Presentation on theme: "Internal audit – Credit Evaluation and Collections Review."— Presentation transcript:
Internal audit – Credit Evaluation and Collections Review
2 Table of Contents Executive Summary 3 Objectives, Scope & Procedures Performed6 Background Information Credit12 Collections17 Appendices A: Best Practices20 B: Process Maps49 C: Benchmarking - Accounts Receivable Diagnostic Tool51 D: Automated Credit Software Package Cost Analysis65 E: Acknowledgments66
3 Internal audit conducted a review of Company As credit and collection processes in Month 20XX. The objective of this review was to obtain an understanding of the existing processes, assess the internal control environment, and identify opportunities for process improvements. In addition, we utilized Company XYZs knowledge base, which included best practices as well as a quantitative analysis in the form of standardized benchmarks within the processes reviewed. Internal audits intent in utilizing these resources was to provide the process owners with additional, value-added information. The Best Practices section provides numerous examples of opportunities where the credit and collections function could implement new processes and significantly improve controls and efficiencies. The Benchmark section contains cost, quality and time performance measures that compare Company A against best companies in Company XYZs database and also highlights additional opportunities for improvement. Further detail regarding scope, objectives and procedures performed can be found on page 6. Key issues identified during the review include: The overall purpose of the credit function and its relevance in the quote to cash process needs to be defined. The current process does not allow for a rigorous, standardized approach to the evaluation of credit prior to the shipment of product and execution of contracts. A detailed credit policy has not been formally developed to include credit limits and other key components. Procedures as well as performance metrics need to be developed and implemented for both the credit and collection processes. Many procedures are manual in nature due to less than adequate systems support. As a result, very few automated controls exist. The manual controls appear to be effective. Incentives for collectors should be reviewed and adjusted to ensure an appropriate level of visibility over all amounts to be collected. Performance measures should also be adjusted to evaluate effectiveness. Based on the benchmark results, an opportunity exists to improve the understanding and tracking of the cost and efficiency components of the two departments. These and other issues are listed in the two following pages with managements action plans to address and the expected timing to complete. Executive Summary
4 1. The overall purpose of the credit function and its relevance in the quote to cash process (strategy) is not well defined. Also, the application of the credit evaluation process is haphazard at times. For example, the credit analysis is often performed at a time when it is least beneficial to the company – after product has been shipped and the contract executed. These instances are generally management decisions. Management needs to define how the credit function is to fit into the quote to cash process. This will better serve the company in making informed decisions to accept/reject credit risk and manage exceptions. (See page 12.) 1. The credit function will work to better define the overall purpose, mission, goals and objectives of the function. Specifically, we will develop a rigorous, well-defined process to evaluate potential customers credit in a systematic way. This process will be communicated to stakeholders. All exceptions to the policy/process will be resolved through a formalized approval process and all exceptions to the policy/process will be documented. (Person A/Q3) 2. A credit policy with specifics relating to credit terms, credit limits and other key factors has yet to be formalized. Also, desk procedures are not yet documented. Performance measures should also be implemented to better manage/monitor the success of the credit function. (See page 13 for details.) 2. A Company A credit policy has been developed, but it has not yet been formalized/implemented. We will review, modify and implement as appropriate to ensure the companys policy on credit evaluation is clear and consistent. I n addition, desk procedures will be drafted to ensure consistency in the process and that knowledge is maintained within the company. Relevant measures and metrics will be identified and tracked regularly and included in the development of documented policies and procedures. (Person A/Q3) 3. The credit evaluation process is very manual in nature (time- consuming and inefficient), particularly the information-gathering process. Therefore, the credit manager has little time to impart expertise due to time needed to collect data. Also, business is growing at a rate that may not be supported by the current resources allocated to the credit team. (See page 14 for details.) 3. Credit is in the process of evaluating growth factors of the business to ensure proper resourced are allocated. Credit is also considering automating certain aspects of the credit evaluation process. A determination will be made in Q3 as to what the best approach will be. (Person A/Q3) 4. Company As current practice is to forego credit evaluations for deals under $100K. However, maintenance is excluded in the consideration. Deals are often less than $100K when maintenance is added. Company A should consider evaluating these deals, as the collection rates have traditionally been lower than higher (larger) visibility deals. (See page 15 for details.) 4. As part of the order management system implementation (ERP system 8.0), this will be addressed. We are evaluating various ways to ensure that all deals get some level of review. We should have a solution sometime in Q3. (Person A/Q3) 5. Currently, no systems solutions exist that allow for company-wide visibility of credit ratings for potential customers and/or credit limits and holds for those customers who have not paid or are over established credit limits. ( See page16 for details.) 5. ERP system 8.0 (in implementation phase) will allow credit limit inputs and reduce the need to review and approve orders for existing or repeat purchases. This will also reduce the number of duplicate credit reviews in the future. Once the database is populated, critical information for decision-making purposes will be available to all relevant parties. (Person A/Q3) 6. At the time of the review, there was a lack of a credit evaluations process for customers in EMEA. ( See page 16 for details.) 6. As of Q2 XX, a credit evaluation process has been implemented for EMEA customers following same guidelines as in the US. (Done) Issues/Observations Action to be Taken/In Progress Executive Summary – Credit Processes
5 1. The overall purpose, mission, goals and objectives of the collections function could be more well-defined and documented. These should be developed at the policy level. (See page 17 for details.) 1. The overall mission, purpose, goals and objectives will be included in the policy and procedures manual, which is currently in process and targeted for completion by Q4. (Person B/Person C, Q4) 2. Desk procedures have not been formalized and documented to ensure knowledge is maintained within the function. At the time of the review, collections processes had not been standardized for all collection agents. (See page 17 for details.) 2. Desk procedures will be drafted to include credit policies to ensure consistency in the implementation of decision-making methodologies. Processes will be standardized across the collections function. Relevant metrics will be identified and tracked regularly – see below. (Person B/Person C, Q3) 3. Develop and implement a robust set of metrics and measures to systematically evaluate performance of individual collections specialists as well as team performance. (See page 17 for details.) 3. Metrics and measures will be defined based on the quarterly corporate objectives. They will include individual metrics for each collection specialist in order to achieve more balanced results in the A/R aging, DSO and cash collection areas. (Person C/Person D, Q3) 4. At the time of the review, it appeared that visibility over $100K and increased collection efforts on individual balances under $100K were necessary. Significant efforts are underway to collect these balances. As of 5/2/01, there was an opportunity to collect a cumulative total of $33 million in outstanding receivables that are individually below $100K. (See page 18 for details.) 