A Ten Thousand Foot View to re-engineer the Order-to-Cash Process

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5 Jun 2023

MANAGING LIQUIDITY RISK IN VOLATILE CONDITIONS: STRATEGIES FOR CREDIT PROFESSIONALS

This article provides you insights into how to identify liquidity issues among your customers and how to increase profitable sales through effective credit management tools, when business conditions are volatile.

It draws on key takeaways from a workshop of the Association of Credit Management for Switzerland (ACMS), on the 25th of April 2023.

The workshop featured a discussion with representatives from Swiss companies, including Falko Junge Commercial Manager CER at Atradius Collections B.V., Olga Glazko Head of Credit Solutions at Aon Switzerland AG, Pietro Pavone Head of Credit Risk Management EMEA at BASF Schweiz AG, and Klara Boor, Managing Director of Klass Academy SA.

Do Liquidity Issues Impact Customers Pools?

Most credit managers see volatile conditions impacting the liquidity of their customer portfolios. While certain companies benefitted from the turbulence of the past 6 months and raised their profits, most companies carefully watch their cash flows.

Takeaways from the ACMS‘ April 2023 workshop are the following:

  1. Governments injected cash into the economy during Covid to help companies. Monetary volume rose, interest rates exploded, and prices increased in the last 12 months. Now companies face liquidity and earning issues both! Those firms, which haven’t managed to be at breakeven prior to the pandemic are heavily hit. The Global Financial sustainability report of IMF issued in April 2023 addressed concerns about stability of the financial institutions, high inflation and geopolitical risks. Read more about inflation and geopolitical risks here.
  2. Interest rates levelled at 8.3% in West Europe, at 25% in East Europe, in March. In some countries, like Turkey inflation summitted at 48%. Rapidly moving rates make markets vulnerable. Inflationary outlook is still optimistic for West Europe, panel members expect moderate lessening of the interest rates.
  3. The Swiss Federation eliminated favourable lending rates. Rates are 2% for any amount exceeding CHF 500’000 as of the 1st of April 2023. Cost of finance has almost doubled to what SMEs had to pay a year ago.
  4. Late payments grew in West-, East- and South Europe, in the past 6 months. Insolvency rates are still at moderate levels.
  5. Credit people see raising dispute levels, masking lack of liquidity, sometimes.
  6. Customers facing liquidity challenges can hardly borrow from banks, or if they do, it comes at huge costs. Cheap alternatives are rare, so demand for longer supplier’s financing is likely to increase.
  7. Companies built in higher cost into their pricing scheme, including cost of finance. However, transparency about cost of finance is not yet a norm.
  8. You will see liquidity issues with customers that are highly leveraged; are overly sensitive to economic cycles and have a rigid cost structure; financed their M&A or technology growth from substantial external resources; or already had poor credit ratings.
  9. Managing large pools is a growing challenge, not only because companies delay payments, but also because many have introduced ticketing systems that do not work smoothly. This, in combination with a work-from-home setup, brings issues for the suppliers.

You can read more about ARE YOU FIT FOR CREDIT IN THE CURRENT ECONOMIC CLIMATE?

You rather be aware that a part of your customer base might be facing liquidity issues as conditions remain volatile. To mitigate the impact on your own cash flow, it’s important to proactively monitor your pool and prepare to address potential issues.

Industry Risks To Be Monitored

The changes in the customers’ pool are often driven by industry specifics. Here are few highlights of the ACMS discussion from 25th of April 2023:

  1. Credit risks have increased in the textile, transportation, and construction industries. Retail and consumer goods are also sensitive to the economic cycle. Distributors might require special attention if their inventory turnover shrinks.
  2. The financial sector, communication technology and pharmaceutical are considered as good risks, in Europe and the USA.
  3. Technology firms lost cheaper finance and VC-s looking for higher yields. Large companies as Amazon, Microsoft, Google laid off 10-30% of their headcount to reduce overhead cost. Competition is high and strategic risks should be considered when evaluating risk rating of technology companies.
  4. Credit risk in the automotive industry needs to be monitored. Leading German brands are earning well, but tier 2 and 3 suffer, and some of them have gone insolvent. Even bigger producers need higher liquidity to reshape their business model, innovate, and maintain profitability.
  5. The risk of banking services remains a question following the establishment of a gigantic UBS. Société Générale and Deutsche Bank also show signs of instability.
  6. Insurers are doing well. Premiums are high, reflecting a higher risk rating, while losses are still at a moderate level. Insurers have started to connect with each other, similarly to banks, in order to mitigate their portfolio risks.
  7. Commodity traders seem to do well. It is still advised to pay special attention to them, as their earning is moderate compared to their revenue. They carry huge risks when trading on unsecured terms.

As the business environment remains complex and volatile you should analyse industry-specific risks and trends along with a company’s financial results, management and organization.

