Ways out of the working capital trap empowering self financing growth through modern supply management

Based on the situation of an increased demand for capital during a period of restrained granting of credit bybanks, approaches to identify and strengthen internal financial power are pre

Erik Hofmann · Daniel Maucher · Sabrina Piesker ·

Philipp Richter

Ways Out of the

Working Capital Trap

Empowering Self-Financing Growth Through Modern Supply Management

123

Dr Erik Hofmann

Universität St Gallen

Kerkhoff Competence Center

of Supply Chain Management

of Supply Chain ManagementLehrstuhl für LogistikmanagementDufourstr 40

9000 St GallenSwitzerlanddaniel.maucher@unisg.ch

40237 DüsseldorfGermanyp.richter@kerkhoff-consulting.com

ISBN 978-3-642-17270-0 e-ISBN 978-3-642-17271-7

DOI 10.1007/978-3-642-17271-7

Springer Heidelberg Dordrecht London New York

Library of Congress Control Number: 2011921254

© Springer-Verlag Berlin Heidelberg 2011

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The trend towards globalization and the increasing division of labor as well asthe rapid development of information and communication technology have led toworldwide value networks associated by material flows, information flows, andcash flows These global supply chains pose major challenges for the stakeholdersinvolved because of their complexity and cross-national major structure.

Therefore, supply chain management deals with the task of planning and ing efficient value creation networks taking economic, environmental and socialaspects into account

direct-A professional advanced purchasing comprises the integrated management ofall processes to supply a company with the required goods from sources outsidethe company Thereby, the foremost target is to contribute to the achievement ofcompetitive advantages of one’s own company By linking the procurement withthe supply chain management, company-wide improvements may be achieved andstrengthened in a sustainable matter

Nowadays, procurement and supply chain management are part of the key agement disciplines and in many companies they are already anchored at the topmanagement level Procurement and supply chain managers are not longer focusedsolely on reducing costs, because of this relevance, but contribute to the differenti-ation of companies and value networks The confrontation with issues such as riskmanagement, financing, sustainability in the supply chain, and product innovationwill increase in the following years due to changing political conditions, oligopolies

man-in supplier markets and further shrman-inkman-ing resources

Despite the great practical relevance of procurement issues, the future challengesmentioned appear not to be adequately addressed from a scientific point of view

so far Furthermore, the connection between procurement and supply chain agement has not been explored extensively The series “Advanced Purchasing &Supply Chain Management” aims to contribute to closing these gaps The intention

man-is to generate benefits both in respect of sciences and practical matters

The realization of this objective is supported by the “Kerkhoff CompetenceCenter of Supply Chain Management” (KCC) – a jointly initiated platform of excel-lence by Kerkhoff Consulting and the University of St Gallen The goal of the KCC

is to create an interface between science and practice Therefore, trends and lenges in purchasing, procurement and supply chain management are to be analyzed

chal-v

vi Series Prefaceand recommendations to be derived for practical issues Meanwhile, a practice-relevant cognitive process is strived for in terms of procurement and supply chainmanagement.

The contributions of the series deal with current issues as well as innovationand excellence approaches in the management of value networks and link theoreti-cal concepts with practical applications Relevant themes are inter alia the purchase

of capital goods, performance measurement in supply chain management and curement, performance contracting or procurement in the public sector The authorsare researchers from the University of St Gallen, researchers of other leadinginternational research institutions with a focus on procurement and supply chainmanagement, consultants from Kerkhoff Consulting as well as practical experts Byforming mixed writing teams from academia and industry, a close integration ofthese areas is ensured This combination takes the application-oriented aspect ofbusiness management into account

pro-The present volume “Ways out of the working capital-trap” opens the series

“Advanced Purchasing & Supply Chain Management” Based on the situation of

an increased demand for capital during a period of restrained granting of credit bybanks, approaches to identify and strengthen internal financial power are presentedfrom a company’s and a supply chain’s point of view With the first volume, theauthors show the close integration between procurement and supply chain man-agement and their impact on the financing capabilities of companies Furthermore,specific recommendations for purchasing managers and supply chain managers aregiven to enhance the financial competitiveness of their company and of partnersalong the value chain

The authors of the series hope that all readers may enjoy this first volume andreceive a number of specific impulses to pursue possible “paths out of the workingcapital-trap” We are convinced that the approaches and tools presented make avaluable contribution to this effort

September 2010

In recent years increasing competition has led to a continuous focus on core tences within companies They reduce their own value-added and buy more fromoutside With this increase in buying, the impact of purchase on the company’sresults rises Therefore, the purchasing function is playing an increasingly crucialrole in a company As one of the new hubs to ensure the company profits, the pur-chase has to make use of all levers available and start to operate professionallyoutside the “traditional” purchasing areas.

compe-A continuous outflow of cash results from the company because of the payment

of the procured raw materials, goods and services There is a time gap within mostcompanies between the payment made by customers and the payment for the rawmaterials As a consequence, the purchase of raw materials, goods and services has

to be financed The cover of this time gap results in financing costs The financingfor companies has become increasingly difficult due to the 2008/2009 financial crisisand the previously enacted Basel II As a result of this situation, a disproportionatedemand in the first phase of recovery may result in the so-called “working capital-trap”

The focus of this book is on the impact of the purchase and its levers able to control liquidity Therefore, the issues of different financing options andoptimization on the debitor’s side are not dealt with in depth

avail-As part of the work on this book, four areas were identified to influence liquidity

in the supply chain, whereby each of them has to be optimized individually:

• Timing and method of payment to the supplier: many companies work with

an extension of payment terms Thereby, it is often overlooked that differentfinancing costs within the supply chain have to be taken into account

• The amount and date of the transfer of goods from suppliers into the company’sown value-added In this context, the issues of size of delivery, way of delivery,and thus the stock height are mainly concerned

• Optimization of the financing costs in terms of cash flows given to the suppliers:there is a need to create a balance between internal and external financing costsand align with new payment tools

• Reducing purchasing costs: this topic relates to the classical understanding of theactivities in purchasing

vii

viii ForewordDirectly depending on the business objectives, a comprehensive optimum has to befound for these four areas.