4. Increased collection efforts were initiated in Q2XX. Most of these low-dollar balances were related to professional services and are to be collected out of Location A. We have moved some of the collection efforts to Location A and set up a collection department specifically for Location A invoices, which will be closer to the billing and ordering functions related to the Location A – type revenues: professional services and education. The < $100K over 60 receivables are being collected by two temporary collectors who specialize in aged receivables and collections involving workouts. (Done) 5. Current incentives used to drive collection specialist behavior may not be in line with overall corporate objectives. These incentives should be evaluated, redefined and adjusted as necessary to ensure expected behavior is in line with the collections function as well as corporate objectives. (See page 18 for details.) 5. We will evaluate incentives driving the current behavior of collectors against the corporate objectives and make necessary adjustments. (Person C/Person D, Q3) 6. No system controls exist to ensure that invoices are not generated without a corresponding PO. This significantly hampers collection and cash application efforts. (See page 19 for details.) 6. This feature will be available with the ERP system re- implementation. SR management must decide its importance in the process. (Person E, Q3) Executive Summary – Collections Processes Issues/Observations Action to be Taken/In Progress
6 Objectives, Scope, & Procedures Performed Objectives Review and evaluate the internal control environment and the adequacy of existing policies and procedures Benchmark Company As internal controls and processes with best practices information Identify opportunities for internal control and process improvements Scope The credit evaluation and rating process in City, State The collections process and associated receivables management in City, State Internal audit did not evaluate the adequacy of bad debt reserves related to un-collectible accounts receivable Procedures Performed During This Review Interviewed key personnel to gain an understanding of the credit evaluation and rating process and the collections process Created process flowcharts of key processes and noted potential process and control improvements Noted if processes followed policy guidelines where developed Reviewed existing corporate policies and procedures and noted if procedures were consistently followed by personnel Reviewed the effectiveness and efficiency of the process, and noted if adequate controls were in place and if the process was streamlined (e.g., manual vs. automated) and functioning smoothly Evaluated the effectiveness and level of integration and communication of the credit evaluation and collection processes with other key functions (e.g., marketing, order management, collections, etc.) Performed limited transaction testing to evaluate if final credit ratings were accurate and credit holds were properly applied and enforced (e.g., orders with credit holds have not been shipped) Performed CAAT analysis on accounts receivable and credit evaluation information Reviewed and evaluated existing credit rating criteria and credit information resources and determined if criteria were applied consistently to all customers (both domestic and international) Reviewed and evaluated the effectiveness of existing metric information used to monitor the processes Determined if customer payment history could trigger the credit rating process Evaluated adequacy of recurring review procedures Reviewed existing documentation in customer credit files to verify proper authorization, completeness and accuracy
7 Background Information - Credit Key Credit Information: The credit function has performed a total of 228 evaluations from the middle of Month through the first week in Month. As shown in the graph below, the number of evaluations performed has grown significantly over that past several months. The graph below also demonstrates the cyclical nature of credit reviews. At quarter end, the credit manager must evaluate many more customers as sales tends to spike at that time. Based on our discussions with the credit manager and our review of the data, it appears that credit may not have enough resources to keep up with future sales growth. A total of 98 credit evaluations were performed in Q1XX. By comparison, 117 credit evaluations were performed in the first five weeks of Q2XX. Per discussion with the credit manager, this is a direct reflection of the tightening credit environment. He anticipates that a larger percentage of Company As new and existing customers will need to be closely scrutinized in the near future if the current credit environment remains tight. We also noted that the credit evaluations performed in the first two weeks of April actually related to deals that had closed in the previous quarter. A total of 73 customers were reviewed after the deal had closed for approximately $20.3M in sales. KEY POINT : As Company As business grows, so will the need for additional credit evaluations. Current resources are not sufficient to keep up with anticipated growth.
8 Key Credit Information: The table above details the current risk rating/definitions that the credit manager uses to grade customer risk. The graph at left details aged receivables from 20 customers that received risk ratings from credit of three (moderate risk) or worse (customer risk ratings in the graph at left ranged from three to six). Total sales for these 20 customers for the period was $15.8M. Approximately $3.1M (19.5% of the total sales) of these sales were over 120 days. Credit and collections personnel should implement this kind of analysis to ensure that receivables from higher risk customers receive additional attention. Background Information - Credit Key Credit Information: The following table details the estimated time the credit manager spends performing his duties: Task% of Total Gather/Research Information35% Analysis/Evaluation30% Solutions Structuring30% Collections Assistance5% Total100% The amount of time the credit manager spends on research(~35%) detracts from his primary roleto timely analyze and evaluate credit information and structure potential deals for customers. Current Risk Ratings:
9 Background Information - Collections Key Receivables Information: The total receivables balance as of 5/2/XX was $319.7M. Based on our review of the AR aging, AR balances < $100K totaled $33.6M (10.5% of the total receivables balance). The graphs at right and below display the receivable aging buckets. Based on a review of this information, it is evident that smaller balances tend to have a longer collection period. This data corresponds with the collection agents current strategy, which has been to focus on larger receivable balances for collections. 2,000,000 4,000,000 6,000,000 8,000,000 10,000,000 12,000,000 Key Receivables Information: The graph at left illustrates that smaller balances make up a significant portion of older receivables and that a more focused effort should be placed on collecting receivable balances < $100K earlier in the cycle.
10 Key Receivables Information: The table at right displays the 20 largest receivable balances > 60 days currently outstanding. The balances > 60 days associated with these 20 customers represent approximately 7.3% of the total AR balance as of 5/2/XX. Key Receivables Information: As of 5/2/XX, total AR balances 60 days old. The graph at left details the top 20 < $100K balances that make up a portion of the $33.6M. Of the top days. The average balance was $67K. Background Information - Collections Insert receivables list.
11 Background Information - Collections Aging Information by Revenue Type: The pie chart below represents the 60 days (total amount = $18M). The majority (34%) of these receivables relate to license & maintenance (34%) and training (22%). Historically, collection for these receivables has been centralized at corporate (in Location B). Going forward, the Location A facility will be responsible for collections related to their revenue (e.g., primarily consulting and training). The chart at right is a breakdown of collection responsibilities (for revenue types) for each facilitys collection department.
