Here’s how companies can build on their responses to the COVID-19 pandemic to improve their cash-management capabilities.
When COVID-19 took its toll on businesses last year, the disruption in economic activity prompted a widespread liquidity crisis. Companies around the world opted for cash and liquidity tactics, and many chief financial officers (CFOs) responded with survival plans that involved freeing up cash and resources to keep operations going. Despite government stimulus programmes to improve companies’ cash flows, these survival plans meant cuts to capital expenditure, smaller dividends, reduced external spending, and temporary plant closures.
However, although the pandemic has brought great difficulty to most industries, COVID-19 has also spotlighted the importance of cash excellence, a set of practices that can help companies improve their cash and liquidity management. Now that we’re over 18 months into the pandemic, many executives can start to make the shift from cash preservation to cash excellence. This means strengthening the cash culture throughout a company, optimising underlying systems and mindsets, and executing no-regrets moves that thread cash excellence into all operations.
Here, the Divisional and Group CFO Gary McGaghey explains how companies can build an effective cash culture and embed cash excellence into ongoing operations to strengthen their competitive positions.
Laying the Foundations for Cash Excellence
Gary McGaghey explains that by developing a strong cash culture from top to bottom, CFOs can take the cash preservation crisis as an opportunity to strengthen long-term cash excellence. For example, many boardrooms are now focusing on cash instead of earnings before interest and taxes (EBIT). They are supporting end-to-end cash management, which requires employees at all levels to make numerous daily decisions. Gary McGaghey emphasises that when a CFO builds a cash-focused culture across the following three dimensions, they can lay the foundations for cash excellence.
1. The company’s people, focusing on role modelling, cross-functional collaboration, and skills.
2. The company’s structure, focusing on governance and roles and responsibilities.
3. The company’s processes, focusing on performance management, communication, and access to key performance metrics
1. People
Many companies label cash management as the sole responsibility of the finance department. But cash-focused companies ensure that wider management also takes ownership of cash performance. Companies can use aligned incentives to ensure this shared ownership.
That said, a strong cash culture starts at the top, so it’s up to the CFO to prioritise the ways that a company manages cash. The CFO’s direction communicates the importance of cash in value creation and in ensuring resilience during downturns. For example, allocating capital for investment in future growth shows employees that the company considers capital efficiency metrics, like the cash conversion cycle, as important as profit and loss metrics.
To put this into perspective, Gary McGaghey refers to an example of a company with multibillion-dollar revenues that completed a cash transformation to reach the top quartile of its peers. The company released over $150 million in cash within the first six months of the transformation, creating a capital fund for a strategic acquisition. Throughout the transformation process, the CFO continuously reminded the employees that the company was focusing on cash to finance growth opportunities. This top-down message helped the employees understand the importance of cash excellence, especially when teamed with capability-building programmes.
2. Structure
A company’s top management and finance teams should regularly discuss cash and set appropriate accountabilities in meetings. Managers should determine a structure that discourages activity that only focuses on improving quarterly or year-end figures. They should also assign decision rights to employees at every level and build an escalation structure so the CFO can handle matters that have the most significant cash implications.
Gary McGaghey recommends creating a ‘cash war room’ to achieve a focused governance structure. This way, a company can push the topic to the highest levels of management and help the company rapidly preserve cash. One example of a company that achieved this is a family-run company that held daily hour-long meetings in a cash war room. The CFO chaired these meetings, reviewing the daily cash balances and identifying areas for quick cash improvement. Within two months, the company had captured cash savings of €30 million and halved its overdue accounts payable.
3. Process
Companies also need to set and monitor clear key performance indicators (KPIs) at the right levels. For example, top-level managers should be responsible for return on invested capital (ROIC), the cash conversion cycle, and working capital as a percentage of sales. Meanwhile, the front line could be responsible for operational KPIs like the percentage of overdues and early and late payments. When a company sets a clear, practical policy framework, frontline workers should find it easier to make daily decisions.
A company’s leaders should also create a coherent cash-reporting system across all entities that all stakeholders can access. A company can make the system particularly efficient by adopting digital tools, like digitally enabled real time financial reporting systems for cash KPIs and systems that automate repetitive back-office, order-to-cash, and procure-to-pay tasks.
