There are four main objectives in business: to produce a product or service, sell it, obtain payment for it and make a profit. Business managers are always looking for improved methods of delivering these goals.
Outsourcing can address one or all of these corporate objectives, but here we focus on obtaining payment. While companies often harbour fears about sub-contracting customer collections to outsiders, in reality there is no reason why most should not benefit from this type of specialist financial service.
The potential advantages are obvious. They include immediate expertise upon which you can draw, a way to combat the late payment habits of customers, and an improvement to your cash flow. But you need to approach the idea with a degree of caution. There are several key questions to consider when deciding whether outsourcing part or all of the sales ledger collection function will be appropriate for your business.
Using a third party – the options:
You have a number of choices when it comes to outsourcing your receivables management operations.
Credit assessment
When a company takes on new clients, it is faced with a decision about whether to extend them trade credit and if so, what amount. Credit reference agencies closely monitor the profile of millions of companies and have gathered statistical data over many years. As a result, they have developed efficient computer credit scoring systems, which can generally be relied upon to assist companies trading both in the UK and internationally.
Employing a credit information service is a sensible precaution. It will alert you to your customers’ payment history, and help you to make a decision about the risk of extending credit.
Risk management
Many finance managers feel that they have experience in minimising bad debt, and often self-insure by putting aside a percentage of their annual turnover ‘just in case’. However, this is an area in which problems crop up. Trade credit insurance helps to protect businesses against bad debt arising from the insolvency or protracted default of customers, thereby lowering the risk of offering credit.
Cash generation
Payment collection is an administrative burden for many companies. You can easily outsource it without necessarily surrendering control of your sales ledger. For example, you could use a collection company to chase the small accounts which characteristically represent a small proportion of sales turnover, leaving your in-house credit control staff to deal with more significant accounts.
Nor does outsourcing collections have to be a permanent arrangement. You can employ a temporary outsourcing partner to help maximise cash flow during critical periods, heavy workloads, or holiday time. It can be particularly useful where, for example, your company has undergone major structural or organisational change, or has to deal with seasonal peaks in its sales cycle.
Dealing with overseas customers can present particular problems. It often makes sense to outsource the collection of overseas debts to a specialist company with personnel who speak many languages and who are used to dealing with the differing cultural requirements of debt collection outside the UK or Europe.
In some instances, where cash flow is tight, factoring may be the answer. About 25,000 UK businesses currently sell their invoices to a factoring service. In the case of non-recourse factoring, this means that the factor also chases late payments. However, such services are generally expensive, and can cost up to 4% of company turnover.
Total receivables outsourcing
Here, the entire order-to-cash cycle is contracted to an outside partner, who handles credit information, credit decisions, debt collection and credit insurance. Software systems are available to allow you to monitor activity on your ledger and receive regular progress reports. Both start-ups and large international companies may decide to outsource the sales ledger management function in order to concentrate on their core competency.
Managing the risks
Choosing to outsource all or part of your credit management operation is self-evidently not simply a matter of choosing a supplier and leaving them to it. A recent research study found that a quarter of organisations experienced serious problems in IT outsourcing. In the financial sector, the risk is magnified - the sums involved can represent the difference between profit and loss, or even between survival and failure. However, if you are aware of the pitfalls and manage your relationship with your outsourcing partner, there is no reason why you should not profit from your decision to outsource.
Reaping the rewards
Having decided upon what level of outsourcing is appropriate, and planned steps to mitigate the risks, you are free to assess the possible rewards of employing an outsourcing partner.
Improved cash flow
Resources sufficient to collect all invoice payments on time will have the greatest positive impact on cash flow within your business. However, it may be somewhat naïve to expect customers to meet their obligations unprompted, so a more realistic goal might be better prioritisation of collections efforts and shortening of the collection cycle.
Employing outside expertise can be expected to improve cash flow if in-house receivables management has been unable to reduce the debtor-sales ratio. If credit control is not already a dedicated in-house function, handled by appropriately trained personnel, or if staff turnover is high (it can take a new collector between 3-6 months to become fully proficient), it may be wise to consider outsourcing.