12 Action Matrix Detail - Credit 1.The overall purpose, mission, goals and objectives of the credit function should be further defined and formally documented. The function needs SR management sponsorship and support to ensure that the goals are achieved. The credit function is a relatively new function at Company A and the general purpose and direction of the function is not entirely clear. In many cases, the credit evaluations are performed at a time when they are the least beneficial to the decision making process – after the deal has been consummated and the product has already been shipped. The actual credit evaluations are not integrated into the quote-to-bill process. The process may even be viewed by those outside the function to be a roadblock or inhibitor to completing a transaction. Management Response: Credit recognizes the need to clearly define the purpose, mission, goals and objectives of the function. While defining these high level objectives, credit intends to ensure that the process fits into the overall objectives of the quote-to-bill process. Specifically, we will develop a rigorous, well-defined process to evaluate potential customer credit in a systematic way. This process will be communicated to stakeholders. All exceptions to the policy/process will be resolved through a formalized approval process and all exceptions to the policy/process will be documented. In addition, credit will seek an SR management sponsor to ensure that its needs are met and its purpose in the overall quote-to-cash process is supported. (Person A/Q3) Issues/Observations Action to be Taken/In Progress
13 2.A credit policy with specific information relating to credit terms, credit limits and other key factors has yet to be formalized. Also, the credit evaluation process (desk procedures) is not well-defined nor formally documented. While the credit process is consistent in its application, the process is not formally documented. In addition, sound policies could be developed defining the roles and responsibilities regarding the decision-making process as it relates to credit-risk acceptance/avoidance. Specifically, tasks performed by the credit manager (researching and analyzing customer information) are not documented. Additionally, some of the resources used provide conflicting information on the specific company (i.e., bond ratings and other information may differ depending on the resource used). Criteria also need to be quantifiably weighted (to the extent possible). The current process is fairly subjective, as the credit manager has access to limited automated tools to assist in performing a more quantitative (and consistent) analysis. To ensure that customer credit is evaluated on a consistent basis, credit evaluation resources and criteria should be consistently applied. In addition, very few performance measures and metrics are tracked to monitor success of the process. Examples of such performance measures include number of evaluations per quarter, cost per evaluation, average time to complete an evaluation, ratio of poor credit risks to number of uncollectible accounts, etc. There are many metrics that track cost, quality and time issues relevant to the performance of specific tasks. See Best Practices information on page 24. Management Response: A Company A credit policy has been developed, but it has not yet been formalized/implemented. We will review, modify and implement as appropriate to ensure the Companys policy on credit evaluation is clear and consistent. In addition, desk procedures will be drafted to ensure that the process is consistent and that knowledge is maintained within the company. Relevant measures and metrics will be identified, tracked regularly and included in the development of documented policies and procedures. (Person A/Q3) Action Matrix Detail - Credit Issues/Observations Action to be Taken/In Progress
14 3.The credit evaluation process is extremely manual in nature and may not be able to meet the needs of the business as Company A continues to grow. The credit managers primary role is to evaluate the credit risk of current and potential customers in order for the company to maximize sales while minimizing credit risk. However, the credit manager currently spends a considerable portion of his time (~35%) gathering financial and credit information on existing and potential customers. Much of this research involves going to various Internet sites and pulling applicable information for the company being evaluated. This is an inefficient use of the credit managers time. Because the credit manager spends a significant amount of time gathering information, he has less time to actually analyze the credit of a particular customer or to assist sales people in structuring potential sales (deals that require special financing arrangements that mitigate Company As credit risk). Much of the research the credit manager performs could be automated via a third-party software solution (CMS) with the necessary data feeds (financials, bond ratings, payment history, etc.). This would allow the credit manager to devote the majority of his time analyzing customer credit and structuring deals. As the company continues to grow, credit will experience increased difficulty in keeping pace (see page 7 for current evaluation growth statistics). Management Response: Credit is in the process of evaluating the growth factor of credit evaluations required and will work to ensure proper resourced are allocated. Credit is considering the automation of certain credit processes. However, much of the process is subjective and therefore may not be automated easily. Automation to the extent of gathering information and calculating ratios by using credit scoring applications (such as Corporate Credit Manager and e-Credit) currently exists in the market today. For consumer purchases or direct business purchases for smaller dollars, automated credit decisions can be implemented through a combination of e-Biz and one of these applications. We will evaluate the possibility of utilizing one or more of these automated tools and will make a decision sometime in Q3. (Person A/Q3) Action Matrix Detail - Credit Issues/Observations Action to be Taken/In Progress See Best Practices information on pages
15 4.Sales < $100K are not reviewed by credit. The credit manager reviews the opportunity forecast report on a weekly basis to verify potential new customers are reasonable credit risks. The revenue forecast report contains sales information for closed, committed and expected (forecast) sales. The credit manager is primarily concerned with the expected sales to new customersthese are the companies that potentially require credit analysis, depending on their overall risk grade. According to the credit manager, expected sales < $100K are not reviewed for creditworthiness per company practice. Additionally, we noted that the revenue forecast report only has license revenuemaintenance and consulting/training are not included. As such, there may be deals in excess of the $100K threshold that are not being reviewed from a credit-worthiness perspective. We reviewed sales information for Q4XX and Q1XX and noted the company had < $100K in sales, totaling $16.7M and $13.1M during those respective periods. According to the credit manager, none of these sales were subject to any credit evaluation. Management Response: As part of the order management system implementation (ERP system 8.0), this will be addressed. We are evaluating various ways to ensure that all deals get some level of review. We should have a solution sometime in Q3. (Person A/Q3) Action Matrix Detail - Credit Issues/Observations Action to be Taken/In Progress
16 Action Matrix Detail - Credit 5.Currently, no systems solutions exist that allow for company-wide visibility of credit ratings for potential customers and/or credit limits and holds for those customers who have not paid or are over established credit limits. Deals are sometimes executed and product is sometimes shipped prior to the performance of credit evaluations. We reviewed credit evaluation documentation for Q1XX and noted that 73 sales totaling approximately $20.3M were closed prior to customer credit reviews. It should be noted that the credit manager has the ability to initiate a credit hold after the sale has occurred. This does not mitigate the companys credit risk; however, it does prevent potential revenue recognition risk, as revenue associated with the declined credit is not recognized until payment is received. This process is manual in nature and therefore runs the risk of not being applied consistently. Management Response: ERP system 8.0 (in implementation phase) will allow credit limit inputs and reduce the need to review and approve orders for existing or repeat purchases. This will also reduce the number of duplicate credit reviews in the future. Once the database is populated, critical information for decision-making purposes will be available to all relevant parties. (Person A/Q3) 6.Per inquiry, credit processes at Company A EMEA were not in place at the time of the review. Management Response: As of Q2 XX, a credit evaluation process has been implemented for EMEA customers following same guidelines as the US. (Done). Issues/Observations Action to be Taken/In Progress
17 Action Matrix Detail - Collections Issues/Observations Action to be Taken/In Progress 1. The overall purpose, mission, goals and objectives of the Collections function are not well-defined or documented in a formal way. A well-defined mission and documented set of objectives will give the function direction and purpose. 2. Policies, desk procedures and performance measures are not yet formalized and documented Based on our discussions with the finance and collections managers, the collections department does not have documented policies and procedures for its collection agents and they are not currently tracking important performance metric information. Collections should consider: Documenting all policies and developing desk procedures to ensure knowledge is maintained with the function Standardizing processes across all collection agents Developing and implementing a robust set of metrics and measures to systematically evaluate team performance and performance of individual collections specialists Utilizing call center software to assist in capturing and monitoring collection information Management Response: The overall mission, purpose, goals and objectives will be included in the policy and procedures manual, which is currently in process and targeted for completion by Q4. (Person B/Person C, Q4) Management Response: Desk procedures will be drafted to include credit policies to ensure consistency in the implementation of decision-making methodologies. Processes and measures will be standardized across the collections function. Measures and metrics will be included in the policies and procedures. Relevant metrics will be identified and tracked regularly. (Person B/Person C, Q3) We will consider capturing and tracking performance metric information to assist management in monitoring the overall collections process. Some potential metrics might include: # of total calls per day/week/month # of calls made to specific customers per week/month $ coverage of all calls per day/week/month # of calls made within specific aging buckets (e.g., 100 calls/day for current bucket, 500 calls/day for the bucket, etc.) We will evaluate implementing call center software to enable easier capture and analysis of metric information.
