Why You Are Leaving Cash on the Table, and Failing to Improve Customer Payment Terms

The most common thing we see when working with businesses to improve cash from the Order to Cash process, is that payment terms are by no means a priority. Rather, they are used as another bargaining chip to secure a sale or protect against price deductions during negotiations. As negotiations are led by the Sales function, it is clear that behaviours will be driven by the objectives and rewards associated with the Sales team.

So what are their objectives and incentives?  How are they measured?

Unfortunately the clear majority of large businesses reward the Commercial function based on sales signed, with no inclusion of payment terms achieved, nor cash receipt timing. Add to this a lack of standard payment terms within commercial policy, and you can end up with up to 100 different payment terms, customer-led and individually negotiated, with very little correlation between margin and terms given, i.e. cash is simply ignored.

In fact, most businesses have very little understanding of profit by product or customer, and therefore cannot even begin to understand whether terms are being optimised for cash and margin. And of c.100 consulting clients, we’ve only ever been able to create that kind of analysis twice, because the data are just not produced by the business.

Both of those times, the Commercial team were adamant that payment terms couldn’t be improved as they were delicately balanced with margin. Both of those times, there was zero correlation between margin and terms. Did we suddenly win the battle and have the business agree to new target terms?

Not exactly, but deeper analysis of terms by customer, by country, looking at margin, sales person, etc. helped to build that picture of improvement opportunity, and when overlayed with clear and correct mathematics around the cash improvement potential, the message becomes powerful enough to trigger a different strategic approach.

Let’s look at some examples.

Each bubble represents one of our client’s top 20 customers, the size varying according to value. Each customer’s margin has been calculated, as shown on the y axis, and their weighted average actual payment terms are calculated on the x axis. If the Commercial team were right in their claim that payment terms were only conceded for improved margin, there would be a clear correlation, with the bubbles lined up from the bottom left to top right of the chart.

This is absolutely not the case, and the underlying pattern becomes clearer when the analysis includes an assessment of payment terms by Sales Contact:

Sales ContactWA Terms

Talking to the three members of the Sales team, it became clear that Smith has always negotiated with shorter payment terms being prioritised – Smith explained that in a previous role, it was really drummed into them that cash is king, an essential part of the commission scheme, and the sooner it was collected, the better. While there was no incentive to agree short payment terms in the current role, it was already in Smith’s DNA as a sales person.

Fernando tended to work to an expectation of 30 days as the standard payment term, normally achieving that baseline.

Cornelius, on the other hand, was accustomed to using payment terms as a negotiating tool to close the sale, giving up payment terms as there was no consequence to him, as terms or cash were completely ignored in the Sales team’s scorecard and appraisals.

So the cash performance across the Sales team in this case varied widely, but had not identified by the business, despite its impact on working capital. Why? Because there are so many levers of cash and they are complex – and most of them go completely under the radar, much of the time.

Cash Improvement Opportunity Calculation

A key part of getting buy-in for the improvement opportunity is to assign credible cash improvement numbers. By looking at historical performance, targets for aspirational standard payment terms could be set, with the assumed cash impact calculated and incorporated into targets. For any given business, achievable targets require a detailed, validated approach that really makes sense according to the circumstances.  Nevertheless, the mathematical principles are still the same.

Taking the same example of our Top 20 Customers, we can set three aspirational standards of 45 days (for any customers with terms over 45 days already), 30 days, and 20 days. Assuming payment timeliness versus due date remains the same, we can then calculate the annualised cash opportunity if payment terms were to improve to that standard. If the payment terms are already below that target, then no opportunity is calculated.

In our table, there are two customers with weighted average terms above 45 days, so little opportunity, but if 30 days were to be set as the new standard term for customers, the total cash opportunity equates to a cash improvement equivalent to 1.2% of annual revenue. In the best case scenario of achieving 20 days across the board, the improvement opportunity moves to 3% of revenue.

For each line: Improvement Days / 365 x Annual Value = Annual Average Cash Improvement

In countries like the UK, and increasingly across Europe and the US, having 30 days as the standard payment term would be the cultural norm, so this could be a very reasonable target, but there is plenty of evidence across the board that even shorter terms are achievable.

The agreed targets can then be staggered according to the next price negotiation dates for each customer, as part of a collaborative objective setting process with Finance and Sales, with success percentages applied and clear incentives for achieving those improvements. With the new standard terms framework in place, new customers can also be monitored for the payment terms they sign up to, ensuring cash leakage remains a thing of the past.

Once again, without the right analyses and visuals, these opportunities may never be unearthed and have little chance of being effectively implemented.

With POP Collect, users have an unrivalled toolbox of automated, on the fly analyses and visualisations, so all levers of cash can be understood, diagnosed and then enhanced, significantly and sustainably improving cash without the need for teams of expensive external consultants.


Christian Terry

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