Achieving Cash Excellence
Many companies that managed cash effectively before the pandemic have remained resilient throughout the crisis and are now finding themselves in competitive positions as they emerge from the crisis. Others haven’t been so fortunate. Gary McGaghey explains how CFOs can hone their cash-preservation measures into structural cash levers by focusing on the following elements of cash excellence.
Improve Cash Flow From Accounts Receivable
With the pandemic aggravating issues surrounding overdues and bad debt, many collection desks – especially those that still use manual processes – have struggled to cope with chasing late payers. Meanwhile, many of the companies that were using strong cash management processes before the pandemic have found it easier to strengthen customer relationships by providing longer payment terms for those facing cash flow problems.
Gary McGaghey recommends three strategies that companies can employ to improve the cash flow from their accounts receivable.
1. Manage Overdues
Companies can better manage overdues by establishing strong customer-credit rating systems with clear policies on pricing, maximum payment terms, and maximum credit exposure. These systems can help companies onboard new customers and guide existing ones. The systems are accessible to credit and collection and sales teams.
Companies can also improve the ways that they manage overdues by preventing these in the first place. A cross-functional team can identify the underlying issues that cause repeated overdues by reviewing the end-to-end process from a problem-solving perspective. Such a team might also use advanced analytics tools to boost its overdue collection strategies. For example, tools can use inputs like company financial health and past payment behaviours to predict a company’s likelihood of paying overdues without intervention from the collection team.
Gary McGaghey gives the example of a B2B company that dealt with several overdues because of a quality mismatch in its online channel. This mismatch was the result of a lack of communication between the IT, sales, and collection teams. When the company established a cross-functional team across all three departments, it was able to recognise the issues, take action to reduce its overdue accounts, and boost morale amongst employees.
2. Standardise Payment Terms and Establish Effective Customer Onboarding Processes
When a company standardises its customers’ payment terms, it can reduce errors and accounts receivable while improving the efficiency of the order-to-cash process. The strongest onboarding processes involve control measures that ensure most customers opt into standard payment terms.
Gary McGaghey recommends setting standard payment terms globally. However, there may be cases where a company needs to adjust the terms for customer groups based on market conditions. It’s important that companies understand the payment terms that are usually acceptable in a particular industry and country and make adjustments where necessary. Once a company has finalised a standard policy, the sales and finance teams should switch non-compliant terms to the standard.
3. Improve Collaboration Between Teams
The third strategy is to improve collaboration between sales, operations, and invoicing teams. Streamlining collaborative processes between these teams is key to avoiding delays and communication lags that disrupt the invoicing process. Such delays are common where manual invoicing is required, like for projects with several invoice dates that link to different milestones.
Adopt Strategic Positions on Accounts Payable
The COVID-19 crisis has put many companies in a position where they need to adopt strategic positions on accounts payable to preserve cash while upholding good relationships with vendors and suppliers. Many companies have had to tackle supplier liquidity issues and supply chain disruption. Where many of the companies that have effectively preserved cash have been able to pay their suppliers earlier and alleviate cash flow challenges, companies with poorer cash flow have struggled. As a result, procure-to-pay teams have seen an influx of supplier complaints about timely payments.
Gary McGaghey explains that companies can achieve greater flexibility by reshaping their processes in three areas.
1. Supplier Management
Effective supplier-management systems help companies share information on suppliers’ enterprise risk and past performance on quality, price, reliability, and code of conduct. Payment and procurement specialists use one integrated platform to support negotiations on pricing and payment terms. They can also use this platform to identify alternative sourcing plans if necessary.
2. Payment Terms
When a company standardises payment terms on the supplier side, it can improve the efficiency of procure-to-pay processes and accounts payable. Although many companies have global standard payment terms for their suppliers, many experience different degrees of compliance with these terms. However, it is possible for these companies to achieve standardisation. Gary McGaghey notes the example of a global materials company that made a step-change improvement to non-compliant supplier payment terms. The company achieved this over a few months by setting up tracking mechanisms and mobilising its procurement teams.
When extending payment terms, companies should collaborate with suppliers to prevent losing momentum on standardisation. Companies may implement exception processes whereby suppliers apply for an exception to the standard terms if necessary. This would require approval from the company’s CFO or chief procurement officer.
