When producing a cash forecast, knowledge of customer payment patterns is a vital part of evaluating the data. Payment patterns are also an important aspect of working capital management. If a forecast system with integration to an enterprise resource planning (ERP) system is used this opens up many opportunities for analysis of ERP data, to support both the forecast and working capital management.

The Forecast

The forecast normally focuses on cash flows in an aggregated manner where they are divided into different categories such as customer receivables, supplier payments, salaries, taxes and internal flows. This approach is recommended to keep the forecast simple and easy to overview. The reason for this is that the reporting units will put in a certain number of hours into producing a forecast and simplification can improve the results. But this simplification also has a drawback, as it does not allow you to follow more detailed cash flows if needed. Such details can be of great value when analysing the forecast - for example, being able to see the forecast for incoming flows on the customer group level. If customers are divided into groups with similar payment patterns, you can more accurately forecast these incoming cash flows. The grouping of customers should be adapted to your organisation's customer base.

Customer Payment Patterns and Overdue Payments

If the ERP system generates the information used in the forecast, it is possible to fetch ERP data on different levels for different purposes, which makes it possible to follow a more detailed view of the cash flows.

Figure 1 shows how the division of cash flow on the customer group level can provide the possibility to manipulate the information taken from the ERP using historic data with payment patterns, making the forecast more accurate. The report also gives the management an insight into customers' payment patterns. If customers pay late this will of course affect the margin expected to be made on a customer.

Figure 1: Improve Forecasting by Following Customer Groups

Customer Risk Management

Old overdue payments may indicate the possibility that these customers will never pay, generating customer loss. Therefore it is essential to be able to follow overdue payments to ensure they are not getting too old. On an aggregated level for a company group, one needs to take into consideration the fact that different countries have different traditions regarding payment terms.

Figure 2: Longtime Overdue Payments Could Mean Non-payment

General Measurement of the A/R

To improve the accounts receivable (A/R) you need to start measuring it and monitoring how it evolves both on an aggregated level and the subsidiary level.

Overdue payments as a percentage of A/R

This could be a good report to start with. It would be important to track this both on the aggregated level and the subsidiary or regional level.Figure 3 shows the report on an aggregated level.

Figure 3: Manage Receivables Efficiently by Comparing Overdue Payments to Total Receivables

How is A/R developing over time?

When you spend time analysing A/R, it is important to be able to see the progress you have made. This can be done by following overdue payments over time. Seasonal variation needs to be taken into account.

Figure 4: Following How Overdue Change Overtime to Monitor Progress

Overdue per subsidiary

It is necessary to follow each (or at least the most significant) subsidiary. System support can enable the treasury and the subsidiaries to view the same reports making communication about overdue payments easier and more transparent.

Figure 5: Get Local Entities Involved in Managing Receivables

How Do Overdue Payments Affect My Cash Forecast?

Overdue payments can affect the forecast in an undesirable way as they can and will give unanticipated incoming flows. This affects both the possibility of handling currency risk and the ability to improve short-term funding and borrowing. So if you manage your overdue payments efficiently you will have fewer incoming payments coming as a bolt from the blue.

Supplier Payments and Overdue Payments

Approving accounts payable (A/P) management is probably the easiest way to improve working capital for most companies, even though this can differ from industry to industry.

Supplier payments need to be managed efficiently, meeting payment terms. It is important for payments not to be made too early, as this costs money. Following the days payable outstanding (DPO) is an easy way to see how a company is managing its payables. In order to follow the DPO on an aggregated level, manual consolidation is necessary if a common ERP system or consolidation system is not used.

Internal Limits and Overdue Payments

Setting up a cash pool and using internal limits is an easy way for subsidiaries to get internal funding. But this can affect overdue payments in a negative way, meaning that overdue payments increase and internal funding is used to cover them. Administration work should not increase due to internal limits being too low and in need of constant changing.

In Figure 6, you can see two subsidiaries that are equal in size and business in general. You can clearly see that one of the subsidiaries is in no need of an internal limit. At the same time, both have a high level of overdue payments. The subsidiary's financial manager should be asked to look into the reason for the amount of overdue payments and the limit should be closed or moved to another subsidiary that is in need of one.

Figure 6: Ensure Internal Funding is Not Used to Cover Overdue Customers

Conclusion

Communication between the subsidiaries and the treasury is the key to efficient and functional cash management. If the subsidiaries are not on board and do not understand the importance of this the quality will be lost and thereby the value of all the efforts put into it. So keep your subsidiaries closely involved in the process and make them understand the importance of the work they are doing. This will ensure that they do not feel like they are sending information into a black box.So why invest in a special system for this? Can't it be done directly by the ERP? The answer is yes, probably part of it can be done by the ERP. But there are two main drawbacks:

1. Integration between the forecast and the working capital management analysis is hard to achieve in an ERP system.
2. Most organisations do not have a common ERP system, so this solution provides the opportunity to consolidate information from many ERPs.

Inventory management has intentionally been left out of this article as it does not affect the forecasting process in the same way as A/R and A/P. But it can be of great value to follow the inventory in a similar way as A/P and A/R, as the inventory affects the cash conversion cycle.

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