Is Your O2C Process Optimized for Superior AR Performance?
A Holistic Approach to Accounts Receivable and Cash Flow Improvement
To optimize the order-to-cash (O2C) process, it's crucial to understand the significant role Credit and Collections plays. This function must collaborate closely with sales, fulfillment, shipping/logistics, and accounting, all of which are integral to converting an order into cash. Specifically, Credit and Collections is responsible for approving new customers for credit terms and managing orders at the beginning of the O2C cycle, while also monitoring risks within the Accounts Receivable (AR) portfolio and collecting overdue payments, both of which are post-sale activities.
What happens during the O2C process, however, apart from credit and collection activities, can have an outsized impact on cash flow and AR performance. When your O2C process is dysfunctional, your AR, one of a company’s largest assets and the primary cash flow generator, is compromised and the entire company is put at risk. Until you put out the fire, things won’t improve. Here are four examples of the problems a dysfunctional O2C process can cause:
Four Dysfunctional O2C Scenarios
1. Complex Billing Environment:
A variety of different billing mechanisms for different distribution channels caused serious cash posting problems for a large national commercial bakery. As a result it would take a week or two to post a single day’s customer payments, and even longer for some items. Huge improvements were made using automated payment algorithms combined with improvements to the payment capture process, thereby reducing remittance processing time to just a few days and requiring fewer staff.
2. Pricing Problems:
A supplier of medical devices implemented a new ERP system, but flaws in the pricing application caused it to frequently default to list price (nearly every accounts had exceptions), thereby generating hundreds of incorrect invoices. Customers refused to pay as billed, frequently demanding corrected invoices. Consequently, Days Sales Outstanding (DSO) increased by almost 50 percent with customer delinquency deteriorating so much that this supplier’s borrowing capacity under its asset-based credit facility was severely restricted. It required hundreds of hours of work over a ten month period to recover from this pricing problem.
3. Quotation Process Challenges:
A packaging machinery company did not have a review process for quotations made to customers. Frequently, a quote was issued by sales guaranteeing performance speeds above what a machine was able to deliver (e.g. guaranteeing to pack 35 cases per minute, when the machine’s capability was only 32). Salesmen were telling customers what they wanted to hear in order to make the sale. The result was unhappy customers, a damaged reputation, returned machinery, zero revenue and a substantial write-off involving the seemingly substandard packaging machines.
4. High Deduction Volumes:
Consumer goods manufacturers and distributors, and in particular those selling to chain stores, often incur high volumes of payment deductions. To a large extent these are self-inflicted wounds, especially when they result from an inability to meet the terms and conditions of the customer vendor compliance agreement suppliers are required to sign. Whatever the situation, reducing deduction volumes by identifying and fixing the root causes of payment deductions is the cure, and can account for as much as a 10 percent improvement in DSO, not to mention the customer experience benefits. Investigating and resolving deductions alone is much too costly.
There are of course lots of other ways where the O2C process breaks down inside and outside of the purvey of Credit and Collections. Poor credit approval and collection practices can single-handedly wreck DSO. The order fulfillment and shipping areas can also contribute their fair share of problems, but as illustrated by the above examples, dysfunction within the selling/billing nexus has a very high propensity to threaten the viability, or at least suppress the profits, of any enterprise.
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Identifying O2C Shortcomings
Begin your O2C analysis from a broad perspective before you start digging into the weeds. A well designed O2C process should run efficiently with minimal oversight, allowing management to focus on business growth and other priorities. Shortcomings in your O2C processing prevent this from happening, which is why it is crucial the O2C process runs smoothly. Wherever there is a disconnect in the order flow, there will be problems, so address any weaknesses promptly to enhance AR performance and cash flow and prevent broader operational issues.
When assessing each input and output factor along the O2C continuum, consider asking the following questions:
Where are there backlogs?
Are there external factors causing the backlog?
What other O2C areas are involved in the problem?
Is all necessary information easily accessible, or is it difficult to locate?
Which AR activities are consuming the most management and staff time?