18 Action Matrix Detail - Collections Issues/Observations Action to be Taken/In Progress 3.More focus could be aimed at collecting accounts receivable balances < $100K. Currently, collection agents tend to focus efforts on larger balances. As collection personnel are motivated to collect as much cash as possible, they have focused greater attention on larger account balances in the past. Based on our review of the AR aging (dated 5/2/01), AR balances 60 days old ($14M is >120 days old). It should be noted that the collections department has recently hired additional temporary help to focus on all account balances > 60 days. Going forward, agents should be properly motivated to spend their efforts on all customer accounts. Collections should: Provide direction to collection agents, stating that all receivables must be managed and collectednot just large balance receivables Consider adjusting the current collections incentive program to ensure that collection agents spend some time working on smaller AR balances. Possible solutions include changing the bonus structure to encourage collecting on smaller balances or requiring all collection agents to make minimum contact with all customers (regardless of the size of the AR balance) Evaluate the current resource level and consider adding additional resources if deemed necessary Consider outsourcing some of the collections work as necessary Management Response: Increased collection efforts were initiated in Q2XX. Most of these low dollar balances were related to professional services and are to be collected out of Location A. We have moved some of the collection efforts to Location A and set up a collection department specifically for Location A invoices, which will be closer to the billing and ordering functions related to the Location A – type revenues: professional services and education. The < $100K over 60 receivables are being collected by two temporary collectors who specialize in aged receivables and collections involving workouts. (Done) In addition, we will evaluate incentives driving the current behavior of collectors against the corporate objectives and make necessary adjustments. (Person C/OConner, Q3) See Best Practices information on pages
19 Action Matrix Detail - Collections 4.Invoices are sent to customers prior to obtaining a valid purchase order number – no system controls exist to preclude this from happening. Based on our discussions with collections personnel, purchase order information is not consistently obtained prior to generation of invoices. As such, when a customer receives an invoice, they may delay payment, as a valid purchase order is not referenced on the invoice. Collection agents spend a significant portion of their efforts working with customers to obtain a valid purchase order created and assigned to the outstanding invoice. This process often takes over 30 days, thus increasing the days outstanding for account balances. We reviewed the invoice history for the last 12 months (Q2XX- Q1XX), and noted that of the 16,383 invoices generated in the US, 9,293 (56.72%) did not reference a purchase order number. This can severely hamper the collection agents ability to collect payments from customers in a timely manner. Also hampering the overall collection and cash application process is the fact that customers do not always reference invoice numbers. With the PSFT re-implementation, management should consider: Establishing a system control in order management that requires all shipments to reference a customer PO. This will ensure that a PO number will be available when an invoice is prepared. To the extent possible, encourage customers to reference the invoice number on the remittance. Management Response: This feature will be available with the ERP system re- implementation. SR management must decide its importance in the process. (Person E, Q3) Company A encourages customers to reference our invoice number with remittance on every invoice. (No action required at this time.) Issues/Observations Action to be Taken/In Progress See page Best Practices information on page 28.
20 Appendix A: Best Practices Scorecard The best practices summary on the following pages is based on Company XYZs knowledge base. The knowledge base has been gathered through numerous special studies and the continuous input of our personnel and clients. As part of this review, Company As practices were benchmarked against the best practices. An evaluation of Company As processes is noted in each instance. Best practices were evaluated as follows: Where possible improvement can be made in the companys best practice structure, a reference has been made to the detailed issues and observations, where managements change implementation plan is described along with the responsible party and estimated implementation timing. Good Use - Best practices currently in use Moderate Use - Improvement possible in order to achieve best practice status Limited/Some Use - Improvement recommended to improve process efficiency/effectiveness 6
21 Appendix A: Best Practices Scorecard 1.Generate invoices that are clear, accurate and comprehensive. Customers are more likely to process payment on bills they can understand. They also look for information in a format compatible with their own. An accounts payable department typically needs the following information to process an invoice: Purchase order number Invoice number Product codes and descriptions Service, shipping or invoice dates Date of receipt of product or service Delivery carrier Benefits: Improves invoice payment cycle time Reduces company and customer costs as information is readily available Improves company and customer ability to track invoices Payments can be quickly matched to invoices Company A often invoices customers prior to acquiring a valid purchase order number. This tends to increase the overall payment cycle time as collection agents must spend a significant amount of their time working with the customer to research or create a valid purchase order so the invoice can be paid. Best PracticeCompany A Practice Reference Rating Action Item # 7 Good use Moderate Use 6 Limited Use
22 Appendix A: Best Practices Scorecard Best PracticeCompany A Practice Reference Rating 2.Offer discounts or other incentives to encourage customers to pay on time or early. Slower payments mean less working capital, which is why companies extend a variety of incentives to motivate their customers to pay. Some companies cover freight on goods shipped; others offer cash or credit discounts for early payment; still others impose rigid penalties for late payment. The motivation behind these terms and incentives is to encourage early or on-time payment. Cash discounts allow a customer to pay less than the original sales price if the customer remits payment within the specified time period after the sale. Benefits: Reduce collection periods Expedite cash flow Diminish the costs associated with carrying accounts receivable Company A does not currently offer discounts for early payment of invoices. Action Item # 6 6 Good use Moderate Use 6 Limited Use
23 Appendix A: Best Practices Scorecard Best PracticeCompany A Practice Reference Rating 3.Provide a single point of contact for customer inquiries. Customers calling accounts receivable usually already have some degree of dissatisfaction with the company, caused by either poor product or service quality, invoicing errors, price disputes, or other disagreements or misunderstandings. If they have trouble reaching the accounts receivable department, their dissatisfaction will likely be exacerbated. A single customer service and account information number, clearly printed on all communications to customers, allows for timely response to customer inquiries. Companies using routing technologya single incoming telephone number, which offers a variety of options to callers and routes calls accordinglyshould keep in mind that customers sometimes wish to speak with a company representative. A routing system that allows customers to drop out and speak with a trained representative is the most effective. Benefits: Increased customer service resulting in high customer retention and satisfaction Invoice direct customers to contact Company As billing department if they have any questions or concerns. Customers needs are addressed centrally from the billing department. None Good use Moderate Use 6 Limited Use
24 Appendix A: Best Practices Scorecard Best PracticeCompany A Practice Reference Rating 4.Document, communicate and evaluate the credit policy message. Best practices companies document credit policies so that the policiesas well as revisions and modificationscan be communicated consistently to employees. Documentation ensures company-wide uniformity of the credit policy message. Employees are able to communicate a consistent credit policy to all customers. Consistency in the application of credit terms among customers helps ensure that the credit function is not a source of customer dissatisfaction. Ongoing reviews allow companies to decide which policies are still appropriate and which restrict efficiency. Benefits: Credit practices are clearly understood by employees and customers and are consistently applied The credit department is still relatively new at Company A. As such, many of the processes and polices have not been formally documented. Key aspects such as credit terms and limits should be included in the credit policy. The credit manager is currently developing desktop procedures and policies for the credit process. Page 13 6 Good use Moderate Use 6 Limited Use
25 Appendix A: Best Practices Scorecard Best PracticeCompany A Practice Reference Rating 5.Discuss and document credit terms with customers at the beginning of the business relationship. Spending the necessary time and effort to clarify credit policies and delineate credit terms during the initial stages of a business relationship can help ensure that bills are paid on time. Credit terms to potentially discuss include: Incentives to pay early, such as a two percent discount if the customer pays within 10 days Late payment penalties Returned check charges Interest charged on past-due accounts Stop-shipment policy for persistently delinquent accounts Benefits: Credit terms are decided upon early in the sales process and are clearly understood by all parties The legal department currently details the terms of the sale in the agreement/contract. Credit has recently begun working with legal to ensure that the appropriate credit terms have been included in the agreement; however, this process is relatively informal at this point. See pages 12, 13 Good use Moderate Use 6 Limited Use
