Payment delays caused by invoice discrepancies can increase past-due accounts receivable and act as a substantial drag on corporate cash flow. Even companies that have an exceptional product or service may not get paid because of billing errors. Inaccuracies in billing create self-inflicted wounds that degrade the quality of the organization’s receivables.
Fortunately, there are some straightforward actions that corporate treasury professionals can take to determine whether their company is leaving cash on the table. And for those who find a problem, there are clear-cut steps to tackle solving it.
Rooting out Problems with Billing Quality
Most customers withhold payment when an invoice contains a material discrepancy other than shipping charges or trivial differences in price or quantity. In these situations, there’s more at risk than the discrepant amount. Even when a dispute amounts to a small fraction of the total bill, companies commonly delay any payment, pending resolution of the dispute.
Such a delay can have a serious impact on the seller’s receivables. Contracts and purchase orders usually stipulate that the terms clock begins on receipt of a valid invoice. So until the customer receives a valid invoice—i.e., an invoice free from material discrepancies—the payment doesn’t even have an established due date. And although payment terms vary widely, some firms have insisted on extending their payables from the once-standard 30-day or 45-day terms to 60- or even 90-day terms. If the seller doesn’t detect billing issues until the payments are due, payment cycle times can double. For businesses starting at 90-day terms, billing errors may mean more than half a year passes between the customer’s receipt of the billed goods or services and the seller’s receipt of payment.
In addition to the potentially significant impact on corporate cash flow, ongoing billing problems can also decrease customer satisfaction and diminish the company’s standing as a supplier of choice. These six steps will help you to establish a baseline and assess whether this is a problem for your organization:
Begin by continuously tracking the percentage of invoices that require rework. This is a byproduct of the collections and cash application process; the data is available from the A/R system as unpaid invoices or unpaid residual balances. As a general rule, any error rate greater than 1 percent is a red flag, although for some businesses an error rate that is a fraction of 1 percent is too costly. The concentration of your receivables with a limited number of customers, and your volume of business, will help you determine the acceptable error rate for your unique A/R function.
Monitor the causes of each discrepancy or dispute, as well, including both paid and unpaid billings in your analysis. Extend the reason-coding methodology that your company likely already uses to explain deductions from payments to also label past-due open invoices. Past-due invoices and deductions often have the same root causes upstream from accounts receivable (A/R), so reporting both using the same reason codes casts a wider net and is more impactful when you’re building a case for the need to address internal billing problems.
The initial analysis should capture a range of potential root causes. Use the Pareto principle—also known as the 80/20 rule—to narrow the focus on the major causes. Order-entry errors, pricing errors, and incorrect purchase order numbers are a few common examples. One best practice is to select a baseline date, then create a bar chart in which the vertical axis represents the frequency of errors and the horizontal axis shows all the causes of errors, in declining order of frequency from left to right. Additional detail can be added using line overlays. The dollar value of the issues, and billing rework costs, can provide supplemental data support, if meaningful. Once you have identified the major causes, perform ongoing periodic (monthly or quarterly) charting of the major causes to look for positive or negative trends.
High-level A/R aging metrics, which are commonly communicated to management at a “reporting” level, lack granular detail that can reveal hidden collection and reconciliation problems. For example, 90-day net A/R can mask underlying complexity, and some balances may in fact be payables, not receivables.
Reclassifying credits to accounts payable, or otherwise removing credit balances from A/R for reporting purposes, provides more accurate and reliable aging statistics and may reveal the need for increased reserves or writeoffs. That’s because large unreconciled or unapplied credit balances that have aged into past-due territory can mask invoices that are past-due. Aged credits buried in the subledger are also subject to abandoned property claw-backs from tax jurisdictions and reimbursement claims from the customer’s auditors.
To uncover hidden receivables, segment all receivables by age. Then compare credit balances to debit balances within each segment, and track debit/invoice balances net of credits.
Although tracking DSO and/or average days to pay on a three-month average is a sensible approach, consider reporting these indicators month-to-month as well. This can help highlight issues more quickly and accelerate follow-up and resolution.
However often you monitor the metrics you choose to track, be sure to investigate even minor upticks in customers’ time to pay. Try to correlate changes you notice in receivables performance with other collection indicators. For example, you might compare DSO with best possible DSO, where best possible DSO is calculated in the same way as DSO, except that instead of using total accounts receivable times days in the period, the numerator would be current accounts receivable times days in the period. Subtracting best possible DSO from DSO results in the average days delinquent.
What to Do If You Have a Problem
Any company that has a problem with ongoing billing errors is relying on its customers to perform quality control for the customer order and billing function. Each time it sends an invoice, it is essentially asking the customer to look over the bill and report back if there are any errors. For both cash flow and customer service reasons, companies need to remedy this situation.
Whatever the cause of a billing issue, companies trying to reverse problems should focus on bringing their billing process as close as possible to zero defects. Treasury should determine whether the problems originate within the customer master file, or whether they stem from the order process. Either way, the credit and collections team probably already knows about them. But having a third-party entity like the treasury team take a look and suggest solutions provides support and amplifies the efforts of the collections team, which may help the company make progress on seemingly intractable problems.
One area for treasury managers to look at is the level of collaboration between the A/R team and upstream stakeholders like customer service and sales. Collections problems often stem from an internal disconnect in communication about contract terms. One best practice is to include a representative from the credit and collections organization in the company’s deal-making process, and to have the credit and collections team provide ongoing feedback on evolving contract language to help avoid contract terms that obligate the company to manage high-cost processes for which it doesn’t have appropriate resources.
As a third-party observer that is clearly invested in resolving the problem, treasury may be able to help A/R bridge such a gap. However, the root causes of collections problems can be deceptively challenging to resolve.
Framing proposals in a way that highlights the tie-in with both the cash impact and customer satisfaction can be effective, as this resonates well across all functions and levels. Overreliance on traditional indicators in communicating with stakeholders about collections issues can result in gaining an “accomplice” who may or may not truly appreciate the bottom-line benefit of the change you want to undertake. It makes more sense to move closer to true business partnership by helping your allies understand how much cash is represented by one day of DSO and how much more cash the company would have available if it reduced DSO. As stewards of the company’s cash and borrowing accounts, treasury can amplify this message.
Paradoxically, the extra time customers take to pay discrepant invoices can act as a deterrent to customer complaints. The sense of urgency is reduced while the payment is on hold, and the onus is on the supplier to research and resolve the matter. Billing issues have a tendency to hide well, and it sometimes takes a bit of teasing to surface them.
Deciding on your billing-quality objectives and where to put the bright line will focus the A/R function on operational excellence, helping the team deliver measurable financial returns and measurable customer satisfaction. Delight your customers by not making them wait to give you their money, and at the same time produce quicker cash to fuel your growth.
Pat Okonek, CCE, is a corporate credit professional and M&A specialist who has worked in the semiconductor, software/services, and data center hosting industries.