to-business payments are made via check.

In part that reflects an infrastructure that has grown up around consumers' payments, he said, including home banking, which allows a consumer to go to his or her banks and pay multiple billers. Companies like insurers and utilities also have websites where consumers can go and make payments.

"On the B2B side, no consolidator model exists, which makes it very difficult to achieve a shift in payment behavior," Casas said.

Nor have electronic invoice payment and presentment (EIPP) efforts worked, he said. "The larger sophisticated payers, they have a very sophisticated and structured [accounts payable] process and they don't want to have to go to a website to make a payment," Casas said, but added that that approach can work with smaller companies which lack complex A/P systems.

Volkwein said factors that can extend a company's days sales outstanding (DSO) include "generous payment terms for customers and poor accounts receivables matching processes."

Companies face steady pressure from customers to extend their sales terms, said Brian DeGraw, one of the leaders of the customer-to-cash advisory practice at the Hackett Group.

While a company's standard terms may give customers 30 days to pay, "if you're out making deals, part of the deal might be, 'We'll give you 45 or 60 days to pay us,'" he said. "If the focus is increasing market share and top-line revenue, often that's going to have an effect on receivables.

"There are a lot of dynamics you have to consider," DeGraw added. "Are you a strategic supplier? Are you a commodity? That's going to affect your ability to negotiate terms."

Persistent Problems

Another hurdle to collecting payments faster is the fact that "in [accounts receivable], there's no single point of trapped cash," Casas said.

He cited the example of a salesperson who makes a deal with a customer that involves a 5% discount. When the transaction is turned into an invoice, that discount is missing, and "the customer says, 'I'm not paying this,'" Casas said. If the customer has a hard time interacting with the company to remedy the problem, that payment can be delayed, extending DSOs, he said.

In order to identify the problems that are holding up payments from customers, companies need to understand their entire receivables process, "from when the order is collected to when the cash is collected and is available to the organization as working capital," Casas said.

They also need ready access to data about receivables, but that may be hard to achieve. "Data residing in multiple systems and in varying formats make it difficult for treasury folks to identify where there are potentially opportunities and risks," Casas said. That means opportunities are often missed and risks can go unnoticed for long periods of time.

Casas suggested that ERP systems are a good place to develop tools to unearth trapped-cash situations. "That said, ERP-related projects can be all-consuming for our clients and require appropriate planning," he said.

DeGraw said ERP systems have made great strides in the functionality they provide around accounts receivable. "They're starting to be able to support very specific collection strategies, do segmentation of your customer base, and align your contact strategy to that," he said. "They're starting to provide that technology on the desktop for the collector."

Bob Meara, a senior analyst in the banking group at research firm Celent, said that while software solutions related to receivables management traditionally focused on speeding up companies' resolution of exceptions, vendors are now rolling out products that employ analytics to pinpoint "nagging and ongoing problems" in this area.

"Rather than resolving exceptions from ongoing problem clients month after month a little more efficiently, why not identify who they are and make a systemic effort to improve on a permanent basis?" he said.

Meara cited such vendors as Direct Insite and Polaris, but noted that the solutions require time and effort to deploy. "But for a treasurer in a large-ish organization with nagging challenges in DSOs, this would be a great place to look in my opinion," he said.

Another approach to improving receivables management is to segment the company's receivables based on where employees' time and effort can be deployed most effectively, REL's DeHaro said.

"What you may find is that you have a lot of smaller customers where you can use other things, like dunning letters or some other process," she said, which frees receivables team members to look into delayed payments involving large customers.

POBO/COBO

Deutsche Bank's Volkwein, pictured at left, said solutions that companies can consider in the receivables area include accounts receivable matching, payment aggregation, and collections-on-behalf-of (COBO) structures.

While these approaches are not new, he said, "a greater understanding of market regulations [and] practices, and advances in ERP, [treasury management systems], and bank technology have helped make these solutions a reality for more companies in more markets."

Volkwein cited the use of virtual accounts to accelerate reconciliation. "When buyers are invoiced, a unique account number is included so that when payment is made, it's made against a specific invoice," Volkwein said. "All of the virtual account numbers correspond to a single physical account, so all collections hit a single account.

