How can mastering the “procure-to-pay” process rescue your company from liquidity crises?

Is your revenue growth strategy secretly killing your business’s cash flow?

Consultant Peter Kingma’s Cash Is King proves that revenue is vanity while liquidity is sanity. Learn actionable strategies to optimize procurement, manage inventory, and build the capital resilience needed to survive economic downturns. Don’t let a cash crunch derail your success—discover Kingma’s proven financial strategies below and start building a recession-proof business today.

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Business experts often invoke the dictum “cash is king,” but cash takes a back seat when a company is chasing revenue. Firms with strong cash positions are more resilient and can seize new opportunities, so cash management is crucial. Consultant Peter Kingma drives home this point using the narrative of the fictional Owens Inc. Sometimes his attempts at humor seem a bit forced, and extolling the advantages of using outside consultants can appear self-serving. Nonetheless, his approach is focused and comprehensive, and entrepreneurs will find this a helpful financial reference.

Take-Aways

• A business should consider its cash flow and not just pursue revenue.
• The procurement process, from order placement to payment, affects a company’s cash position.
• Other business functions, such as marketing and warehousing, can also help optimize the cash position.
• Management of logistics, a dynamic process, can lead to better inventory management.
• Plant management procedures can also ensure that money invested in inventory yields the best returns.
• A firm’s cash position can benefit from greater working capital management.
• Managers should use performance measurement metrics effectively.
• Improved cash management can boost a business’s resilience and guide it through bad times.

Summary

A business should consider its cash flow and not just pursue revenue.

If a company is to sustain its growth, it should consider best cash management practices in addition to revenue generation. Consider, for instance, the imaginary Owens Inc., a manufacturer of electrical equipment that learned that its sales terms were too favorable. It also found that its internal processes were complicated enough that they influenced its invoicing practices and the effectiveness of its collections process.

The company had grown by taking risks and ramping up sales, but it didn’t have a good grasp on its inventory management. Owens had initiated capital projects, but it was getting harder to forecast the company’s cash flow situation and fund these initiatives. Moreover, some customers were taking their time with payments and not adhering to sales terms, to the extent that the company’s Chief Financial Officer noted that Owens was effectively functioning as a bank to its customers. Although Owens’s Chief Executive Officer had at one point declared that “cash is king,” he had lost sight of that mantra as the company grew.

“Owens chased sales growth, which in itself is not at all bad. But they did so without considering the trade-offs they were making. They gave away terms to get the sale, and they allowed internal processes to get so complex that it was affecting the quality of invoicing and effectiveness of collections.”

Some best practices a company could initiate to manage its sales and client management include segmenting its customers to determine the costs to serve each group. The firm’s credit and risk management would benefit from a credit review policy to onboard customers and from occasionally reviewing client accounts. Best practices also apply to ordering and invoicing, such as keeping track of how many invoices are paid on time. The collections process could include setting targets for collectors, and payment management might eschew less efficient physical checks and move to electronic payments.

The procurement process, from order placement to payment, affects a company’s cash position.

The decisions that a procurement department makes affect a firm’s balance sheet. For Owens, the “procure-to-pay” process is summarized as:

• “Sourcing strategy,” which should include occasional reviews of supplier performance.
• “Supplier and contract management,” which involves bringing up payment and other terms when negotiating price to get the best overall deal.
• “Good receipt and payment management,” which, for example, would require purchasing orders that can help document a transaction.

“The life of a sourcing professional is a bit like that of an air traffic controller. Not only do they have to manage routine processes but also they must deal with emergencies that pop up daily.”

The procurement team faces so much pressure that sometimes it doesn’t notice the trade-offs it makes that affect a company’s cash position. For instance, lead times, minimum order quantities, and time to deliver all have impacts on a company’s cash position, as do terms for payment and how often payments are made.

Other business functions, such as marketing and warehousing, can also help optimize the cash position.

At Owens, the vice president of operations noted, “Each function has their own interests and goals, and if not synchronized, our inventory doubles like it has these past few years.” Procurement personnel tend to focus on negotiating the best prices, but this may make for inventory management that is not optimal.

“In a transactional relationship, there is little incentive for the supplier to creatively engage in trade-off discussions that can ultimately bring costs down, service levels up, and just-in-time inventory.”

For instance, long lead times and minimum purchase requirements could result in too little or too much inventory on hand. Moreover, the purchasing department tends to have either transactional relationships with suppliers, or it can get too comfortable with suppliers and continue doing business the same old way.

“Having the right material at the right place and at the right time is a big part of the aim for an optimized logistics function.”

Some techniques that the marketing and engineering functions could follow include keeping an eye on inventory to identify products that have lost demand or become unprofitable. And when introducing new products, ensure that there is legitimate demand and that these new products aren’t just creating minor variations of existing products that will merely add to cost. When it comes to logistics and warehousing, aiming for a higher service level will call for keeping more inventory at hand.

Management of logistics, a dynamic process, can lead to better inventory management.

Effective logistics, the process of packaging and delivering goods to customers, can be a positive for inventory management. Logistics management is a dynamic process, considering that customer needs change, transportation costs fluctuate, and innovation opens up new opportunities and could disrupt existing dynamics. For instance, the COVID-19 pandemic pushed consumers to e-commerce, which led to changes in the supply chain. Manufacturers had to send products to individual customers, rather than to distribution centers that would pass on the product to retail stores.

Other logistics challenges include changing consumer tastes, supply chains that have become more global in nature, and regulatory changes, such as those aiming to manage climate change. Such factors could also have fallouts for inventory management.

