The economic downturn has resulted in more companies “managing for cash”, that is maximising cash flow by reducing non-core expenditures, slowing down outgoing payments, and aiming to collect owed monies from customers more quickly. We asked Christine Christian CEO of Dun and Bradstreet, a leading financial information company, on how these trends are now playing out in the local economy.
ceoforum.com.au: What trends are you seeing in how local businesses are managing their cash flows?
Christine Christian: There is no doubt that Australian businesses are currently under real pressure. For example, business-to business payments or the average time taken to settle accounts in the December 2008 quarter had blown out to near 60 days, which represents a significant increase compared to a year ago.
To put this in context, this is the highest level recorded since 2001 and an increase of four days over a 12 month period. This was immediately following the introduction of the GST, and businesses then were still adjusting to the GST and the need to make quarterly payments to the tax office. The fact that average payment times are now at similar levels reflects, I believe, that the general outlook is poor and worsening.
ceoforum.com.au: Other than the general economic slowdown, do you think there are other more particular factors at work in the deterioration of payment terms?
CC: One of the first impacts of the crisis was a tightening of credit. Clearly the banks are lending less than they were before, and doing all they can to preserve their cash. They have tightened up their credit terms and policies generally, and this has made things difficult for some businesses. As a consequence we began to see business cash flow impacted as borrowing was no longer an easy option to cover shortfalls.
This is the first time in over a decade that we have seen such a general credit tightening, and it is a bit of a shock for businesses that have been used to managing their cash flows with the assistance, say, of overdraft facilities. Despite the significant impact that trade payment days have on business cash flow they have not traditionally been seen as an important indicator of the financial health of a company. A sharp rise in terms or a continual increase such as we saw during 2008 should be viewed as an early indicator of trouble.
I believe private equity-owned (PE) businesses are an exception to this: in most PE-owned businesses, cash flow is monitored very closely as is managing the working capital position, so their approach could be a good one for businesses in the current environment.
The other thing the data is showing is that, generally speaking, big businesses (companies employing 500+ staff) have been the slowest to pay for more than nine consecutive quarters. Larger businesses are generally quicker to adopt cash flow conservation measures, and more alert to the benefits they can gain by slowing down payment. They also have the purchasing power to enforce favourable terms on their suppliers. Businesses who have primarily large businesses as their customers need to be aware of how these responses will impact on their own cash flows.
ceoforum.com.au: What do you suggest businesses do to minimise the risk of being adversely impacted by these types of behaviours?
CC: Being vigilant about AR (accounts receivable) is essential. You need to ensure that you have watertight contracts, with very clear terms and conditions, and sanctions for late payment if appropriate. Where there has been a breach, you need to follow up promptly and effectively. There is a clear relationship between the age of the debt and the likelihood you will be able to collect payment: the older the debt, the less likely it is you will be able to collect.
It’s also important to note that a lot of businesses have responded to the downturn by redoubling their efforts in sales and marketing, that is, as the economy slows down, there is a strong push to hold on to existing customers, and even gain new customers, to make up for expected revenue shortfalls. The point is, however, that it is not enough simply to generate sales: you also need to ensure you can collect payment from the sales you make! I would suggest that, in some businesses, some of those extra resources would be better deployed in enhancing collection capabilities.
Of course, traditionally accounts has had a relatively low organisational profile – it has been seen as an unglamorous back office function. That thinking may need to change a bit, however, if this issue is to get the management attention needed.
ceoforum.com.au: What do you see as the CEO’s role in “managing for cash”?
CC: Basically, the CEO role is to communicate the importance of the issue for the business, and back that up with the required actions. That may mean, for instance, changing the performance reporting systems to give greater emphasis to cash measures (as many PE-owned companies do), giving more resources to areas like accounts receivable, or other actions consistent with that message. Being able to effectively manage for cash will become a vital management competency for many companies as we navigate our way through this downturn.