"Treasurers can also use a payment aggregator to compile and consolidate payments made to the same beneficiary to reduce volume of payments and associated transaction fees," he said.

Companies that use payments-on-behalf-of (POBO) have their ERP system consolidate all the payments due to a single supplier, and treasury then makes a single payment. COBO takes the same approach to collections.

"All of the account structure complexity normally associated with multinational corporates, where each legal entity or business unit has multiple accounts by country and currency, is replaced with a single set of accounts owned by treasury," Volkwein said. "The liquidity benefits are significant."

In addition, "treasury no longer needs to view balances across hundreds or thousands of accounts, but rather views balances on a single set of global accounts," he said.

Kyriba's Person said treasuries are also using approaches like factoring—selling their receivables to banks and finance firms—in order to reduce their DSOs.

He noted that DSOs vary considerably in different regions of the world. Some countries in Southern Europe, such as Italy, Spain, and Portugal, "are notorious for having longer payables cycles," Person said. "If the average DSO for North America is 45 days, you could be looking at 150 days-plus in certain geographies."

In some of the regions where payments are slower, such as Latin America, Person said he is seeing more companies turning to factoring.

"While it's not a free program, from a working capital perspective, it takes [the receivables] off the balance sheet and improves the company's liquidity position," he said.

He also noted companies' use of electronic platforms where they can post receivables and let hedge funds and other investors bid on them. "Again, it gets the receivable off your books and you get the cash," Person said.

Company Stories

Organizational complexity is another barrier to efforts to improve receivables management.

"Many of our clients have grown through acquisitions, and in many cases treasury must manage through a fragmented network of businesses and functional groups," Casas said. "Depending on whether they have a centralized treasury model versus a decentralized model, it can be very complex to realize efficiency and effectiveness.

"Many of our clients have implemented shared service center models to create efficiency and to better control and manage their businesses, particularly those that have global operations," he added.

At $6.6 billion Ryder System, which provides fleet management and supply chain solutions, receivables management took a turn for the better once the company centralized its North American receivables into a single shared service center.

Until the mid-1990s, each of the Miami-based company's 80 district offices in the United States and Canada was responsible for its own billing and receivables, said Doug Hansen, Ryder's director of receivables management.

Moving billing and receivables to the shared service center took 18 months, and Hansen said things got worse before they got better. Once the company announced the move to a shared service center, "we started losing people very fast," he said. "We had districts with no billing people, no collections people."

Hansen also noted the difficulty involved in getting customers to direct their payments to the two new lockboxes the company established, in Los Angeles and Chicago, instead of to the 80 district offices. "It takes time to get [customers] to change their A/P systems to send their money to the lockboxes," he said.

But centralizing receivables management "helped tremendously," Hansen said, in part because it gave the company a single view of its customers for the first time. Centralizing the credit department paved the way for more consistency in Ryder's credit approvals. And with lockbox employees keying in invoice numbers, Ryder was able to move to automated cash application.

The centralized accounts receivable system that takes in the feed from the company's bank is part of Ryder's ERP system, Hansen said.

Ryder is now considering deploying software that would use intelligent character recognition to read the information off the images of the checks it receives. "We think it would improve our cash application hit rate," currently at 90%, Hansen said. "And it would save us the money we pay the bank to keypunch the numbers."

Hansen argued that the state of a business unit's receivables says something about how well it's going about its job. "If you have a particular unit with lousy payments, there's a story behind it," he said. "It may be operational issues, it may be financial issues, it may be something we promised that we can't do and [the customer] stopped paying to get it.

"That's why receivables is so important," he added. "It's a key performance indicator."

While all of Ryder's receivables involve B2B transactions, Mercy, a St. Louis-based health system, bills both the consumers who are its patients and payers such as insurers and government organizations. But Mercy, the fifth largest Catholic health care system in the U.S. with 35 hospitals and almost 700 clinics and outpatient facilities in four states, has also seen its receivables management benefit from centralization.

As Mercy moved to a centralized business office, it standardized the processes and procedures used at all its facilities and centralized the management of receivables using a system that also handles patients' medical records.