3. Procure-to-Pay Process Efficiency
Companies that are looking to build trusting partnerships with suppliers must position themselves as reliable and able to pay on time. This is more important than ever amidst current supply chain disruptions. Companies can also use new technologies, like robotic process automation, to reduce human errors and the costs associated with payment processes. This needs to be supplemented with a strong communications strategy with suppliers to ensure they remain informed on cash flow planning and liquidity constraints and supportive of the business.
Rethink Inventory Management Strategies
Disruption in supply and demand has caused fluctuation in many companies’ inventory levels. Limitations on cross-border trades have meant that companies with global supply chains have had to move their inventories to accessible locations and find new sourcing options for affected suppliers.
Meanwhile, rapidly evolving consumption patterns, such as the increased need for personal protective equipment and hand sanitiser and the decrease in demand for petroleum and luxury goods, have left companies adapting their supply chains. The pandemic has underlined the importance of reshaping inventory management models in changing environments. Now, companies that are looking to optimise spending should recalibrate their inventory management strategies while upholding resilience in their supply chains.
Companies that need to improve collaboration and visibility across the supply chain may rethink their supply chain strategies in line with their changing business models. Companies may need to depart significantly from their existing models and revisit their inventory strategies. For example, as e-commerce becomes increasingly essential to retail companies, these businesses may change their warehouse locations and stock-keeping rules and lower their inventory levels through inventory pooling.
Retail companies may also make the most of digital tools that improve supply chain visibility. Real time visibility can help managers make quick, well-informed decisions on which inventories to repurpose or stock up on based on current demand. New-to-the-scene technologies like the Internet of Things (IoT) and blockchain can also be particularly helpful here.
Meanwhile, the pandemic has shown that strengthening partnerships with suppliers is ideal for ensuring success across the ecosystem. And collaborative partnerships often require a greater level of transparency. Many companies and even competitors have grown more willing to share data and information on inventory levels and contracting models over recent months.
Gary McGaghey explains that it is important for companies to conduct regular reviews of their supplier bases to optimise supply chains and decide which suppliers to build collaborative relationships with. He refers to a global fashion company that often evaluates its suppliers’ prices, quality, lead time, and code of conduct. The company uses this evaluation to segment the suppliers into tiers. While the first tier comprises the critical suppliers that are ideal for collaborative relationships, the last tier comprises the suppliers that don’t meet the criteria and will be phased out.
Manage Capital Expenditures
Another essential lever in cash excellence is managing capital expenditures (capex). Companies should endeavour to allocate capital and maximise the productivity of this capital. However, the COVID-19 crisis has caused many companies to slash capex by 25 to 30 percent. Many of those that hadn’t prioritised capex before the crisis made cuts that represented significant sunk costs in their current projects. Meanwhile, the companies that had more cash headroom were able to allocate capital to growth opportunities.
Gary McGaghey recommends that companies make specific investments during recovery to secure a competitive advantage. In this case, they should focus on capital allocation and capital productivity.
Shifting cadence and processes can help companies approach capital allocation decisions more effectively. Gary McGaghey recommends using an agile capital allocation process to reallocate funds during times of uncertainty. Typically, companies that reallocate funds outperform companies that don’t. In the aftermath of the COVID-19 crisis, many companies are now reallocating their capital multiple times a year. Companies can rank investment requests using a common metric like present value over investment. This way, they can gain a big-picture view of the overall investment portfolio, enabling rigorous allocation of CAPEX to investments with the highest return on investment.
Companies should also evaluate completed projects to measure their productivity and recognise the best practices in completing projects to both deadline and budget. Companies can then create structural systems that help them apply these practices to future projects. This kind of post-mortem analysis can reveal essential insights for future projects.
Strengthen Your Company’s Approach to Cash Management
Timing is key to strengthening your company’s approach to cash management. And the pandemic has provided the ideal opportunity to build momentum towards cash excellence. Seizing this opportunity could help your company become more competitive and ready for the unexpected.
About Gary McGaghey
Gary McGaghey is the CFO of the €1.3bn end-to-end marketing production services group Williams Lea Tag. He oversees the company’s implementation of commercial plans, with a particular focus on cash generation, and makes investment decisions to strategically maximise the value of the firm’s holdings. Before taking on the role of CFO at Williams Lea Tag, Gary McGaghey achieved impressive organic and M&A-driven growth for a host of private equity, privately owned, and listed companies in several sectors.