The purchaser is faced with a continuous increase in complexity In order to vide the adequate value contribution in this environment, the purchaser has to leavethe beaten track and make use of integrated approaches to a complete procurementoptimization This book aims to provide food for thought on this issue and alsoconstitute a guide

pro-The joint work on these issues has repeatedly shown us that by dropping tional attitudes and approaches the purchase influence can be expanded significantly

tradi-In this regard, our special thanks go to Mr Gerd Kerkhoff, the Chairman of the Board

of Kerkhoff Consulting, who has provided us and the authors with many new ideas.Furthermore, we would like to thank the authors who have succeeded in describ-ing the various levers of purchase and have thus created a guide for purchasingdepartments

September 2010

1 Call for Action: From Financial and Economic Crisis

to Working Capital Trap 1

1.1 Effects of the Financial Crisis on the Real Economy 1

1.2 Looming Credit Squeeze as an Obstacle to Growth 3

1.3 The Working Capital Trap as a Challenge 4

2 Determination of the Internal Financing Power of Corporate Growth via the Self-Financeable Growth Rate 7

2.1 Limits of Growth and Growth Financing of Companies 7

2.2 Financial Growth Potential According to the Self-Financeable Growth Rate Approach 8

2.3 Possibilities for the Optimization of the Self-Financeable Growth Rate 12

3 Strengthening Internal Financing Power Using Cash-to-Cash Cycle Optimization 13

3.1 Presentation of the Cash-to-Cash Cycle 13

3.2 Influence of the Cash-to-Cash Cycle on Corporate Value 16

3.3 Possibilities for the Optimization of the Cash-to-Cash Cycle from the Corporate Viewpoint 17

3.4 Interdependencies of the Cash-to-Cash Cycle from a Supply Chain Viewpoint 20

4 Measures for Strengthening Internal Financing Power from a Corporate Viewpoint 21

4.1 Management of Payment Terms 21

4.2 Inventory Management 31

4.3 Product Group Management and Supplier Management 41

5 Measures for Strengthening Internal Financing Power from a Supply Chain Viewpoint 55

5.1 Finance-Oriented Supply Chain Sourcing 56

5.2 Supply Chain-Oriented Supplier Financing 59

5.2.1 Reverse Factoring 59

5.2.2 Cross-Company Financing of Capital Goods 61

ix

x Contents

5.3 Collaborative Cash-to-Cash Management 62

5.3.1 Collaborative Cash-to-Cash Management with Varying Inventory Carrying Rates 63

5.3.2 Collaborative Cash-to-Cash Management with Varying Capital Cost Rates 64

5.4 Collaborative Cash Pooling and Netting 64

5.4.1 Cash Pooling and Netting in the Corporate Group as a Starting Point 65

5.4.2 Cash Pooling and Netting in the Supply Chain 68

5.5 Supply Chain Financing Platforms 70

6 Case Study: Increasing Internal Financing Power of a Supplier in the Automotive Industry 75

6.1 Company’s Starting Situation 75

6.2 Presentation of Measures 76

6.3 Performance Measurement Using a Working Capital Management Analysis Tool 77

7 Measuring Procurement Contribution to Corporate Performance using the “Procurement Value Added” 81

7.1 Measuring Procurement Contribution to Corporate Performance 81 7.2 Presentation of the Procurement Value Added 81

7.3 Exemplary Calculation of the Procurement Value Added 84

8 Conclusion 87

8.1 Summary 87

8.2 Outlook 88

Literature 91

Chapter 1

Call for Action: From Financial and Economic Crisis to Working Capital Trap

1.1 Effects of the Financial Crisis on the Real Economy

The financial crisis was triggered by defaults and delinquent payments on the U.S.real estate market in 2007 and increasingly spread to the real economy during 2008.The reasons for this were a combination of the banks’ restraint in lending, insecureconsumers worldwide and homemade problems in some industries, such as existingexcess capacities in the car industry The financial crisis, moreover, coincided with

a downswing of the economic cycle This resulted in a serious decline in globalindustrial production In Europe and in the U.S.A., production indices dropped byabout 20% points within a few months (Fig.1.1)

This dramatic plunge in economic performance also had its effects on the labormarket The unemployment rate in Europe increased from about 7% to nearly 10%

Fig 1.1 Development of production indices in the EU and the USA (cf Eurostat2010a )

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and in the U.S.A from about 4.5% to about 10%.1Only the raw materials marketsshowed positive Before the crisis, raw materials prices had reached top values due

to speculation; but as a result of lower demand during the crisis, oil and natural gasprices dipped significantly

The automotive industry was hit especially hard by the economic crisis Theindustry’s structural crisis caused by high fuel prices in previous years resulted in

a reallocation of demand in favor of small cars This was even further impacted bycompanies failing to invest in their vehicle fleet, as well as by a lack of demand onthe part of nervous private consumers Thus, car production worldwide dropped by0.9% in 2008 and by 10.4% in 2009, the first reductions in production volume since

2001 (Fig.1.2)

Owing to the difficult economic situation, many companies recorded profitreductions or losses, or even had to file for bankruptcy.2 Even large corpo-rations had to instigate insolvency proceedings, for example, General Motors(approx 243,000 employees), Chrysler (approx 132,000 employees), Arcandor(approx 86,000 employees), Quelle (approx 3,400 employees) and Karmann(3,500 employees) Since business insolvencies are a typical late economic indi-cator, a wave of insolvencies frequently reaches its crest only 1 year after passingthrough a crisis According to a study, administrators in bankruptcy estimate that

–12% –10% –8% –6% –4% –2% 0% 2% 4% 6% 8%

Cars sold Change versus previous year

Fig 1.2 Development of worldwide car production (cf Organisation Internationale des

Constructeurs d’Automobiles (OICA) 2010 )

1 Cf Eurostat ( 2010b ).

2 In 2009, more than 33,000 companies filed for insolvency in Germany This is equivalent to an 11% increase on the previous year Cf Bürgel Wirtschaftsinformationen ( 2010 ).