Reducing overheads
It would be a mistake to see outsourcing as just a way of offloading staff expenses. although it does represent an opportunity to reduce the overheads associated with directly employed personnel. It will have a further impact on indirect costs, such as the recruitment and training of new collectors and also on the management costs associated with staffing. Combining collections management with credit assessment and insurance will streamline the credit management process and reduce trading risk.
Customer care:
Customer satisfaction is, of course, a high priority for all businesses. In order to preserve good client relationships for ‘that next order’, many suppliers are nervous of chasing late payment too assiduously. A good outsourcing partner should be able to develop relationships with company debtors at an early stage so that disputes or payment problems have a better chance of being resolved promptly, rather than simply resulting in protracted inaction, which may damage business relationships.
As increasing numbers of businesses are now discovering, there is no real substitute for professionalism. Outsourcing receivables management should not therefore be dismissed as an act of desperation by a company which is incapable of managing its sales ledger. On the contrary, if approached and managed from a position of strength, outsourcing will improve cash flow and encourage a clear focus on customers and core competencies. Further, as a demonstration of sound financial management, it can often prove a positive influence in obtaining external funding for investment in growth.
The absolute minimum goal for any outsourcing project is that it should pay for itself through cost savings or improved cash flow. Beyond this, the rewards can be a more efficient and revitalised business.
COUNTRY RISK TRENDS
Amid signs of a slowdown since the beginning of 2001, both the impact of the 11 September attacks and publication of worse-than-expected results for the first three quarters, marked the end of 2001, said Coface’s January 2002 newsletter on country risk trends . Between September and December, IMF world growth forecasts fell from 2.6% to 2.4% for 2001 and from 3.5% to 2.4% for 2002.
The main uncertainties associated with those forecasts are:
The worldwide payment default rate recorded by Coface La Défense has risen 18% since the beginning of 2001 and 5.7% since September last year.
The newsletter says that signs of a slowdown are increasing in Europe, while the stability pact limits the room for manoeuvre in bolstering economic activity. Germany recorded the region’s weakest growth rate in 2001 and forecasts for 2002 are no brighter. In France, economic activity has clearly decelerated. UK, industry has to deal with a strong pound, which causes a lack of competitiveness.
The simultaneous slowdown across all industrial countries has a major impact on emerging countries in terms of decline in foreign trade, financial markets’ wariness, fall in raw material prices and decline in tourism.
KEY RISK MANAGEMENT CONSIDERATIONS
Flexibility and control Avoid restrictive long-term contracts, which limit your room for manoeuvre as circumstances change, for example, if an important customer goes elsewhere. Beware of what initially seems to be a favourable deal. It may be that the outsourcing partner has sought to boost growth in this way and may, as time goes by, shift its resources to more profitable clients, or even attempt to re-interpret the original contract terms. In either case, you will no longer be in full control of what is being done on your behalf.
As a general rule, do not bind your own hands. Be aware of what is in the contract and maintain regular contact with your partner to ensure it understands and agrees with what is expected. Most important of all, set project goals, measure success and be ready to adjust tactics to improve results.
Caveat emptor The decision to entrust collections management to an outside company cannot be taken lightly. Should your partner fail to meet expectations, they will only lose a customer. The main victim will be their client - your company.
As with any business supplier, you need to be satisfied that your partner has committed enough resources and expertise to your account. Visit the premises and talk to the people who will be handling day-to-day management. Ensure there is appropriate quality certification, such as membership of the Credit Services Association (CSA). Decide if the collections will be made in your name or theirs, and at what point in the process the agency takes over the task. If a client defaults, what steps will be taken to recover the money? For example, well-established contacts with the debtor will almost always yield better results than a simple demand letter.
In-house expertise It is tempting to view outsourcing as an opportunity to reduce fixed costs such as credit management staff. However, it is important not to see employing an outside agency purely as an exercise in retrenchment. Immediately dispensing with the services of existing in-house expertise may be a costly mistake if the agency fails to meet expectations. Moreover, you have a better opportunity to develop a good working relationship with your outsourcing partner, if you have a mature manager, with some knowledge of the subject, overseeing day-to-day contact.