"That's one of Mercy's strengths. We put the sources into centralizing our internal process and implementing the electronic health network process," said Steven Walden, manager of treasury at Mercy.

Peggy Burroughs, vice president of patient financial services, said that effort improved Mercy's key performance indicators around receivables.

When it comes to getting its bills to insurers paid on a timely basis, Mercy focuses on fine-tuning the claims that it submits. "We do a great deal of review; we call it claims scrubbing," she said.

Mercy has software that knows what information each insurer wants to see on a claims form and how it wants a claims form to look, and it formats each bill accordingly.

"Our best defense at getting a claim paid quickly is having a clean claim," Burroughs said.

While most B2B payments are still mired in paper, the vast majority of Mercy's payments from insurers arrive electronically, courtesy of an Affordable Care Act mandate that insurers offer electronic payments. Mercy is still working with some smaller insurers to convert them to electronic payments, Walden said.

He noted that 95% or more of electronic payments can be posted automatically, while a manual process is still required to post payments made by check.

Mercy has made it as easy as possible for patients to pay their portion of the health care bill. Consumers can use a credit card to pay online via Mercy's patient portal, and they can also pay with a credit card at the various hospitals and clinics.

"Revenue has driven us to put that capability to take a payment everywhere we can," Walden said.

Centralizing in a Shared Service Center

The impact of working capital management on a company's cash flow and liquidity puts it squarely in the treasurer's wheelhouse.

But efforts to improve working capital management involve many other parts of the company in addition to treasury.

"It's a decentralized process with multiple stakeholders and often no clear owner," Citi's Casas said. "The salesperson is acting independently, the invoice team is working independently, you've got treasury, you've got customer service—a whole host of areas just doing their job."

Treasury exercises no control over many of the other players involved. And when it comes to working capital, some of the other units involved have interests that run counter to treasury's.

"Treasury thinks in terms of working capital management and liquidity risk," Deutsche Bank's Volkwein said. "On the other hand, the departments responsible for accounts payable and accounts receivable have different focuses. Procurement may be thinking primarily about supply chain health or reducing the cost of goods sold—two objectives that would require additional working capital funding.

"Treasurers face a similar challenge on the sales or credit side of the enterprise, where objectives may be to increase revenue by offering generous terms and/or ample credit to customers and distributors—two actions that also add stress to working capital funding needs," Volkwein said.

One way for treasurers to rally the company around a working capital effort is to use key performance indicators, Volkwein said.

"As soon as the individual departments within the company can agree on a quantitative measure and a shared goal, that company will recognize the gains in efficiency almost instantly," he said. "Ultimately, improvements to working capital management have a bottom line impact, which make them increasingly difficult to ignore."

DeHaro said that incorporating working capital goals into compensation arrangements is something REL sees at companies that perform well on working capital management.

Working capital is "used all the way through the organization as a metric to drive behavior," she said. "So not only are top companies becoming much more clear as to their goal, they're relating that to individual performance."

The metric used to calculate part of an employee's compensation varies depending on the role of the employee, DeHaro said. Salespeople might have a goal related to receivables or bad debt, while a procurement metric might be related to payment terms or discounts taken, and the operations team's metrics could involve inventory levels or carrying costs.

Benchmarking

Companies don't often benchmark their performance against that of their peers when they're considering working capital optimization, but it's a useful tool, Casas said, and information about how their statistics compare with their competitors' is readily available.

"Let's just say, for example, that their main competitor has a DSO of 20 and they have 30," he said. "If you take the 10 days of lost DSOs, you can easily calculate the impact from an overall opportunity-cost perspective.

"We don't see enough of our clients doing that, but we certainly suggest that they do," Casas said. "It helps with the business case."

Treasury should also try to get senior management on board with its plans to improve working capital management.

Kyriba's Person said treasurers should start off by getting buy-in from top executives for their working capital management projects. He suggested presenting the plan, including the extent of the improvement possible in the company's free cash flow, to the CFO or even the CEO.

"It's true these programs often involve other parties outside of treasury," he said. "If you get that buy-in and support from a senior executive standpoint, other colleagues in the broader finance department will fall in line. It becomes a mandate from the top down."