1.2 Looming Credit Squeeze as an Obstacle to Growth 334% of the petitions in bankruptcy are triggered by the crisis and more than 17%

of the insolvencies in small and mid-size companies are exclusively because of thefinancial crisis.3

A recovery in the industry was seen to emerge in early 2010 In April 2010,industrial production in the EU increased by 7.8% versus April 2009 to reach its

2003 level.4A recovery was also evident in the car industry Owing to the ing demand for cars in Asia, worldwide production is expected to grow by about500,000 vehicles by the end of 2010 In China alone, car sales are forecast toincrease from an estimated 8.3–12.5 million vehicles between 2009 and 2012.5Butthe banks’ looming credit squeeze might prove to be an obstacle to growth

increas-1.2 Looming Credit Squeeze as an Obstacle to Growth

At the beginning of the financial and economic crisis, its effects on the banks’ ing attitudes could not be comprehensively assessed But the first group companiesquickly reported difficulties in obtaining high-volume credit In particular, small andmid-size companies complained about a restrained lending policy by the banks pri-marily because of the insecurity of financial institutions in view of unpredictable

lend-market developments According to a survey by the ifo Institut in September 2009,

43.7% of the 4,000 companies polled stated that banks were restrictive in awardingcredits In August 2008, only 28.7% of those polled had stated this These factsare confirmed by statistics and statements from the European Central Bank andthe Kiel Institute for the World Economy, who stated that credit volumes in the 16Euro countries had shrunk greatly in June 2009 Loans granted to businesses wentdown by 0.7% or 35 billion Euros compared with the previous month This wasthe largest reduction since these statistics started to be collected in 2003.6In 2009,the volume of corporate loans in the Euro zone decreased by approx 4% versusthe previous year.7Numerous media talked about a credit squeeze The Verband

der Automobilindustrie in Deutschland (Association of the Automotive Industry

in Germany) also complained about this condition with regard to automotive pliers According to the definition by the Council of Economic Advisers, a creditsqueeze designates a situation in which loan supply is lower than would have beenexpected based on the prevailing interest rates and the economic feasibility of invest-ment projects.8Additionally, credit applications by small and mid-size businesses

sup-3 Cf Euler Hermes Kreditversicherungs-AG ( 2009 , p 8).

4 Cf Eurostat ( 2010a ).

5 By contrast, the west European market including Germany, Great Britain and France will recover more slowly It is expected that the 2007 level will only be reached again in 2012 Cf Mauerer ( 2010 ).

6 Cf Die Welt ( 2009 ).

7 Cf European Central Bank ( 2010 , p S33).

8 Cf Council of Economic Advisers ( 1992 , p 46).

increased by about 32% in volume in the first half of 2009.9Companies are facingmajor challenges with this combination of decreasing loan extensions and simulta-neously increasing demand Companies need loans to prefinance emerging growth.

To satisfy increasing demand, production capacities are again utilized to a higherextent and formerly empty warehouses are refilled

According to assessments by the Bundesverband der Deutschen Industrie

(Federal Association of German Industries), the risk of a sustained credit squeezefor 2010 has not been reduced In 2010, numerous small and mid-size companieswill apply for loans and must disclose their presumably bad balance sheets from

2009.10

1.3 The Working Capital Trap as a Challenge

During the 2009 financial and economic crisis, many companies focused on ing their existence Considering their vastly reduced sales, their main attention wasinitially directed towards reducing costs To realize savings within procurementfor example, price cuts were negotiated with suppliers, inventory was rolled backand completed volume contracts were extended or cancelled With low productionutilization rates, many companies used short-time work to cut back on personnelcosts.11 Such short-term measures helped to reduce some of the costs to securethese companies’ survivals

secur-Yet, the slump in order intake seen in many sectors of the industry frequentlycaused a considerable drop in cash flow or even losses As a result, reserves wereused up If that was not enough, the consequence was that outside capital had to beborrowed to keep up business activities However, financially troubled companiesusually have below-average credit standings, which go hand in hand with increasedoutside financing costs

After having passed through the crisis, many businesses re-experienced higherincoming orders in mid-2010, and sales increases were expected Car manufactur-ers were also bearing out this optimism and again communicated solid planningvariables For example, VW confirmed that, despite the crisis, they would stick totheir “18 plus” strategy according to which sales are expected to increase from 6.3million cars to more than 10 million cars by the year 2018.12

However, the beginning of a cyclic economic upswing presents additional lems Because of the belt-tightening measures taken during the crisis capacities

prob-9 Cf Management Praxis ( 2009 ).

10 This further hampers access to liquidity loans, especially considering the increasing use of automated and statistical assessment procedures by banks for reviewing creditworthiness.

11 From November 2008 to May 2009, the number of people on short-time work went from 130,000

to a maximum of 1,533,000 Although 102,000 short-time workers were registered in the annual average for 2008, that figure jumped to 1,143,000 in 2009, with about 20% of these in vehicles construction Towards the end of the year, the situation somewhat eased with 890,000 short-time

workers Cf Bundesagentur für Arbeit (2010 ).

12 Cf Financial Times Deutschland ( 2010 ).

1.3 The Working Capital Trap as a Challenge 5that were cut back are now lacking Investments in new plants and increases

in personnel stock are necessary and must be financed The combination of acompany’s increasing liquidity demand through growth and low average inven-tory levels with simultaneously hampered access to outside capital because of therestrictive lending practices of financial institutions can be described as a “work-ing capital trap” Figure1.3presents the flow from the beginning of the financialand economic crisis up to the “working capital trap” as well as possible waysout of it Here, an iterative process first determines a company’s internal financ-ing power and subsequently takes measures to strengthen this internal financingpower

This book aims to present possibilities for implementing this process of ting out of the trap by following a procedure oriented on practice and solutions(Fig.1.4).Chapter 2determines the internal financing power of corporate growthvia the self-financeable growth rate (SFGR).Chapter 3follows with a presentation

get-of strengthening internal financing power by means get-of optimizing the cash-to-cashcycle Subsequently, measures are presented to strengthen internal financing power

Reduction of industrial

production

Profit reduction or,

respectively, losses for

many companies

Depletion of reserves,

reduction of inventories,

and relatively lower rating

"Working Capital Trap"

Increased capital demand

due to the beginning

upswing

Hesitant lending by banks

(credit squeeze)

Way out

Financial crisis

Determining internal financing power

Strengthening internal financing power

Fig 1.3 Effects of the financial and economic crisis on companies’ working capital

Chapter 1

Call for Action: From Financial and Economic Crisis to the "Working

Capital Trap"

Chapter 2

Determination of the Internal Financing Power of Corporate

Growth via the Self-Financeable Growth Rate

Chapter 3

Strengthening the Internal Financing Power by Means of

Cash-to-Cash Cycle Optimization

Case Study: Increasing Internal Financing Power by the Example of

a Supplier in the Automotive Industry

Fig 1.4 Overview of this book’s content

from a corporate point of view (Chap 4) and from a supply chain point of view(Chap 5) Using the example of a supplier in the automotive industry, Chap 6illustrates and clarifies the presented statements To measure the procurement con-tribution for business performance,Chap 7presents the “procurement value added”(PVA) Finally, a conclusion as well as an outlook will follow (Chap 8)

