Cash Management

The Argument for Financial-Chain Management

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Why? The key factor is not the limitations of technology per se. More than enough information exchange and processing capability is in place to make radical improvements achievable. The real problem is a misalignment of power and focus, which makes the buyer side in business-to-business transactions — the side that has driven efficiencies in physical working capital — far less motivated to adopt the same mechanisms to attack financial working capital.

Put starkly, buyers hold the upper hand in almost any commercial relationship. Absent a monopoly, buyers have choices, sellers have competitors. Buyers have every motive to create rich information transparency — that is, clarity — between their own operations and those of their suppliers. To date, however, they have had no such motivation to create clarity at the level of accounts receivable/accounts payable interaction with their suppliers.

The reason is simple: Financial working capital is traditionally a zero-sum game. The seller has to finance his buyer about 90 percent of the time. There is more working capital finance in corporate balance sheets than in the banking system for the simple reason that from a buyer's perspective, it is free.

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Of course, it is not free. The seller's cost of financing receivables is an element of his cost of goods sold to the buyer. But that is not a cost that is visible in the buyer's accounting. His books look better to the degree his payables are larger and slower than his receivables. In fact, if aggressive enough, a firm can run on negative working capital, effectively financed by its suppliers and customers.

From a systemic perspective, the only winners in this game are the financial intermediaries who price and ration the working capital shortfall in the overall economy.

Total working capital management represents the extension of information logistics beyond the physical supply chain into the financial supply chain. It is the first difficult but vital step toward doing more business with less working capital.

Corporations Must Take the Initiative
The survey report "Electronic Payment Initiatives and the Internet," published in August 2000 by the Association for Financial Professionals, gives three top reasons, from the perspective of corporations, why business-to-business commerce is slow in adopting electronic settlement of transactions. First, electronic payments systems are not integrated with the accounting systems which hold the relevant AR/AP information. Second, integrated payments and remittance information cannot be sent and received. Third, linkages between payment and financing and risk management providers are either cumbersome or nonexistent.

In other words, it is easy to manage current cash positions and make electronic payments through the current treasury management services of banks, which are very good at what they do. These services, however, are not very useful for total working capital and risk management across the full purchase-to-pay cycle.

So, what can be done? The technology is now becoming available to streamline AR/AP processes, link the flow of funds to the flow of transaction data, and — by creating greater visibility to future cash flows — give businesses access to a wide array of financing options.

Corporations must create the kind of financial information logistics connectivity with their trading partners and suppliers that they have been achieving in the physical supply chain. Banks can be and must be valuable partners, but their key strengths are as trust agents, liquidity providers, and settlement executors. They simply do not have a deep understanding of the purchase-to-pay cycle as their corporate customers live it.

Corporations themselves must take the initiative to do the following three things:

• First, implement new Web-based solutions that link accounts payable/accounts receivable systems and payment systems, both within and between firms. The proven techniques for doing this already exists in the financial economy. Wholesale financial markets handle cash settlement using value-dated, pre-reconciled (that is, sum certain/date certain) payment instructions that have been confirmed between the parties after the trade but before the due date. This saves vast amounts of reconciliation and dispute resolution cost, as well as cash liquidity. The same degree of collaboration between buyers and sellers in the real economy is possible at a minuscule fraction of the investments made by the financial economy players by using the Internet.
• Second, apply Internet technology to overlay a data-rich information flow on top of narrow bandwidth EFT flows. Corporate remittance detail is complex; so are invoice disputes and adjustments. The bandwidth, connectivity, and interactive nature of the Internet make it perfect for collaborative commerce. It is far less suitable for high-value payments. The bank EFT system is actually very efficient at what it does, which is moving debits and credits between bank accounts with minimal data. Payment and remittance data can be integrated through efficient information logistics without having to travel together through the same channels.
• Third, leverage connectivity and data availability to improve trade terms, risk management, and financing. Today, sellers are almost always involuntarily bankers for their customers. They, in turn, need to finance their working capital largely on the strength of their current balance sheet and historical cash flow. If trading partners can achieve clarity and transparency about future cash settlements between themselves, they lower credit risk to bankers and other providers of working capital.

The goal toward which corporations should be heading is global working capital optimization. This represents a significant step beyond simply managing working capital more effectively. It really does mean, Do more business with less working capital.

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