Read more about Construction Industry

Country Credit Risk Differences Are Moderate

The ACMS workshop from 25th of April 2023 highlighted that country differences are moderate within the European region, exhibiting traditional payment and risk patterns with slight changes:

  1. Liquidity issues equally impact companies in Europe, and there are no major country-specific changes compared to the prior Covid period.
  2. Italian companies often receive payment terms exceeding 90 days. Payment delays are still on the rise.
  3. Companies in the UK seem to struggle with liquidity issues the most. Inflation reached 10% which an adding to the Brexit implications.
  4. As a result of the 15-25% inflation East European companies more often delay payments. Terms are still 30-60 days.
  5. German companies’ risk ratings have somewhat increased, yet cash collection issues remain manageable.
  6. Swiss companies are respecting payment terms and pay on time.
  7. Within the collections outsourced to Agencies, insolvency rates increase, reaching 50% in the debtors’ pool, sometimes.

Predictable commercial interest rates and stable economic environment are important elements to foster healthy business growth. Country differences exist and you should be constantly monitoring dominating countries which dominate your portfolio and those with sudden and significant changes.

Automation Leveraged with Intense Customer Discussions

Fundamentals of Cash Collection have changed over the last 10-15 years, highlighted by several credit professionals on the ACMS discussion from 25th of April 2023. Collection via emails and statements has been automated, which helped cash collectors through the pandemic. Post Covid era introduced further changes, you see below:

  1. Leading companies put “Customer experience” on a pedestal. Energy, technology firms and those facing strong competition gave relationship building targets to their cash collection teams. Cash collection professionals talk more to customers. They focus on problem solving and they offload administrative tasks from the sales teams.
  2. Relationship building gained increased importance within the credit teams. Motto: “Know your customer intimately”.
  3. Collection teams follow the news closely, such as temporary closure of businesses, or flood in Germany. They constantly evaluate their impact on the liquidity of the pool.
  4. Internal communication intensified within companies having an important cash flow target. Some have introduced weekly cash collection meetings to gather different stakeholders, business developers and CFOs. The change created alignment; stakeholders define customer strategies together, especially when it is about holding customer orders!
  5. Customer segmentation gained place everywhere. Segments are created by country, industry, and financial characteristics and reflect risk appetite of the supplier. Segment’s characteristics are actively monitored. Credit managers optimise the segment’s risk and define its collection strategies. Algorithm have been developed to analyse characteristics of the segment and predict customer possible liquidity risks.
  6. Internal process improvement continued. Dispute handling became a priority.
  7. Companies are testing open AI for emailing / communication tasks. Credit software providers are offering chatbot functions to discuss standard collection matters with customers. Feedback to AI solutions is mixed:
    7.1. AI has helped outsourced Cash Collection centres with large teams prioritise and use proper language in written communication. AI solution works if communication goes only via emails; such as large volume customers with low value outstanding or large pool of customers largely dependent on the supplier.
    7.2. Chatbot works for “clean” overdue situations. Whenever a dispute was raised; the customer was unable or unwilling to pay, the issue lands back at the table of the cash collector.
    7.3. Concerns raised about the open AIs security risks. Certain companies dealing with large volume collection transactions are developing their own AI tools.
    7.4. The personal influence of cash collection specialists is not going away within the near future within those companies aiming to improve customer experience. “You want your customer to pay you first; you want to understand what is going on with your customer; and want to create an emotional bond with customers.” AI is an option only for certain back-office tasks, whenever Cash Flow is a key KPI.
    7.5. It does not make much sense to replace small but efficient team with AI tools. Cash Collectors are resolving complex issues, involving various stakeholders. Chatbots are not helping here.
  8. It is cost effective to automation recurring tasks, for example repetitive accounting entries. When embracing AI initiative companies need to consider the cost and time not only for the implementation but also for the maintenance, upgrades and securities! Read how innovation will shape O2C here.

Cash Collection practices showed dual development compared to the prior Covid times; customer discussions intensified and use digital tools increased.
Open AI is tested by many; however, most companies don’t see replacing the human touch with robots.
In your credit role you should strive for excellence in communication with the customer, for improving the order to cash process flow, and make the best use of automated tools.

Soft Data to Spot Liquidity Issues in Volatile Environment

Credit risk assessment practices have undergone important changes in the past two years. Companies are now adapting their risk assessment practices to spot early indications of liquidity risks at the customer level. The following practices have been accentuated the ACMS workshop from 25th of April 2023:

  1. It is no longer sufficient to solely rely on past payment performances of customers. Monitoring payment patterns, comparing them with country and industry standards is necessary to identify potential risks.
  2. Many suppliers act as business partners with customers having long-term relationships with, they usually provide support if cash flow issues emerge.
  3. Dialogue with customers has become more important, with a focus on understanding their current situation and what to expect in the future. When calling for overdue payments, it is not only about how much should be paid, but also how much they collect from their customers. Understanding the customer’s customer has become indispensable. Financial information is collected and compared with country and industry standards. “Soft” information is gathered about the customer, it is analyzed, and shared with other stakeholders. Credit teams regularly review customer issues and pay close attention to soft information from sales colleagues, who have a better understanding of the customer and can hear what competitors are saying.
  4. Internal communication has intensified with sales teams, pricing, and supply chain personnel. Better connectivity enables credit people spot early warning signals earlier and elaborate credit solutions. Major suppliers are paid on time, and they don’t necessarily notice customer issues. Customers requesting longer than usual terms or discount terms may indicate negative changes in their cash flow. Repeated disputes may signal liquidity issues, too. Regularly discussing finding, monitoring doubtful accounts and payment schedules helps mitigate risks.
  5. Companies implemented dashboards to predict which companies are at liquidity risk. Dashboards are fed by the customers financial statements, credit agency reports past and forecasted data, as well systematically analysed “soft information”. Strong IT teams design and support dashboard automation.
  6. Early indicators of liquidity issues at the company level include a sudden increase in overdue accounts; a decrease in sales combined with low profitability; rigid cost structure; a sudden change in working capital; a strong decline in cash reserves; difficulty in meeting financial obligations (e.g. decline of Paydex), and a sudden downgrade of their credit rating.
  7. Using credit agency alerts became indispensable. Companies scores might rapidly change whereby companies select triggers to reflect their credit appetite.
  8. In addition to the traditional financial metrics, soft information gained an increased importance, such as:
    a. Character: The borrower’s integrity, “leanness” of the organisation and the team spirit.
    b. Capacity: How agile they are to find new products? How flexible they are to identify new channels to replace the struggling ones? Do they have problem solving mindset?
    c. Conditions: Economic and industry specific factors affecting their revenue generation capacity and cost structure. Strategic risks – how dynamic they are compared with the competition?
  9. Companies are developing scoring models with a 10-40% weight on soft information. Scoring models may include qualitative information exceeding 50% weights for fast-moving technology firms or start-ups. Scoring applications exist, but companies define the setup of qualitative- quantitative information to reflect their risk appetite for the country and the product. Qualitative factors are measured systematically.
  10. While scorecards help assess risks with customers, the most important element remains knowledgeable and responsible credit analysts who know the industry, the country and who can make rapid, responsible decisions to support profitable sales.

If you’d like to spot early warning signals on liquidity issues, you cannot rely on past data, only! Systematically analysing soft information must be part of the credit risk assessment process.

Flexibility When Extending Payment Terms to Customers

To protect margins companies might revise their terms and supply conditions exercising both flexibility and prudence as per the ACMS discussion from the 25th of April 2023.

  1. Prior extending credit terms credit managers evaluate what is the liquidity situation of the customer – with and without the terms extension. How does the extension impact cost of finance and margins? The request can be easier accepted, if the If costs were covered and there was no short/ midterms insolvency risk.
  2. It is worth noticing that it is often the competitor which drive up payment terms. That’s why it is important to stay on top of the market trends!
  3. Suppliers try to charge interest fees. While there are no industry standards for charging interest, some companies include this possibility in their standard terms and conditions. It has been observed that companies charging interest are often paid faster than those who don’t, which indicates customers are more likely prioritize paying off debt that includes interest fees.
  4. Another option is to increase prices to account for the cost of financing. This is typically a commercial decision, and some companies are more transparent about this cost element than others.
  5. When customers are consistently late in making payments, some suppliers choose to work with collection agencies. These agencies pursue payments, including interest fees more aggressively.
  6. Late days interest is typically linked to the debtor’s country’s central bank rate and follows its fluctuation. Companies use weighted working capital cost or the supplier’s refinancing rates as basis for late payment charges. Fees are currently around 5% in Switzerland and 5% + Euribor in Germany.

Overall, it is important you craft your supply conditions carefully and provide terms that support sales at good margins. You might be looking into charging interest fees or increase prices to compensate for terms extension.

2023 Credit Risk Evaluation Practices Are Changing

Post Covid credit conditions remain volatile due to the inflation, the fragility of the financial system, and the geopolitical issues.

Most companies see liquidity issues appearing in their customer portfolios, sometimes under the umbrella of insignificant claim or disagreements. Industry differences are significant, country alterations are moderates in the European markets.

Most companies mitigate risk by monitoring segments of high to moderate risks with low to moderate margins. Many companies show flexibility in extending terms yet strive to increase prices or charge interest fees.

To manage your enterprise’s liquidity risk within volatile conditions your best strategy is to intensify customer discussions; to systematically include soft data into your credit evaluations; and to exercise flexibility in defining terms.

Managing Credit risk in volatile conditions are not always easy!

Your key assets are the people who are adequately equipped to assess the credit risks and who are motivated to resolve issues on the spot.

Klass Academy is educational body of the Swiss Credit Association.
Klass Academy provides digital training, virtual coaching and live courses for Finance, Sales and Order to Cash professionals.
Would you like to know more about Credit and Financial Analysis? Visit our website or email contact@klassacademy.com.


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