Chapter 2

Determination of the Internal Financing Power

of Corporate Growth via the Self-Financeable Growth Rate

2.1 Limits of Growth and Growth Financing of Companies

A company can reach its growth limits in different ways External business tors, such as the saturation of sales markets or the scarcity of a skilled, experiencedworkforce, but also internal business aspects, such as capacity limits, below-averageproductivity, lack of capital or organizational inefficiencies can present growthobstacles for a company These factors will mean that a company’s own growthpotential is not fully utilized Nonetheless, a company’s growth-inhibiting start-ing position can be fundamentally changed by means of adequate measures forstrengthening its financing power

fac-With growth investments, a company assumes that profitability requirements arerealized and investment proceeds exceed prorated capital costs In this case, it isgenerally aimed at paying for growth investments with internal financing since thisgenerates corporate value A company’s internal financing is limited by its ability

to generate sufficiently high cash flows from its operative business Any increasedoutside financing of growth is connected with risks for the lenders and is therebyonly reasonable to a certain extent for the company Aside from general factors

of credit standing, a company’s justifiable outside financing rate will depend, inter

alia, on the risk and type of investment project to be financed In particular,

exces-sively outside financed growth stages are considered risky since annuities must bepaid irrespective of the development of business results In this context, the litera-ture talks about the expansion crisis in which excessively outside-financed growthmostly results in a serious financial crisis within a company.1

The limits of outside financing through equity capital are frequently determined

by the owners’ financial powers The question is, on the one hand, whether theyhave sufficient financial funds and, on the other hand, whether they are willing toinvest such funds in the growths of their businesses Moreover, financing by means

of capital increases can result in undesirable shifts in the ownership structure and isconnected with costs and organizational expenditures

1 Cf Volkart ( 2006 , p 704 et seq.).

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Based on these theoretical considerations, we can establish that, in many cases,growth should be financed from operatively generated funds In view of the fre-quently found situation of the “working capital trap”, the question presents itself

as the internal financing power of corporate growth – i.e which growth rate can berealized with operatively generated funds? Which factors act upon this growth rate

as a driving force – leaving out of account any outside financing and divestments?Can this limit be displaced by specific financial management? The following sectionclarifies these questions by means of the SFGR concept

2.2 Financial Growth Potential According to the

Self-Financeable Growth Rate Approach

The following section presents the potentials, fundamentals and structures ofthe SFGR approach The SFGR describes a company’s growth rate realizablefrom operatively generated means without divestment and outside financing.2Thiscompany-specific growth rate essentially depends on three factors:

• Time of an operating cash cycle (OCC)

• Time of tied-up funds for financing the working capital as well as the operatingcosts per OCC

• Freely available generated funds per OCC

The OCC comprises the period of time in which financial funds at a company aretied up in stock inventories as well as other working capital before payment isreceived for the services rendered (Fig.2.1)

The OCC time is calculated from the sum total of days inventory held (age ofstocks, DIH) and of days sales outstanding (age of accounts receivable, DSO), whichare obtained from different ratios of the balance sheet and the P&L account:

Payment Receipt from Customer

Days Sales Outstanding Days Inventory Held

Operating Cash Cycle Time

Fig 2.1 Operating cash cycle on the basis of goods and payment flows

2 Cf Churchill and Mullins ( 2001 , p 135 et seq.).

2.2 According to the Self-Financeable Growth Rate Approach 9The DIH ratio describes the period of time from the receipt of resources from thesupplier until the sale of finished products to the customer and is calculated asfollows from corporate ratios:

DIH [d]= Inventories

Inventories essentially comprise raw, auxiliary and operating materials, as well

as unfinished and finished products that are not yet sold Cost of goods sold areexpenses incurred from the consumption of goods and the utilization of services formanufacturing, expanding or improving an asset, and are shown in the P&L accountaccording to the cost of sales method.3According to the German Handelsgesetzbuch (HGB – Commercial Code), they comprise direct costs in the materials and manu-

facturing area and can optionally also comprise all overhead costs in the areas ofmaterials, manufacturing and administration A reduction of DIH results in a reduc-tion of tied-up capital costs and inventory management costs, but can also lead tohigher ordering and out-of-stock costs

DSO comprises the period of time from the sales of finished products until thereceipt of payment from the customer With the help of the balance sheet and P&Laccount, this ratio results from accounts receivable as well as net sales:

DSO [d]= Accounts Receivable

The DSO ratio essentially depends on stipulated payment terms and the efficiency

of accounts receivable management; the faster customers pay their outstandingaccounts the smaller the ratio The payment terms enforceable on the market essen-tially depend on the sector of the industry, the company’s position of power withinthat sector and its geographic activity profile

It is problematic that to calculate the OCC time you need to know a pany’s cost of goods sold These are shown in the P&L account according tothe cost of sales method However, the cost of sales method is only absolutelymandatory according to US Generally Accepted Accounting Principles By con-

com-trast, accounting principles according to the HGB and International Financial

Reporting Standards allow the cost of sales method and nature of expense method.Accordingly, in practice, net sales instead of cost of goods sold are frequently used

as the basis for calculating the DIH to improve external comparability.4 Anotherproblem results from the period under review Since the calculation of workingcapital ratios is based on balance sheet and P&L account figures, their calculationmerely presents a selective consideration A higher reporting frequency can increasethe informative value of the ratios However, data from internal accounting must beconsulted for this

3 Cf Handelsgesetzbuch (HGB) ( 2006 , § 255 para 2).

4 Cf Reason ( 2004 , p 78).

The necessary financial funds per OCC as another determinant of the SFGR arecalculated as follows, because of the different tied-up funds for cost of goods soldand other expenses:

Tied-up funds manufact costs= Tied − up funds [d]

OCC manufacturing costs [d]·Cost of Goods Sold

Net Sales

(4)

Tied-up funds other expenses= Tied − up funds other expenses [d]

Net Sales

(5)The sum of the tied-up funds of cost of goods sold and the tied-up funds of otherexpenditures per Euro of sales results in the total tied-up funds per OCC The freelyavailable funds per OCC indicate a company’s absolute financing power in mone-tary units per Euro of turnover They are calculated from net sales minus cost ofgoods sold as well as other expenses This residual value is equivalent to the profitmargin and is available to the company for investments Figure2.2is a schematicpresentation of the procedure for calculating the SFGR The annualized SFGR pro-vides information on the extent a company can grow per year without having to rely

on outside financing If the enterprise grows at a lower rate than the SFGR, morecash is generated than that necessary for growth But if it grows at a higher rate, itmust depend on outside financing to ensure liquidity

To illustrate the mode of calculation, we will look at a company’s data in Fig.2.3with balance sheet ratios and duration of tied-up funds of cost of goods sold (timefrom outgoing payment to the supplier until receipt of payment from the customer –also called cash-to-cash cycle time – seeChap 3)