26 Appendix A: Best Practices Scorecard Best PracticeCompany A Practice Reference Rating 6.Create customer-focused teams that align the sales and credit functions. Sales and credit historically have been at odds with each other because of seemingly conflicting objectivessales wants to close the deal, while credit wants to minimize risk. In reality, both share a common goal: to enhance customer satisfaction and generate revenue for the company. Credit decisions are an integral part of the sales process because selling terms, sales volume, profit margins and credit risk are inseparable. While credit has traditionally always been a finance function, credit managers are typically less interested in payroll and budgeting than they are in new prospects, new products and other customer-related issues. Aligning credit with sales leads to improved internal communication and quicker resolution of customer issues. Benefits: Sales are maximized and credit risk and potential bad debt is minimized The credit manager reviews the opportunity forecast report each week for forecasted sales and potential deals. This information is used to drive the credit evaluation process. The current credit evaluation process has difficulty keeping pace with the amount of sales coming through the pipeline that need to be evaluated. Credit is aware of this problem and investigating ways to automate and expedite some of the processes to ensure that evaluations can be performed in a timely fashion. See pages 12, 13 Good use Moderate Use 6 Limited Use
27 Appendix A: Best Practices Scorecard Best PracticeCompany A Practice Reference Rating 7.Reduce processing float with lockboxes. For a company dealing with hundreds or thousands of invoices, manual processing is slow and expensive, creating information time lags known as processing float. As a result of processing float, employees within a company who need to know as soon as payment arrivestypically those in customer service, credit, collections and accountingoften don't find out about it until several days later. At the minimum service level, a lockbox providerusually a bankprocesses wholesale remittance items electronically. Automated workstations read the magnetic ink character recognition (MICR) line of each check and deposit the amount to the company's account. The bank then delivers all remittance information, including envelopes, contents and copies of checks, to the accounts receivable department for posting. Several providers offer special zip codes and 24-hour processing seven days a week. Despite the onset of electronic commerce, some 60 billion checks continue to be written each yearmore than 4 billion of which are processed by lockbox providers. Benefits: Payment processing time is significantly reduced, reducing the overall float time as well as processing expenses Company A utilizes a lockbox to optimize its receivables management. None Good use Moderate Use 6 Limited Use
28 Appendix A: Best Practices Scorecard Best PracticeCompany A Practice Reference Rating 8.Post payments on receipt. A number of lockbox service providers offer more than just timely deposit benefits. Rather than transmitting remittance information back to the company physically, many lockbox services can now furnish this information to the company electronically, which expedites posting. Benefits: Cost savings from timely application and operational savings from reduced staff requirements There is one employee that is dedicated to the cash application process. Additionally, collection agents may assist in the cash application process. As of 4/30/XX, there was approximately $15.8M (or 5% of total receivables) of unapplied cashreceipts the company had received but not yet posted. Most of the items were not posted are due to lack of pertinent information (i.e., the invoice number was not referenced and the payment amount is not easily identifiable for matching). See page 19 Good use Moderate Use 6 Limited Use
29 Appendix A: Best Practices Scorecard Best PracticeCompany A Practice Reference Rating 9.Reconcile mismatched payments and deductions as quickly as possible. Few companies have hit ratesthe percentage of payments a system is able to match without employee interventionof 100 percent. A payment may not match an invoice for a number of reasons. For example, a customer may pay less than indicated because of: Pricing errors Shipping errors Damaged goods Freight charges Promotional allowances Charge-backs Miscalculated allowances Known as deductions, these adjustments can account for up to 15 percent of total accounts receivable, depending on the industry. For companies that receive a large volume of checks, even a small percentage of deductions (resulting in unmatched payments) can mean significant hours of staff time spent in investigations and rebilling, as well as delayed payment. Benefits: Reduced processing costs There is one employee that is dedicated to the cash application process. Additionally, collection agents may assist in the cash application process. As of 4/30/XX, there was approximately $15.8M (or 5% of total receivables) of unapplied cashreceipts the company had received but not yet posted. See page 19 Good use Moderate Use 6 Limited Use
30 Appendix A: Best Practices Scorecard Best PracticeCompany A Practice Reference Rating 10. Ensure access to real-time remittance information. Customer inquiries and deduction investigations require access to payment documentation such as invoices, customer remittance statements and checks. Filing, storing and locating hard copies of such documentation is both expensive and time consuming. With an automated remittance processing system and imaging technology, real-time access to remittance information is available to the staff who need it. Once payment is posted online, credit personnel release orders for shipping, collections personnel cease their dunning activities, and salespeople are free to pursue additional orders. Benefits: Reduced processing costs Higher call rates resulting from faster processing times Possible staff reduction opportunities Lower days sales outstanding Increased customer satisfaction Reduced write-offs for bad debt Collection agents have automatic access to customer invoices, contracts and purchase order information (when possible) via System #2 downloads. However, the credit manager does not have the ability to hold and subsequently release orders for shipping. The system check that could perform this task exists but has not yet been implemented. See page 14 Good use Moderate Use 6 Limited Use
31 Appendix A: Best Practices Scorecard Best PracticeCompany A Practice Reference Rating 11. Create cost-effective procedures for credit investigation. Credit information is a valuable tool for companies striving to employ the most effective collections techniques in dealing with their debtors. Credit information and ratings are useful in three potential ways: As stand-alone values: when all criteria and weights are defined, understood and captured promptly and accurately, the credit rating possesses value by itself When changes occur in the credit rating: if a change in the financial condition, stock price or key ratios occurs, then the credit rating is altered. By tracking these changes, the company can employ the most appropriate credit and collections tactics When used in comparison with other data/indicators: comparative data that could affect the credit and collections process include: Billing during the current month fluctuates compared with the company's overall credit line Total suits, liens and judgments increase as a percentage of monthly/annual revenue Revenue compared to receivables exceeds days sales outstanding (DSO) ranges A customer's cost of capital is significantly different that that of industry competitors Benefits: Increased reliability of credit limits Reduced risk of delinquent accounts Decreased write-offs for bad debt The credit function is currently conducted solely by the credit manager. The criteria for assessing credit risk is neither standardized nor documented. Information is gathered from a variety of different sources. The credit rating is derived from non- standardized quantitative and qualitative information. The current CMS proposal (see Appendix D cost benefit analysis slide) will standardize information and produce consistent risk ratings. See page 14 6 Good use Moderate Use 6 Limited Use
32 Appendix A: Best Practices Scorecard Best PracticeCompany A Practice Reference Rating 12. Use credit and behavioral scoring models to grant credit, assign credit limits, and monitor payment behavior. Credit scoringthe process of assigning values or risk ratings to various elements of a company's credit history and payment performance to quantify its creditworthinessis widely prevalent in credit and collections. Credit scoring models are popular because they permit a systematic approach to credit approval and account monitoring. They are also becoming increasingly affordable. These models can be used to: Automate the credit approval process Set credit limits Check account status before accepting a sale Identify existing customers with deteriorating creditworthiness Determine appropriate action should the account become delinquent Benefits: Decreased processing time and costs Increased reliability of risk ratings Reduced risk of fallen angels defaulting (i.e. formerly good credit standing customers) The credit function currently uses an informal credit- scoring model based on several criteria; however, the process is not automated, does not assign credit limits and can not adequately monitor customers with deteriorating creditworthiness. The current CMS proposal (see Appendix D cost benefit analysis slide) will automate the process, assign credit limits and continually monitor customers based on payment history and real-time financial condition information. See page 14 6 Good use Moderate Use 6 Limited Use
