Gianfranco Tabasso, a member of the EC’s experts group on e-invoicing and co-ordinator of CAST, stresses the importance of working capital management improvement programmes and its relationship with e-invoicing, and the automation of the financial supply chain (FSC).
When times are hard liquidity becomes the top priority for companies. Unfortunately, the current crisis in the capital markets and the shaky state of the banking system has made it harder to come by external sources of financing, such as capital and loans, and has increased costs.
With falling sales revenues, senior managers are increasingly looking for ways to free up cash within their companies such as delaying investments, cutting operating expenses and reducing working capital requirements.
Freeing up cash
Working capital management (WCM) is a CFO’s primary responsibility and the major source of internal financing, with corporations on both sides of the Atlantic operating with excess working capital, estimated in the order of €1,000bn.
“Companies that cut CC days improve their ROCE, showing up in the first quartile of C2C ranking in their industry.”
Working capital accounts roughly for 15% of sales and 20% of total capital employed. The appeal of focusing on working capital stretches beyond the balance sheet by positively affecting P&L. Effective management of working capital can also allow a one-off release of cash and ongoing cost benefits. Working capital management is therefore of strategic importance and a key driver for operational and financial performance and market valuations.
Improving the cash conversion cycle (C2C) is a key responsibility of CFOs and cash cycle (CC) days are the key indicators of WCM. There is a relation between good WCM and financial performance. Companies that cut CC days improve their ROCE, showing up in the first quartile of C2C ranking in their industry. For instance, according to Ernst & Young, between 2001 and 2005, 3M company managed to reduce CC days by 26%, and improved ROCE in the same period from 25% to 39%. BT cut C2C from 27 to 11 days and went from a negative ROCE in 2001 to 10% in 2005.
The potential of WC
Ernst & Young estimates that the leading 1,000 European companies have a €420bn ‘excess’ of working capital, or 18% total working capital. By implementing best practices they could see an annual cost reduction of €18bn. For these companies, realising the full working capital cash and cost potential would reduce debt by 33%, increase net profit by 8% and improve ROCE from 13.5% to 15.4%.
The same projection shows that these companies have a WC reduction potential of -47% (inventory -16%, A/R -15 %, A/P +24%). Comparable US companies have a -36% potential, having done some of the work already.
Improvement programmes tackle each component of WC and specialists and well-established methodologies can be used to reduce inventory, re-negotiate terms of trade with clients and suppliers, improve payments and collections, and improve conditions with banks.
Working capital and e-invoicing
You may be convinced of the importance of WCM improvement programmes but what is their relationship with e-invoicing and automation of the financial supply chain (FSC)?
FSC automation and e-invoicing are the most powerful tools to reduce working capital requirements, cut operating costs, increase quality of service, reduce operational risks, and improve relations with suppliers, customers, banks and other parties along the chain.
Unlike other methods for improving WC that usually end in a zero-sum game, dematerialisation, standardisation, and full integration of the links of the chain creates a win-win situation.
Corporate Action for Standards (CAST), an ongoing initiative of the European Association of Corporate Treasurers, estimates that if European companies switched from paper to electronic invoicing they would make annual savings of €243bn. Individual companies could reduce administrative process costs by as much as 80%.
A combination of e-invoicing and ‘reverse factoring’ could also cut financing delays by 37 days and reduce interest rates for suppliers.
Another area that is labour-intensive and prone to errors is automatic reconciliation of A/R with incoming payments. CAST studied a number of cases and found that possible improvements affected each component of the cycle, including sending, receiving, controlling and booking of an invoice, payment, remittance advice, reconciliation and booking of payment.
CAST recommended the use of new XML standards for the invoice, remittance advice and payment, improvements in ERP functionalities and more cooperation between the parties. The result is a higher degree of end to end straight-through processing (E2E STP) which benefits all parties.
Until recently, few CFOs thought of electronic invoicing, standards, the internet and FSC automation as strategic projects that demanded their attention and involvement. It was considered too technical, something to be left entirely to CIOs and IT managers. The evidence gathered by CAST in 2007-2008 shows how the presence of financial departments is still minimal in FSC automation projects.