OCC

Number of OCC per year (OCC n )

Tied-up funds manufacturing costs per OCC

SFGR per OCC (SFGR OCC ) Tied-up funds

other expenses per OCC

(1+SFGR OCC ) OCCn –1 = +

=

=

Fig 2.2 Calculation diagram of the annualized SFGR

2.2 According to the Self-Financeable Growth Rate Approach 11

110,000,000 Inventories

130,000,000 Accounts Receivable

800,000,000 Net Sales

560,000,000 Cost of Goods Sold

108.2

Balance Sheet Ratios

Tied - up period, cash [days]

Fig 2.3 Basic data for the calculation example

These data can be used to calculate DIH and DSO:

is paid off on the first day of the OCC or zero days if payment receipt from thecustomer and settlement of the liability coincide Accordingly, to simplify matters,tied-up funds of other expenses are assumed to correspond to half the OCC (i.e 65.5days) For further calculation, other expenses are determined from the difference ofnet sales, on the one hand, and cost of goods sold and net operating profit after taxes,

Fig 2.4 Example of the calculation of annualized SFGR

The profit margin amounts to 3.5% Based on Fig.2.4, an SFGR of 0.049 results.With 2.79 OCCs annually, the company can consequently realize a growth rate of14.3% by its own efforts Figure2.4shows a summary of the calculation steps ofthe example This is retaken up inChap 6to show the effects on the SFGR owing tomeasures introduced by the purchasing department for optimizing working capital

2.3 Possibilities for the Optimization of the Self-Financeable Growth Rate

The SFGR can be increased by influencing its determinants Potential measures can

be classified into the following categories:

• Shortening the OCC, e.g by lowering the period of inventory lockup, ing the accounts receivable payment terms or increasing the accounts payablepayment terms

lower-• Reducing cost of goods sold and other expenses, e.g discounts

• Increasing net sales, e.g through lower sales prices because of reduced purchaseprices

From the viewpoint of supply chain management, the period of inventory lockupcan be reduced, for example, by the measures described inChap 3in the forecast-to-fulfill process A reduction in cost of goods sold can be realized through themeasures indicated in the purchase-to-pay process The following chapter showsmeasures for strengthening the internal financing power using cash-to-cash cycleoptimization Chapter 6 illustrates a case study to determine the capability ofcorporate growth regarding internal financing by means of the SFGR

Chapter 3

Strengthening Internal Financing Power Using Cash-to-Cash Cycle Optimization

3.1 Presentation of the Cash-to-Cash Cycle

The importance of working capital for a company’s success has long been known.Thus, Lough wrote more than 90 years ago:

“Sufficient working capital must be provided in order to take care of the normal process of purchasing raw materials and supplies, turning out finished products, selling the products, and waiting for payments to be made If the original estimates of working capital are insuf- ficient, some emergency measures must be resorted to or the business will come to a dead stop.” 1

An increase in corporate value through revenue increases, cost reductions or a tion in the period of time of tied-up capital results in a better chance of receivingoutside financing and strengthening internal financing power Yet, many companieseven today still ignore the active control of working capital through a manage-ment approach Working capital management deals with problems arising from theplanning, steering and control of short-term working capital and the liabilities andinterrelations existing between them.2

reduc-An essential ratio in working capital management is that of net working capital.This is understood as the difference between working capital and short-term liabil-ities (Fig.3.1) Working capital includes those things that are not intended to bepermanently used for the business operation and comprises inventories, receivablesand other assets, securities and liquid funds Short-term liabilities are obligationsthat are paid within 1 year This includes short-term financial liabilities, accountspayable, short-term reserves and other short-term liabilities Thus, a positive networking capital has one part of the working capital financed with long-term avail-able capital A negative net working capital means that one part of fixed assets isfinanced with short-term available capital

Aside from the absolute ratio of net working capital, the cash-to-cash cycle cept (also called the cash conversion cycle concept) presents one possibility for

con-1 Cf Lough ( 1917 , p 355).

2 Cf Smith ( 1974 , p 4 et seq.).

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Short-term outside capital Short-term financial liabilities Accounts payable

Short-term reserves Other short-term liabilities

Fig 3.1 Net working capital on the balance sheet

measuring and controlling the effectiveness of working capital management onthe basis of relative ratios The cash-to-cash cycle comprises the period of timefrom payment outflow for resources to suppliers up to payment inflow for finishedproducts from customers (Fig.3.2)

The cash-to-cash cycle time is the essential ratio of the cash-to-cash cycle cept Stewart defined the cash-to-cash cycle time as a ratio explaining the averagetime necessary to convert one dollar invested in raw materials into one dollarreceived from the customer.3For service companies, this is the period between pay-ments for resources consumed while rendering a service until the receipt of thecustomer’s payment for this service.4 As opposed to the OCC time, a calculation

Sales of Finished Products

Payment Receipt from Customer

Days Sales Outstanding

Cash-to-Cash Cycle Time

Days Inventory Held

Fig 3.2 Cash-to-cash cycle time based on the flows of goods and payments

3 Cf Stewart ( 1995 , p 43).

4 Cf Supply-Chain Council ( 2006 , p 22).

3.1 Presentation of the Cash-to-Cash Cycle 15

of the cash-to-cash cycle time also takes into account – aside from the DIH andDSO – the days payables outstanding (age of accounts payable, DPO) Thecash-to-cash cycle time results as follows:

C2C [d] DPO [d]

DSO [d]

DIH [d]

Sector of the Industry

82 57

11

65 46

18

31 24

10

66 54

21

36 52

5

50 60

18

51 58

24

51 67

16

44 76

1

33 62

6

43 15

67

60 68

50

52 57

56

40 46

56

46 48

67

46 52

72

57 66

73

56 72

67

46 63

66

54 77

76

49 61

87

40 62

77

43 60

85

48 59

95

41 68

102

33 42

134

50 59

54

Fig 3.3 Cash-to-cash cycle times in 2005 by industry sector (cf Hofmann2010 , p 249 et seq.)