33 Appendix A: Best Practices Scorecard Best PracticeCompany A Practice Reference Rating 13. Process credit applications promptly. By using online credit reference services such as Dun & Bradstreet, companies provide credit to new customers in a matter of minutes. The faster a company processes credit applications, the sooner it ships product and generates revenues. Benefits: Decreased processing time and costs Reduce or eliminate the risk of credit checks not being preformed or being performed inadequately due to time constraints The credit function currently uses many free online information resources in evaluating credit standing. However, the process is manually intensive and time- consuming. Furthermore, many smaller customers will not be reviewed due to time constraints. The current CMS proposal (see Appendix D cost benefit analysis slide) will automate the process by using the Dun & Bradstreet service among others, assigning credit limits, and continually monitor ing customers based on payment history and real-time financial condition. See page 14 6 Good use Moderate Use 6 Limited Use
34 Appendix A: Best Practices Scorecard Best PracticeCompany A Practice Reference Rating 14. Secure letters of credit or credit insurance on foreign sales. As the international marketplace shrinks and more businesses go global, they face difficulty with getting paid. Payment terms and payment behavior vary widely across the globe. For example, payment terms worldwide run the gamut from net 30 days to net 90 days. Benefits: Reduce default risk and number of delinquent accounts Reduce amount of write-offs Improve DSO The International credit function is split between EMEA, Japan and the corporate credit department (covering all other areas). The credit manager will demand the use of a letter of credit in cases where the corporate credit department feels that there is significant risk in dealing with a particular international customer. None Good use Moderate Use 6 Limited Use
35 Appendix A: Best Practices Scorecard Best PracticeCompany A Practice Reference Rating 15. Segment the accounts receivable portfolio based on risk. Companies are prone to using the same approach for all customers. All too often, this approach over-manages some customer segments while under-managing others. Segmenting or stratifying the account portfolio by high, medium and low risk accounts fosters better accounts- receivable management because a company can focus on the high-risk portion of the portfolio, which requires more attention. The company is better able to perform the following on its high-risk accounts: Track payment behavior trends Schedule collections activity accordingly Anticipate customer performance Prepare for the outcome of that performance as necessary Progressive companies codify their customer profiles using specialized software systems like data warehouses, which allows them to prioritize and modify collections tactics for each customer. Benefits: Increase cash collection per collection agent Decrease write-offs for bad debt The collections department currently stratifies the accounts receivable portfolio into risk, aging, and dollar values of individual accounts. This allows collection agents to spend more time dealing with more risky customers who will be more likely to delay payment. However, more attention is focused on high dollar-value accounts. Focus in the past has been on higher balances. The number of customer with balances under $100K has grown, now totaling over $33.4 million in total outstanding receivables. There is a renewed initiative to collect lower balances. See page 18 Good use Moderate Use 6 Limited Use
36 Appendix A: Best Practices Scorecard Best PracticeCompany A Practice Reference Rating 16. Empower and train credit and collections staff. Companies that place credit and collections staff on a par with revenue-generating staff have seen performance meet or exceed expectations. When recruiting, they seek experienced professionals with proven track records and compensate them accordingly, or educate new hires with a rigorous training program. Benefits: Increase employee morale and motivation Improve turnover rates of top-performing employees Increase the feasibility of hiring and promoting from within the organization The credit department currently consists of one employee who had been trained before joining the company. Assistants have been used in collections during peak activity times and were trained informally for the work. The collections department employs informal training techniques. Management is currently considering bringing in an experienced collections agent to conduct a formal training in the near future. None Good use Moderate Use 6 Limited Use
37 Appendix A: Best Practices Scorecard Best PracticeCompany A Practice Reference Rating 17. Establish realistic performance goals. Collections staff are best motivated by attainable performance goals. These goals typically combine the company's objectives with the department's. Boosting goals beyond realistic levels serves only to demoralize staff, causing turnover, absenteeism and low effort. Measures within each collector's controlsuch as dollars collected or a percentage reduction in collector portfolio better reflect collector performance than days sales outstanding (DSO), because DSO can change based on credit activity, sales activity and market activity. Benefits: Improved employee morale More accurate financial reporting estimates Decreased employee turnover The collections incentive plan has undergone much change over the past few quarters. Incentives now focus not only on DSO but also performance on accounts over 60 days in arrears as well as team incentives. The current collections incentive plan has not been formalized. This reduces the ability of an incentive plan to properly motivate collection agents throughout the duration of the plan. See page 18 Good use Moderate Use 6 Limited Use
38 Appendix A: Best Practices Scorecard Best PracticeCompany A Practice Reference Rating 18. Monitor and reward individual and team-based performance measures. In an industry facing annual turnover rates between 50 and 100 percent, companies are invariably seeking new ways to retain collectors with the right skills. The most effective performance incentives have proven to be monetary and are determined by the collectors themselves: bonuses, commissions, and awards. To sustain a high level of motivation, companies reward successful collectors within a week or two of reaching their goals. Some companies share performance results among collectors by rewarding each team member for the results of the entire team. Team-based performance measures are successful only if the company focuses on and rewards the team based on its peak performersnot if it penalizes the team based on its poor performers. Benefits: Improved employee morale Decreased employee turnover The collections incentive plan has undergone much change over the past few quarters. Incentives now focus not only on DSO but also performance on accounts over 60 days in arrears as well as team incentives. The current collections incentive plan has not been formalized. This reduces the ability of an incentive plan to properly motivate collection agents throughout the duration of the plan. See page 18 Good use Moderate Use 6 Limited Use
39 Appendix A: Best Practices Scorecard Best PracticeCompany A Practice Reference Rating 19. Develop selection criteria for outsourcing collections. Companies develop selection criteria for outside collection agencies based on the age and dollar value of an account as well as customer history and relationship. Using only one agency does not allow a company to compare performance or negotiate fees while using too many might stretch the collection pie too thin, resulting in a lack of interest or effort from collectors. An investigation of outside agencies typically includes the following: Reviewing the agency's income statement and balance sheet Checking bank and trade references Verifying that the agency is licensed and bonded Confirming adequate insurance coverage for general liability and errors and omissions Other considerations include: Collection techniques, including legal action taken on uncollectible accounts Collection activity, including frequency of calls and letters Collection history Average payment size Staff training and experience Willingness to return accounts at company request Benefits: Reduced staffing costs Increased cash collection from non-outsourced customers resulting from increased collector attention. The collections department has begun to hire experienced temporary employees to assist in collection of receivables over sixty days in arrears in order to allow internal collectors to concentrate on larger ticket items. Company A reviewed many of these criteria before entering into an agreement. None Good use Moderate Use 6 Limited Use
40 Appendix A: Best Practices Scorecard Best PracticeCompany A Practice Reference Rating 20. Forward accounts with low collection probability directly to agencies, regardless of age. Companies are sometimes reluctant to outsource any portion of their receivables portfolios because outsourcing comes with a fee. What they sometimes overlook, however, is that accounts lose value every day they remain unpaid. Companies often end up having to pay a collection fee and collect far less on the account than they would have if they had initiated collection efforts at the outset. Research from the National Association of Credit Management in Columbia, Md. illustrates that a dollar in a company's receivables portfolio is worth less than 20 cents after three years. The following bar graph represents the downward spiral in the value of an unpaid accounts receivable portfolio. Best practice companies realize that they can come out ahead by forwarding an account with low collection probability directly to an agency instead of waiting for that account to become past due. The agency can begin collection efforts on that account immediately and increase the company's chances of getting paid. Benefits: Reduced staffing costs Increased cash collection from non-outsourced customers resulting from increased collector attention. The collections department has brought in specialized collection resources to aid in the collection of older receivables to allow internal collectors to concentrate on more current, larger receivable balances. Management is now considering using more of these agencies to better collect lower value, highly aged receivables. See page 18 6 Good use Moderate Use 6 Limited Use