Logistics can affect a firm’s cash flow through:

• Variations in batch size or labeling that can influence labor costs and lead times for fulfillment.
• The use of technology, such as radio frequency identification (RFID), that could mean more steps in the fulfillment process and reduced flexibility.
• “Incoterms,” or standardized terms of trade, that could mean insurance, documentation requirements, and transfer of ownership affecting the flow of goods and inventory.
• Service terms that are negotiated by customers. Customers look to “on-time-in-full” service, and variances catering to individual customer needs should be monitored so that they don’t get out of hand.
• Managing warehouses for optimal performance so as to have an impact on how fast products enter and leave a warehouse.
• Linking customer status updates on the order fulfillment process to functions such as billing to help cut down on administrative time.

Plant management procedures can also ensure that money invested in inventory yields the best returns.

Inventory in a plant can be raw material, work-in-process, finished goods, or maintenance-related. Manufacturing companies need inventory, but it tends to tie up a lot of money.

“It’s important to acknowledge that every dollar invested in inventory has equal value with unequal returns, meaning, investing in inventory that sells quickly and at a high margin produces more favorable returns on the investment than inventory that sits around unused.”

“Safety stock” is the level of inventory required to adequately fulfill a specified customer service standard, such as a 95% service level. Businesses calculate this based on historic variations. If a firm has invested in materials requirements planning tools, they should be used to the utmost to make safety stock calculations. There should be minimal stock on hand for made-to-order products. Firms should keep an eye on stock in transit, aiming to cut down on transportation time and minimum order requirements. A business can build to basic requirements and be flexible so that customization can be introduced later, if necessary. Carefully consider dollars invested in inventory so that money isn’t tied up in slow-moving items or in too much inventory.

A firm’s cash position can benefit from greater working capital management.

A good financial controller can help a business tackle its accounting and financial reporting. Financial controllers can follow certain best practices to ensure good working capital management. One is reviewing “absorption costing,” or the allocation of fixed cost to every inventory unit a firm produces. That could provide incentives for a manager to produce more units to lower the fixed cost allocated per unit. This, in turn, could have the impact of generating more inventory than needed. A financial controller could then review operations to stay on top of fixed cost allocation.

“A great controller will use that insight and data to help the business make more informed decisions.”

Another aspect to watch is a company’s weighted average cost of capital (WACC), which takes into account the cost of all sources of capital, including debt instruments and equity. When a company takes on more debt, its stock price is affected, as investors consider the risk associated with debt.

“As share prices become more volatile (have a higher beta) relative to index prices, the cost of debt also often rises. It’s like a storm moving over warm waters — they start to fuel each other.”

Controllers should be wary of using the prevailing short-term cost of debt, such as the Secured Overnight Financing Rate index, to make cash-related decisions. This could lead to a “free money” mentality when the index is low, without taking into account the cost of equity. And they should be aware that “strong performance in one category of working capital can hide poor performance in another area.” Also, a business unit that performs well can mask the poor performance of another.

Managers should use performance measurement metrics effectively.

Businesses use different performance indicators to take stock of how they are doing. But do these indicators really help them get a handle on business performance, and are they linked so as to make for more informed decisions? It’s too often the case that these metrics are not connected.

“It’s hard to know if we’ve made progress or if we are somehow falling behind unless we capture measurements.”

Metrics that businesses commonly use include inventory turns — assessing the number of times inventory is sold or used during a specific time period — and cost per unit — capturing both the fixed and variable costs that go into making a unit of a product. Operational indicators are passed on to leadership, and operations personnel should have metrics available to show how their actions influence the business. Too often, it seems that the metrics that management uses do not align with those that operations uses. This could be because of data integration issues or because no one has ever done a review of what data is being gathered and if it is being used.

The metrics used by leadership to signal the company’s health should serve as warning lights that inform before it’s too late. Too often, management’s metrics tend to be like a car’s fuel gauge, reporting after the fact, rather than like a speedometer that helps drivers stay within limits. Operating metrics must capture the input management needs to measure. Key performance indicators and bonuses could be aligned to performance on the cash front. The team should understand its role in this process so it can contribute in a positive manner.

Improved cash management can boost a business’s resilience and guide it through bad times.

Resilience demands recognizing the importance of cash flow and not merely focusing on revenue. Unfortunately, many businesses consider cash an afterthought. Many companies have found themselves stalled as their markets changed and they couldn’t adjust because they didn’t have the cash required to make changes.

“Netflix reinvented itself from a DVD by mail business into an entertainment behemoth. By contrast, Blockbuster, once a mighty video rental chain, is now just a distant memory.”

Companies that are above-average in working capital management tend to bounce back faster from setbacks and preserve shareholder capital better. An average daily cash balance depicts a company’s position well since it’s not about window dressing; it is actual cash available to pay down debt, make investments, and go for acquisitions.

And cash management is as important for service sector firms, such as retailers and health care providers, as it is for the manufacturing sector. It’s just that the considerations are different. For instance, since customers typically pay for purchases at the point of sale, retail businesses tend not to have to manage a big accounts receivable portfolio.

“Bringing about changes beyond incremental and ensuring that the changes are sustainable will likely require a concentrated intervention through the formation of a cash leadership office.”

As the fictitious Owens Inc. moved forward, the company focused both on its cash position and its growth. The CEO met with company stakeholders and the leadership team, presented the relevant data, and informed them that cash is as critical as growth. The company wouldn’t be able to realize its priorities without a meaningful cash infusion. At that point, the company’s entire management team was on the same page; it was in a position to assess its decisions’ results and advise the business on whatever trade-offs or compromises might be necessary. Eventually, it will become clear whether the cash leadership office has effectively guided the company toward its ultimate goals.

About the Author

Peter W. Kingma is a principal with EY Parthenon, leading the consultancy’s working capital practice in the Americas.