DPO measures the time interval from the receipt of resources until payment outflow

to the supplier and is calculated from the accounts payable as well as the cost ofgoods sold:

DPO [d] = Accounts Payable

Similar to the calculation of DIH, net sales are used as the basis of DPO if cost

of goods sold are unknown From the point of view of the individual company, thehighest possible value of DPO should be aimed for in contrast to DIH and DSObecause of the financing function of the accounts payable By utilizing the period oftime from the receipt of goods until payment outflow, the operative business presents

a source of short-term financing.5However, the utility of the financing function isalso confronted with costs that primarily depend on the length of the credit anddiscount period

Figure3.3presents the results of a study investigating cash-to-cash cycle timesfor various industry sectors Telephone companies and those in the travel and leisureindustries have the shortest cash-to-cash cycle times primarily because of their lowages of their inventories By contrast, pharmaceuticals and biotechnology, spacetechnology and defense, as well as the tobacco industry have, on average, the longestcash-to-cash cycle times because of the high ages of their inventories

3.2 Influence of the Cash-to-Cash Cycle on Corporate Value

The following section presents the influence of the cash-to-cash cycle on corporatevalue (Fig.3.4) With unchanged cost of goods sold and net sales, a reduction inDIH and DSO can be realized by reducing inventory and receivables, whereas theDPO will increase because of an increase in liabilities These measures result in areduction in net working capital Moreover, fixed assets can be reduced by indirecteffects, such as the possibility of reducing storage areas or warehouse space because

of lower inventories These two effects cause a reduction in the necessary net ating assets, which – at an unchanged capital cost rate – results in the reduction of acompany’s capital costs On the side of the operating result, cost of goods sold can

oper-be minimized by means of additional indirect effects, such as lower inventory ing costs through lower inventories and improved discount drawing rates because ofhigher liquidity Administrative expenditures can also be reduced through optimizedsupplier and ordering management These indirect effects bring about an increase

carry-in the operatcarry-ing result Thus, the economic value added (EVA) as a measure of thecorporate value can be increased not only by improving the operating result but also

by a reduction in capital costs and also has the consequence of increasing internalfinancing power

5 Cf Schall and Haley ( 1991 , p 696).

3.3 Possibilities for the Optimization of the Cash-to-Cash Cycle 17

Fig 3.4 Influence of the cash-to-cash cycle time on corporate value

Furthermore, empirical studies have substantiated the positive connectionbetween a shortening of the cash-to-cash cycle time and the earning power ofenterprises.6

3.3 Possibilities for the Optimization of the Cash-to-Cash Cycle from the Corporate Viewpoint

For the optimization of the cash-to-cash cycle, the following demonstrates a fewpossibilities that can be especially influenced by the procurement department of acompany It is here differentiated between the order-to-cash process, the forecast-to-fulfill process, the purchase-to-pay process and the credit-to-interest process(Fig.3.5)

The order-to-cash process comprises credit assessment, contract design, billing,payment handling, dunning and collection systems, as well as information pro-cessing The cash-to-cash cycle time can be shortened by a reduction in accountsreceivable This objective can be achieved, for example, by the following measures:

6 Cf Deloof ( 2003 , p 573 et seq.) or Garcia-Teruel and Martinez-Solano ( 2007 , p 164).

Receivables Cash

Sales on Credit (Order)

Value Generation

on Target

Sales

on Target

Bank Loan (Additional Cash)

Payback

of Loan (Payment

of Interests) = Order-to-Cash Cycle

= Forecast-to-Fulfill Cycle

= Purchase-to-Pay Cycle

= Credit-to-Interest Cycle

Make Plan

Deliver Source

Financial Services Provider/ Bank

Fig 3.5 Management processes of the cash-to-cash cycle

• Acceleration of the billing process, e.g by e-billing.7

• Implementation of a consistent dunning and collection system strategy.8

• Sale of receivables via factoring to a financial services provider.9

• Use of instruments to avoid losses of receivables outstanding – e.g operatorinformation, advance payments, risk-minimizing payment terms, etc.10

• Granting discounts for a reduction in the times allowed for payment and thedelinquent payment risk.11

However, the influence by a company’s procurement department on the cash process is rather low because of a lack of interfaces

order-to-7 Cf Seuring and Goldbach ( 2002 , p 171).

8 Cf Nicholas et al ( 2000 , p 237 et seq.).

9 Cf Soufani ( 2002 , p 21 et seq.).

10 Cf Leijdekker ( 2002 , p 25 et seq.).

11 Cf Ouyang et al ( 2005 , p 290 et seq.).

3.3 Possibilities for the Optimization of the Cash-to-Cash Cycle 19The forecast-to-fulfill process comprises procedures of production and inven-tory management, as well as materials requirements and ordering quantity planning.Possibilities for a reduction in inventory include:

• Outsourcing: Fixed assets and working capital can be reduced by passing on tasks

to third-party companies.12

• Vendor-managed inventory: The supplier takes care of the management and trol of the procuring company’s stock Through close ties with the supplier interms of information, the bullwhip effect13 can be eased and inventory can bereduced.14

con-• Just-in-time: Delivering the goods at the right time, in the right quantity, to theright location will bring about a synchronization of supply and consumption withthe consequence of inventory reductions.15

• Cross docking: Cross docking is the transshipment of goods in distribution tems without intermediate storage to shorten throughput times and avoid storagecosts.16

sys-• Optimization of materials requirements planning and order quantities planningfor inventory reduction, e.g by reviewing and adjusting safety stock levels.17

• Optimization of inventory management, e.g by reducing warehouse levels aswell as the variety of parts and variants.18

The purchase-to-pay process comprises all procedures within the context of thecreditor management, i.e the process between purchase and the payment of thesupplier Possible measures for expanding liabilities include:

• Optimization or standardization of payment processes: Avoiding payments madeeither too early or too late

• Optimization of payment terms: Renegotiation of payment terms and Incotermswith existing suppliers and preparation of guidelines for new suppliers as well aspreventing down payments Figure3.6presents the average times allowed for thepayment and receipt of accounts receivable in Germany.19

12 Cf Tayles and Drury ( 2001 , p 605 et seq.).

13 The bullwhip effect describes fluctuations in stocks of order quantities along a distribution chain Reasons for it might be planning uncertainties and lack of information about downstream levels concerning actual demand (cf Lee et al 1997 , p 546 et seq.).