41 Appendix A: Best Practices Scorecard Best PracticeCompany A Practice Reference Rating 21. Outsource part of the current receivables portfolio. To obtain the efficiencies of outsourced collections, some companies have found it most cost-effective to split their current receivables portfolio, outsourcing the traditional 80 percent of their customers who provide 20 percent of their revenue and keeping the large accounts in-house for better customer-service control. In some situations, a company's customers are unaware that the account has been outsourced. The agency makes all its calls using the client's name. Collection letters and revised invoices bear the company's name and address. Customers call a toll-free number and the agency answers with the company's name. Benefits: Reduced staffing costs Increased cash collection from non-outsourced customers resulting from increased collector attention The collections department has brought in specialized collection resources to aid in the collection of older receivables to allow internal collectors to concentrate on more current, larger receivable balances. Management is now considering using more of these agencies to better collect lower value, highly aged receivables. There are no goals in place to outsource a predefined percentage of receivable balances. See page 18 Good use Moderate Use 6 Limited Use
42 Appendix A: Best Practices Scorecard Best PracticeCompany A Practice Reference Rating 22. Track signs of financial distress. Most companies have dealt with troubled customers in the past. As a result, collections departments know what to look for to stave off, or at least minimize the effects of delinquency. For publicly held companies, much of this information is available in their annual and quarterly reports. For privately held companies, credit rating agencies provide the basics. In addition to late payments, some other signs of financial distress are: Cash shortages – signaling the tightening of cash availability Lower gross profit margins – usually a result of lowered prices to boost sales volume to make up for lost customers Consistent operating losses – a key indicator of financial distress Sporadic financial reports – because companies rarely rush to publicize poor results Lack of information – because upper management tends to be tight-lipped about problems Benefits: Reduce delinquency risk of private collections' ability to manage customers in distress The credit manager currently attempts to track negative changes in customers ability to make payments. This information is then shared informally with the collections agents. Since the current system is not automated, there is a large risk that the lone credit manager may not be able to simultaneously track all of the approximate 2400 customers that currently have receivables balances. None 6 Good use Moderate Use 6 Limited Use
43 Appendix A: Best Practices Scorecard Best PracticeCompany A Practice Reference Rating 23. Develop a treatment time line for delinquent accounts. A sound treatment time line reflects both customer risk category and total customer account exposure. For example, sending a firm collection letter to a well-established, low-risk customer who is late for the first time is inappropriate, but so is waiting for 30 or more days past the payment due date to begin collection activity on a high-risk customer. Companies are increasingly contacting customers just a few days after a missed payment date. Some even call or send a letter ten days before payment is due. The letter serves to confirm receipt of the shipment and verify that invoice and shipping documents are in order. It might originate from accounts receivable, customer service or sales. The goal of this letter is to resolve any barriers to payment before they cause problems. If the first several contacts indicate that the balance on this account will take substantially more effort to collect, then it is time to turn it over to an outside collection agency. Benefits: Reduce default risk and number of delinquent accounts Reduce amount of write-offs Improve DSO Decrease training times for new collectors Collections currently employs an informal time line for delinquent accounts. Steps are communicated verbally among collection agents. The collections manager is currently in the process of documenting the treatment time line. In addition, collectors are always encouraged to use their own judgment in creating time lines for customers based on personal experience. None Good use Moderate Use 6 Limited Use
44 Appendix A: Best Practices Scorecard Best PracticeCompany A Practice Reference Rating 24. Initiate corrective action for persistently delinquent accounts. On one end of the collections spectrum, customers might not have realized their account is past due. On the other end, they might have serious financial problems. A collections agent's first priority is to determine the customer's situation and then to tailor the collections approach to that customer. For persistently delinquent accounts, the collections approach includes one or more of the following: Initiating a stop-shipment policy, or holding back shipment of goods until the past-due account is paid Renegotiating sales contracts and payment terms Implementing cash-only delivery Benefits: Reduce default risk and number of delinquent accounts Mitigate the risk of bad debt write-offs Improve DSO Stop risky deals from being shipped The credit manager works with the district manager to structure a deal that will mitigate risk. Cases where this occurred resulted in changing the order to cash- only, requiring a sizable down payment, using extended dating payment plans and changing the terms and conditions of the sale. The credit manager does not have the ability to stop a shipment to a risky customer. The credit manager may only suggest that the sale not be recognized as revenue until full payment has been received. None Good use Moderate Use 6 Limited Use
45 Appendix A: Best Practices Scorecard Best PracticeCompany A Practice Reference Rating 25. Customize the credit processing system to reflect the company's credit policies. Maintaining a consistent credit policy across an enterprise can be a daunting task, even in an online environment. For example, companies sometimes have to push the credit process from accounting on to the sales staff in order to close a deal quicklya switch that often leads to miscommunication and misapplication of credit policies. A well-programmed online credit processing system can alleviate such problems. The system reflects predetermined acceptance rules and other critical information about a company's credit policies, ensuring their consistent application across departments. Leading e-commerce companies take an active role in programming their credit processing systems so that they absolutely reflect the company's credit policies right from the start. For example, before implementing an online credit- processing system, the companies would ask themselves if the system were capable of executing company procedures. Benefits: Reduce default risk and number of delinquent accounts Mitigate the risk of bad debt write-offs Improve DSO The current credit evaluation process is informal. There is no set algorithm for producing risk ratings. Also, there is no documented company policy for credit checking. Management is currently considering using CMS software. This software package allows the credit analysts to customize the algorithm according to company policy. None Good use Moderate Use 6 Limited Use
46 Appendix A: Best Practices Scorecard Best PracticeCompany A Practice Reference Rating 26. Automate the collection process where possible. An automated collections systemlike an automated remittance processing systemcan result in immediate and significant gains by freeing staff time for collection calls. An automated collection system includes the following: Automatic identification of delinquent accounts Automatic prioritization of accounts for collection activity Automatic queuing of accounts for calls Automatic preparation of demand letter Immediate notice of changes in account status to sales, credit, customer service and shipping Benefits: Reduces DSO Enables performance metric tracking Facilitates collection agents with guidelines for collection The collections process has been partially automated. Collection agents receive reports, invoices, contracts and lock box reports automatically through the ERP system and System #2. However, several aspects of the process have not been automated such as: account queuing, prioritization of accounts/calls, incorporating changes in customer and credit information. Management is currently considering implementing ERP system 8.0 to allow collection agents to extract internal information on a continual basis top assist in the collection process. See page 14 Good use Moderate Use 6 Limited Use
47 Appendix A: Best Practices Scorecard Best PracticeCompany A Practice Reference Rating 27. Use an online credit network for credit and financial processing. Progressive companies today increasingly use online credit networks to improve business-to-business credit and financial processing. Previously, a supplier would have had to wait for days to complete a credit check while the potential customer tried to secure financing for a purchase. That time- consuming process often made closing a sale difficult. In contrast, the new online credit networks bring together merchants, customers and lenders at one web site where they can match up with the appropriate partners immediately. In addition, the networks open up financing to a bigger pool of corporate customers and expedite the transaction process. Savvy companies can do almost everything on the network, including taking credit applications, retrieving information from credit bureaus and financial systems, scoring the applications, making decisions on credit limits, securing financing, sending out responses to applicants, and even communicating payments. The one-stop shopping experience offered by online credit networks enables companies to make credit decisions within minutes and complete payments just a few days later. Benefits: Reduced cycle times Increased sales Reduced staffing costs Currently no online network exists to process credit and order financing. See page 14 6 Good use Moderate Use 6 Limited Use