But times are changing. A survey of German CFOs shows how e-invoicing ranks as the number one area for potential improvements. The study found:
- 76.4% of CFOs prefer an integrated solution for the financial supply chain to optimisation of single components because there is more potential in a harmonised approach
- 52% consider the interlocking of financial processes with customers and suppliers to be fundamental
- Although 25% of the IT budget is allocated to financial processes only 6% are content with their financial processes.
“Standards are primarily set by banks, ICT providers and consultants, all from the ’sell side’.
Setting standards
To work efficiently and operate at low cost, a ‘network economy’ needs commonly accepted standards. To obtain cooperation, the solution must benefit all participants in the chain, for example it should achieve E2E STP in communication and interfaces with internal procedures, which is possible only by adopting the same standards.
After years of confusion and dispersion, a ‘new world order’ is taking shape, with ISO and UN CEFACT recognised as the international standards in the business domain. Under the aegis of ISO 20022, a new family of XML standards has been developed over the last four years, covering the area of payments, invoicing, financing and securities.
Various standards organisations, covering single industries, are adopting XML and wish to register under the ISO label, which guarantees compatibility and acceptance. While this is fine in principle, there is a problem with the limited involvement of end-users in setting standards. Corporates and CFOs take standards for granted and few companies send their experts to organisations and working groups that evaluate and develop business standards. Standards are primarily set by banks, ICT providers and consultants, all from the ‘sell side’.
Another anomaly with standards is that, despite their importance, there is little or no money supporting their development. Experts have other jobs, their time for standards is limited. There is no money for field research and testing.
SWIFT is a notable exception. It employs experts, has a budget, pays expenses of working group members and has always tried to include corporates in its development process. But often, corporate response has been disappointing.
Therefore, CAST’s other major objective is to familiarise CFOs with the world of standards and commit them to support development work.
Standards organisations need corporate people to define business requirements, evaluate and test finished results. Corporates experts must sit at the same table as banks, ERP providers and standards experts to produce workable solutions. SEPA is the latest unfortunate example of standards decided by banks alone.
Tying it together
E-invoicing is the linchpin of the financial value chain because it starts the payment cycle, records monetary amounts in GL and provides VAT to governments.
Directive 2006/112/EC, amending Directive 2001/115/EC, currently rules VAT and e-invoicing but the EC has published a proposal of amendments and an expert group created by the commission is at work to provide a European e-invoicing framework to overcome barriers and provide incentives for faster growth of e-invoicing, particularly among SMEs.
What are the barriers and the problems of e-invoicing? The primary barrier is legal uncertainty in cross border e-invoicing. The VAT directive left too many options to member states and too much room for interpretation. The result is the existence of national legislations with differences that make it complex and expensive for a multinational and/or its service provider to be compliant in all the countries where it operates.
Today there is little interoperability between operators of different countries, because of competition, cost, complexity, and the risk of ‘loss of control’ when conferring a file to another intermediary who is not the final end-user.
Some of the differences and complexities concern the use of electronic signatures. The directive defines three systems for producing a valid electronic invoice: EDI, advanced electronic signature, and other means to prove authenticity and integrity. Most countries opted for electronic signature. The Nordic countries, the UK and a few others chose EDI and other means.
In the current directive, the concern of the legislator is data protection including proof of origin, authenticity and the integrity of the electronic document, from its creation to its archiving. The proposal changes all of this. Directives must be technology-neutral with no prescriptions but only high principles, a code of practice and best-practice guidelines. The basic principles are:
- equal legal treatment for paper and electronic invoices
- control in internal processes of companies is more important than data protection.
Electronic signature is allowed but no longer prescribed as a method for producing valid e-invoices.
To be approved and adopted by member states by the end of 2012, the new directive must be voted in unanimously by the European Council. National communities are starting to evaluate the proposal and its implications. Smooth sailing through the council is by no means guaranteed.
Source: www.the-financedirector.com
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