14 Cf Arora et al ( 2010 , p 39).

15 Cf Hutchins ( 1999 , p 6 et seq.).

16 Cf Apte and Viswanathan ( 2000 , p 291 et seq.).

17 Cf Kelle and Silver ( 2006 , p 725 et seq.).

18 Cf Schwartz et al ( 2006 , p 1311 et seq.).

19 Cf Morgan ( 2004 , p 13 et seq.).

Private customers B-2-C

Business customers B-2-B

Fig 3.6 Average times allowed for the payment and receipt of accounts receivable in Germany in

2009 (cf Intrum Justitia 2009 , p 20)

• Avoidance of early deliveries or use of contract clauses so that early deliverieshave no effect on payment terms; i.e they would be handled as if they had beendelivered at the stipulated date

• Cooperation from internal and external buyers to strengthen negotiating power.20

The credit-to-interest process comprises the steps of liquidity forecast, risk agement, administration of payment flows and investment of surplus funds Afew examples such as cash pooling and netting (Sect 5.4) and reverse factoring(Sect 5.2.1) will be discussed later

man-3.4 Interdependencies of the Cash-to-Cash Cycle from a Supply Chain Viewpoint

The reduction in the cash-to-cash cycle of a focal company has consequences forthe upstream and downstream companies in the supply chain A reduction of DSOresults in a reduction of DPO of the customers, and an increase in DPO results in anincrease in DSO of the suppliers Thus, a reduction in the cash-to-cash cycle time bymeans of the optimization of DSO and DPO implies an increase in the cash-to-cashcycle time of the upstream and downstream companies in the supply chain Thisphenomenon is known as the “zero sum game”

This disadvantage can be balanced out by a cross-company optimization of thecash-to-cash cycle Within the scope of “collaborative cash-to-cash management”presented inSect 5.3, different inventory carrying costs and capital cost rates withinthe supply chain can be used to minimize total costs Before addressing the issuefrom an inter-organizational perspective, the following section discusses concretemeasures for strengthening internal financing power from a corporate viewpoint

20 Cf Schotanus et al ( 2005 , p 135 et seq.).

to a study by Creditreform in 2004, almost every fifth insolvency can be traced back

to financial errors.1Depending on the industrial sectors, it would actually be ble to reduce tied-up capital by 25–40%.2To realize this objective, we must take acloser look at the management of payment terms (Sect 4.1), inventory management(Sect 4.2) and the management of product groups and suppliers (Sect 4.3)

possi-4.1 Management of Payment Terms

The objective of the management of payment terms is to optimize the interactingparameters of liquidity increases and cost savings Payment terms essentially resultfrom the ratios of discount rate, discount period and net days The discount rateindicates the percentage of price reduction granted by the supplier on the invoiceamount for goods or services if the invoice amount is paid within a defined period

of time.3The discount period describes the period of time between the delivery ofthe goods and the deadline up to which the invoice can be paid after the deduction

of the discount rate After the expiration of the discount period, the period of time ofthe supplier credit begins (net days), which ends with the time allowed for payment(Fig.4.1)

From the viewpoint of an individual company, any increase in discount rates

or expansion of the time allowed for payment (discount period and net days)principally has a positive effect on liquidity The discount ratio, which is defined

as the quotient of the sum of the discounts granted and the net purchase

1 Cf Verband der Vereine Creditreform e.V ( 2004 , p 18).

2 Cf Löwer ( 2010 ).

3 Cf Lauer ( 1998 , p 59).

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Fig 4.1 Functional significance of payment terms

volume, here indicates the average discount rate granted, as shown in formulas 1and 2:

Discount ratio = Sum of discounts granted

Net purchase volume = (Net price rebates) · Quantity (2)

To be able to present the actual utilization of the discounts granted, the discount lization ratio is determined This is the ratio between discount yields and discountsgranted Discount yields are generally recorded by bookkeeping upon the payment

uti-of the invoice and are allocated to the goods expenditure account

Discount utilization ratio=Sum of the discount amount

Sum of discounts granted · 100%

Discount ratio · Net purchase volume· 100%

(3)

The following example shows the calculation of the discount utilization ratio At

a discount rate of 2% and a net purchasing volume of 10 million C, the sumtotal of discounts granted is 200,000 C Since the actual discount yields are only120,000 C, a discount utilization ratio of 60% results

Example:

Discount rate = 2%

Net purchasing volume = 10,000,000 C

Sum total of discount yield = 120,000 C

Discount utilization ratio= 120, 000

0.02· 10, 000, 000· 100% = 60%

To strengthen internal financing power, from a corporate viewpoint, the aim is toincrease the discount utilization ratio and the discount rates Moreover, an extension

4.1 Management of Payment Terms 23

Fig 4.2 Process overview of the optimization of payment terms from a buyer’s viewpoint

of the times allowed for payment versus the supplier results in a reduction of thetied-up capital time and, consequently, a reduction in tied-up capital costs The pay-ment terms agreed with the supplier here form the basis of these parameters Theoptimization of payment terms is an extensive process which, because of its com-plexity, requires a structured and planned procedure Figure4.2shows the individualsteps of the optimization process of payment terms

In larger companies or in group companies with several business units, it must beclarified at the beginning of the process which subsidiaries or branch establishmentsare to be included in the optimization The first step includes the collection of allrelevant information for an evaluation of the status quo (Fig.4.3) That informationcomprises:

• Ordering data to indicate at which conditions goods have been ordered from thesupplier

• Data on the receipt of goods to show at which payment terms the delivered goodshave been invoiced

• Creditor master data to explain the stipulated payment terms for every supplier

• Accounting data to show within which periods of time and at which termsinvoices were actually paid

Divergent data regarding payment terms for deliveries and suppliers can be verified

by a comparison of the different sources of data, Consolidating the data sources anddetermining the actual condition via the parameters “used frequently” or “maximumcondition” can also help obtain a better overview The objective is to establish adatabase that specifies for each supplier one payment term as the starting point

Fig 4.3 Optimization process of payment handling – actual analysis of payment terms

Fig 4.4 Consideration of the

market power of supplying

and buying parties

Based on a verified database, a detailed analysis of terms on a product group levelcan be subsequently performed by showing benchmarking potentials

The times allowed for payment and discount rates are structured depending onthe negotiating power of buying and selling companies Relative to specific productgroups, one’s own market position can be assessed first and thereafter the supplier’sposition in the market Figure4.4shows which combinations can result within thescope of the offer/demand power matrix.4

Offer and demand power essentially depends on the product group being cured, as well as on the offered or demanded volume The presented examples (I toV) typically show that, in procurement volume, different product groups exist thatcan have different characteristics depending on the company:

pro-I Low demand power versus very high offering power by the supplier: Oneexample for this is the purchase of products protected under patent law

II Low demand power versus medium offering power: This case is typical for thepurchase of computer processors from an oligopolist

III Low offer and low demand power: Product groups with a small share in purchasevolume and for which the demand power is low One example for this is theprocurement of office materials

IV Medium demand and low offering power: This situation is based on III, withbuyers building up large demand power by bunching volumes versus polypolists.One example for this is the procurement of energy through buyer cooperation

V High demand and low offering power: This combination represents ity” products, such as packaging materials for which numerous sellers are on themarket and the buyer’s negotiating power is high

“commod-4 Cf Cox et al ( 2000 , p 18).

