The arrival of the coronavirus prompted the Federal Reserve to effectively cut its benchmark rate to zero in March. Providing companies with liquidity, the Fed intended the cut to counter a likely economic slowdown that may drain many companies’ cash coffers. Consequently, the days sales outstanding (DSO) metric may regain prominence. Companies are likely to face new challenges in terms of collecting payments from customers, stretching DSO.

AFP’s latest Payments Guide, underwritten by MUFG, seeks to provide AFP members with insight into how their peers are managing DSO across different parts of the payment process.

LOCKBOXES EVOLVE

Collecting payments from customers is a component that tends to have a big impact on DSO, and it is an area they have little control over in terms of timing. Lockboxes, which collect a company’s payments in locations maintained by its bank, have for decades accelerated matching up payments with invoices and improved the flow of information between parties. While lockboxes can improve DSO, they have tended to be a costly option.

A plethora of vendors have stepped up over the years to provide companies with alternatives to lockboxes and other elements of the “order-to-cash” process, whether end-to-end solutions or those focusing on specific steps along the way. In turn, lockboxes have adapted. David Bochnovic, executive vice president of Phoenix-Hecht, which has measured the performance of individual banks’ lockboxes for upwards of 50 years, said that technology has enabled lockboxes to “morph” essentially into remittance hubs, whether for NACHA’s ACH with emailed invoices and other electronic payments or paper checks, or all of the above.

“The lockbox has become the consolidator of information that the company needs to update its receivables,” Bochnovic says.

According to Bochnovic, vendors have stepped up to provide technology that essentially allows companies to take part of the lockbox function in-house and integrate it with other steps in the payment process. For example, High Radius launched an on-premise, multi-module solution aimed at Fortune 1000 companies in 2006, when it began operations. It automates steps along the AR process, starting with the initial customer credit check and including cash application when incoming payments are matched with receivables invoices, deductions related to short payments, and collections.

In 2010, ahead of many competitors, High Radius moved the modules to the cloud, providing corporate customers with a more accessible software-as-a-service (SaaS) solution. It also reached agreements with several large banks, including Bank of America, Citibank and PNC, to update their lockbox solutions by white labeling the firm’s software, incorporating machine learning and other state-of-the-art technology.

Companies weigh the cost of using a third-party solution compared to performing the function in-house, and midsize and smaller companies often decide that the advantages of banks’ lockbox services outweigh the costs. Even large companies with significant resources may opt for third-party solutions, to avoid the often complicated and tedious chore of matching payments to invoices.

“When companies use lockboxes today, it’s more for outsourcing, because they have a large volume of small payments coming from smaller customers,” said Susan Hillman, a founding partner of consultancy Treasury Alliance. “There can be a lot of paper to process, so outsourcing it to a bank means the company doesn’t have to do it internally.”

In addition, the cost differential between performing the function in-house and using a third party has fallen. Bochnovic says the cost to process an item through lockboxes has changed negligibly over the last decade, “so there’s been downward pressure on pricing.”

DSO CONSIDERATIONS

Advancements in technology will likely make the payment process even more efficient, and that should enable companies to reduce DSO further, at least on the surface. Experts note that DSO is an imperfect metric that can be gamed by operational staff, and taking steps to lower DSO may have a negative impact elsewhere. Providing a discount to reduce DSO, for example, could end up costing the company more in absolute terms. 

In addition, companies may calculate DSO in very different ways, complicating comparisons with peers. For example, some companies may say the payment is due in 30 days, while others start the countdown at the end of the month and still others from the date of the invoice. In addition, she added, if the payment term is 30 days, customers receiving an invoice between the first and 15^th of the month often will pay it at the end of the month, and if the invoices arrives in the latter half, they’ll wait and pay it at end of the next month. That results in an average DSO of 45 days due to customer policies the company has little control over. Furthermore, said Hillman, standard terms differ from country to country.

This article is excerpted from AFP’s latest Payments Guide, Managing AR and Reducing DSO, available here.