How much time is dedicated to collections versus payment deduction/dispute resolution?
Where is there excessive exposure to risk?
What policies and procedures are in place, and what are missing?
Are decisions being made strategically or on an ad hoc basis?
Are you fully utilizing your software's capabilities, or could improvements be made?
Conducting such an assessment helps isolate key issues affecting AR performance. If deficiencies are identified, determine the necessary actions to address them. Typically, solutions will be evident, allowing you to prioritize issues and implement corrective measures efficiently.
Seven Critical Factors for AR Success
Once you have a broad perspective on your challenges you can be more introspective as it relates to credit, collections and AR management. Effective credit and collections are essential for a streamlined O2C process, and a strong inter-dependency exists between these functions and the other O2C components. A well-coordinated approach in both areas is necessary for optimal performance. To achieve this, address the following seven critical factors:
Set Appropriate Risk Assessment Parameters: Establish credit limits and risk classifications using well-defined standards. Consistent decision-making depends on having clear parameters for evaluating new accounts and monitoring existing customer risks. Your credit policy should be aligned with your gross margins: lower margins require more conservative credit policies, while higher margins allow for more flexibility.
Develop Efficient Order Approval Procedures: As order volumes increase and the need for quick fulfillment grows, efficient order approval becomes more critical. Orders should be assessed promptly to ensure they comply with credit approval parameters, such as sufficient credit limits and the absence of past due invoices beyond the grace period. Orders on credit hold must be addressed quickly, and unresolved issues should involve communication with sales and customer contacts.
Root out Barriers to Payment: Ensure your invoices match the customer's purchase order and receiving documents to avoid delays and payment discrepancies. Billing inaccuracies often result in delayed payments or deductions. To prevent these issues, generate accurate invoices and consider offering multiple payment options, such as ACH, credit cards, and alternative payment solutions like PayPal, Venmo, Zelle, and Klarna, especially in the context of omni-channel commerce.
Collect Systematically: Effective collection of overdue balances requires a structured approach. Delaying collection activities can lead to reduced cash flow and bad debt losses. Prioritize collection efforts, focusing first on broken promises, followed by other follow-up actions, and targeting accounts with the largest overdue amounts. Implement collection strategies that include predetermined actions (e.g., emails, calls, escalations) based on the debt size and associated risk.
Ensure Efficient Cash Posting: Timely posting of payments to the AR ledger is crucial for effective credit and collections management. Delays in cash posting can negatively impact order approvals and unnecessary collection activities. Accurate and timely remittance processing helps maintain efficiency throughout the O2C cycle.
Maintain Complete Visibility of Customers and Transactions: Reliable, up-to-date AR data is essential for informed decision-making in Credit and Collections. Lack of transparency and visibility into customer interactions can hinder performance. Regularly update customer contact notes, share insights between sales and back-office functions, and supplement internal information with data from credit bureaus, industry groups, and other external sources.
Clearly Define Responsibilities: In many small and mid-sized businesses, Credit and Collection responsibilities are shared among multiple individuals who have other primary roles. Establishing written credit policies and procedures is vital for coordinated efforts and alignment with sales and order fulfillment. Clearly defined roles enhance operational efficiency and improves customer experiences.
In Conclusion . . .
Optimizing the O2C process requires a holistic approach that integrates Credit and Collections with every facet of the O2C process. As demonstrated by the scenarios outlined, inefficiencies in billing, pricing, and fulfillment can have far-reaching consequences on AR performance and cash flow. By proactively identifying and addressing weaknesses in these areas, businesses can safeguard one of their largest assets—accounts receivable—while enhancing overall financial health.
Furthermore, a successful O2C process is contingent upon a well-coordinated effort that prioritizes strategic decision-making, streamlined workflows, and clear visibility across departments. Implementing systematic risk assessments, efficient order approval procedures, and consistent collection practices are just a few of the key factors that can drive improvement in AR management. By focusing on these critical areas, businesses can not only improve their cash flow and reduce operational risks but also foster stronger customer relationships and ensure long-term success.