4.1 Management of Payment Terms 25

To establish market power constellations, the prevailing power relationships aredefined specifically for every company and determined individually for every singlesupplier or customer Accordingly, no generally valid presentation can be providedbecause of the different framework conditions

The multitude of prevailing payment terms is another factor influencing mization potential Any large, unsystematic and little regulated multitude ofdifferent payment terms indicates a relatively low degree of professionalism inpurchasing However, this problem is frequently underestimated by purchasingdepartments The use of ratios, therefore, is indispensable for arriving at an objec-tive evaluation In practice, the average number of payment terms per supplier orthe number of suppliers of the company with more than one payment term is con-sidered Special attention is paid to the different payment terms of own locations orbusiness units if the same products are procured from the same supplier Also, it iscommon that suppliers take advantage of the customer’s weaknesses in informationtransparency and organization A classification within the scope of a matrix of timeallowed for payment/discount rate is expedient per product group or supplier group(Fig.4.5):

opti-I For every creditor, only one payment term is allocated in the creditor masterdata This case represents the ideal condition to be aimed for

II Many discount rates are faced with a few number of payment times allowed Forinstance, four different discount rates are considered too many The number ofdiscount rates should be reduced to counteract this

III A moderate number of discount rates but a multitude of different times allowedfor payment This case stands for product groups where suppliers are billed atone discount rate, but where a great many discount due dates and times allowedfor payment exist This is mostly a result of supplier relations that have existed

Fig 4.5 The multitude of

payment terms

for a long time but whose payment terms were renegotiated in a disorganizedmanner In those cases, the creditor master data were updated only rarely or not

at all

IV Since several payment terms are deposited for one creditor who is billed viadifferent payment terms, we call such a case the classical “wild spread growth”.This situation frequently arises in so-called “maverick buying” where goods orservices are procured by other departments without calling in the purchasingdepartment.5This is the opposite of a well-organized payment terms structureand is frequently found with decentralized purchasing organizations

Another objective of the analysis is to identify the critical suppliers and criticalproduct groups that are not being taken into account because of bad cost/benefitratios This can concern product groups, for example, for which it is unusual todraw on a discount or grant long payment times Indicators for the identification of

these product groups are, inter alia, high personnel intensity or services having a

fee character Examples of product groups not to be considered further under theaspect of payment terms are rental fees for buildings, insurances or security guardservices

In general it is not possible to optimize payment terms if suppliers have acustomer–supplier–customer relationship6(counter-trade transactions), if there hasbeen a valid framework agreement for many years or if specific framework con-ditions preclude any modification Such framework conditions exist frequentlybecause of the supplier’s great market power Examples are suppliers acting asmonopolists or oligopolists and suppliers of key products It is also rarely success-ful to realize subsequent improvements in payment terms with suppliers involvedlong-term in capital-intensive R&D projects

As a rule, optimization is potentially possible if the character of the materialgroup includes a discount affinity the negotiation power is considered adequate andorganizational strength on the supplier side is inadequate To identify all relevantsuppliers for this project step, an ABC classification of them is necessary based ontheir purchase volumes This has the objective of ensuring an adequate cost/benefitratio of the measures Protracted negotiations are not worthwhile for C-suppliers;however, for A-suppliers, successful negotiations have the greatest leverage effect

on liquidity and earnings

After critical suppliers and product groups offering no optimization potentialhave been excluded after the analysis phase, the next step is to identify the rele-vant cases within the scope of a “payment terms strategy” (Fig.4.6) One standardpayment term can be specified for every product group – based on the informa-tion of the creditor master data and the analysis described Two important itemsmust be taken into account in the definition of this payment term On the one hand,the time from the receipt of invoice to its entry in accounting must be internally

5 Cf Karjalainen et al ( 2009 , p 245 et seq.).

6 Cf Lecraw ( 1989 , p 47 et seq.).

4.1 Management of Payment Terms 27

Fig 4.6 Optimization process of payment handling – strategy definition

recorded This period of time can be several days since an invoice passes throughseveral departments during processing and there can also be subsequent approvalprocesses It would be inefficient to agree on payment terms with suppliers thatthen cannot be utilized because of internal delays at the company On the otherhand, the executive officers as the decision-makers must determine which strat-egy is to be pursued in coming years through an optimization of payment terms

Is an increase in the discount sum favored or a later outflow of liquid means?The introduction of an increase in discount rates will limit the possibilities forexpanding the time allowed for payment If the same goods are procured fromdifferent sectors (e.g mechanical engineering and logistics services), it is possiblethat the payment terms cannot be adjusted to the standard, because of their speci-ficity for an industrial sector In this case, strategies are to be formulated at theproduct group level since the new payment terms have long-term validity and theproject is sustained by taking all framework conditions into account for the strategydefinition

A success factor of the optimization process is that the aimed new payment

terms are laid down in writing in the “Allgemeine Geschäftsbedingungen” (General Standard Terms and Conditions) and the “Allgemeine Einkaufsbedingungen” (AEB – General Terms and Conditions of Purchasing) Moreover, all internally

involved employees should be adequately informed to ensure coordinated action orappearance on the procurement market In the strategy phase, workshops can also beorganized with the relevant departments (purchasing, controlling, accounting, legal,etc.) to discuss in advance any implementation barriers and increase the acceptance

of the new payment terms within the company

The following optimization step is devoted to a written contact with the supplier(Fig.4.7) All identified A-, B- and C-suppliers are contacted and asked to confirmthe new payment terms For cost/benefit aspects, a standard covering letter is formu-lated, which is modified for every product group according to the newly requestedpayment terms Suppliers with previously agreed payment terms should not be con-tacted is these terms are equivalent or more advantageous than those requested.The procedure for the covering letter should be according to the plausibility testpresented in Fig.4.8to exclude non-relevant suppliers from the process

Fig 4.7 Optimization process of payment handling – making contact

Fig 4.8 Steps of the plausibility test to release the covering letter to suppliers within the scope of

payment terms optimization

Suppliers’ answers to the covering letter are recorded in tabular form for sis Standardized reminders are sent to suppliers exceeding the advised period foranswering If an answer again fails to come within the set period of time or if thenew payment term was not accepted, the next level in the escalation process is used

analy-As a rule, there is no further escalating step for C-suppliers because of the lowcost/benefit ratio Figure4.9shows a standard escalation process, which can varydepending on management specifications