48 Appendix A: Best Practices Scorecard Best PracticeCompany A Practice Reference Rating 28. Build an interface between the biller's e-billing and the payer's e-payment systems. B2B invoicing and payment has traditionally been a long, multi-step process. In fact, it usually takes an average of 60 days for a paper invoice to complete the payment circuit as it winds its way through a maze of steps that includes the mail, the approval authorities, and the data-entry and record- keeping mechanisms at both the biller's and payer's ends. However, with new advances in B2B bill-and-pay technology, companies can now link workflow from one partner's accounts receivable (A/R) system to the other's accounts payable (A/P) system, which helps eliminate some of the in- between steps, shorten the B2B payment cycle, and improve cash flow. Benefits: Reduced cycle times Reduced processing costs Currently no such interface exists. However, collectors receive lock box reports (three times per day) of all payments posted in order to track customer payments and schedule follow-up calls. None 6 Good use Moderate Use 6 Limited Use
49 Appendix B: Credit Evaluation Process 4 Internal control point (manual) Internal control point (system-based) Internal control weakness Sales operations prepares a revenue forecast report. This is a list of potential deals in the pipeline that relates information such as the likelihood of closing, the license revenue and the district manager (DM) on the deal. Revenue forecast is sent to the credit manager. The report has no visibility of the other service revenue (e.g., consulting, training, etc.) amounts involved in the deal. The credit manager is not receiving adequate information in order to assess the credit risk. (See issue #X.) Credit manager determines which customers present the highest degree of credit risk and those closest to a closing date and begins his analysis on these cases. Revenue Forecast 1 4Credit manager begins the credit check process by gathering information from the Internet such as financials, bond ratings, sovereign issues, legal issues and any other material news available. 4Gathering this information is time-intensive and manual in nature. On average, the credit manager will spend four to five hours per customer gathering this information. 4 Credit manager assesses this information by using a self- designed tool modeled after Moodys and Fitch rating systems for applying quantitative risk ratings to customer information. Since the information input into this calculation is not standardized, there is no assurance that the output is dependable. (See issue #2.) 4Using the risk rating as a guideline, the credit manager assigns either an accept, accept with special terms or decline assessment to the potential customer. Credit Check 2 In the event that a customer is accepted, the credit manager does not inform sales, sales operations and credit. These departments assume an acceptable credit rating if credit does not inform them of any potential issues. (See issue #1.) In the event that a customer is denied, a credit denial form is completed containing a summary of the information previously assembled as well as a qualitative analysis outlining the main rationale for the denial. This document is sent via to the DM for rebuttal. If the DM is unwilling to accept this decision and subsequently discontinue negotiations with the denied party, dialogue will then begin between the credit manager, DM, controller and possibly the CFO, depending on the importance and magnitude of the deal. The credit status is officially rejected or accepted. Credit Control 3 There is no formal policy on reevaluating credit. (See issue #2.) Collections generated a list, or escalation report, of customers who are considered to be in risk of default or unwilling to make payment. This report is sent to the credit manager for review. Changes are made to the document based on recently assembled material information. Changes made in this report will be reflected by assigning each party a new risk rating. Collections manager receives the updated document and relates this information to the collectors, DMs, sales operations and the financial executives. DMs will be asked to assist collectors in obtaining the outstanding balance in order to expedite the process. Credit Re- Evaluation/Escalation 4
50 Appendix B: Proposed Credit Evaluation Process Sales operations prepares a revenue forecast report. This is a list of potential deals in the pipeline that relates information such as the likelihood of closing, the license revenue and the district manager (DM) on the deal. Revenue forecast is sent to the credit manager. Credit manager places a credit hold on all customers on this list pending further review. This will stop any order from going through the system until removed. The report contains all types of service revenue amounts involved in the deal. Credit manager uses the CMS software to accumulate information and automatically enters all required data fields by using data feeds by automatically grabbing data from selected financial service providers databases. Revenue Forecast 1 4Credit manager completes all input fields in the CMS system and a risk rating is automatically generated. 4Credit manager analyzes this information and will, when necessary, change the weighting on the variables involved in the risk rating to properly reflect the risk environment. 4Credit manager will complete a qualitative assessment of the company in addition to the system-generated risk rating. 4Using the risk rating as a guideline, the credit manager assigns either an accept or decline assessment of the potential customer. The completed credit evaluation is sent via to the sales operations manager, collections manager, Controller and if necessary, the CFO and any district managers involved in the deal. All customers with acceptable credit risk ratings have their credit holds removed by either the credit manager or the controller (skip to the next column). Credit Check 2 In the event that a customer is denied, a dialogue will occur involving the aforementioned parties. The credit status will be discussed and any new information will be incorporated in the assessment. The controller and the credit manager will agree upon a risk rating as well set up acceptable terms and conditions. This is then communicated to the district manger for negotiation purposes with the customer. The credit manager will work with the district manager to create an acceptable payment plan for this customer. Sales operations creates a contract request form (CRF) and send this to the credit manager for review. If the deal is acceptable, the credit manager will remove the credit hold on the customer to allow the order to go through. If not, the credit hold remains and the deal is terminated or new negotiations begin. Credit Control of High-Risk Buyers 3 The CMS software constantly updates the same information initially fed into the system in step one and adjusts the risk rating accordingly. A customers payment history as maintained in the ERP system is integrated with the credit scoring software and any significant payment problems will cause the risk rating to increase. A weekly aging report is issued by collections based on customers over sixty days in arrears. The credit manager will review these customers and check for any significant developments by checking the CMS system. Collections manager receives the updated document, or escalation report, and relates this information to the collectors, DMs, sales operations and the financial executives. DMs will be asked to assist collectors in obtaining the outstanding balance in order to expedite the process. Credit Re- Evaluation/Escalation 4 4 Internal control point (manual) Internal control point (system-based) Internal control weakness
51 Appendix C: Benchmarking - Accounts Receivable Diagnostic Tool Cost statistics Total accounts receivable cost as a percentage of revenue Staff per 1 million in revenue Total accounts receivable cost per FTE Total remittance processing cost per remittance processed C&C cost per account requiring credit activity C&C cost per account requiring collections activity Cost structure Accounts receivable cost analysis Receivable statistics Bad debt as a percentage of sales Percentage of write-offs to total receivables Average write-off bill Accounts receivable turnover Days sales outstanding Span of control The global best practices benchmarking tools offer an effective way to benchmark performance throughout the process of change and improvement. Use of these tools can help companies chart their progress and adapt their plans accordingly. In most cases, data utilized was for fiscal year This type of benchmarking has become an important aspect of continuous improvement efforts among companies of all sizes. They often find it to be an educational experience as well. The structured benchmarking measuring process provides a clear view of the "as is" state compared to the "should be" goal. Following is a list of performance measures used to benchmark Company As processes with various other companies processes: Workload statistics Annual volume of remittances per FTE Number of active accounts per FTE Credit application turnaround Percentage of customers requiring credit activity Percentage of customers requiring collections activity Percentage of collections customers referred to OCAs Remittance processing statistics Average remittances processed per day Percentage of remittances that are a first-time match Percentage of remittances with errors Percentage of remittances received on or before the due date Percentage of same day credit to customer account
52 Chart interpretation report - interpretation of results The results report presents the findings of a benchmarking exercise that compiles the data provided by all the survey respondents. To make interpretation easier and more meaningful, the results are presented graphically. The results report uses a combination of chart types to present results. Bar charts and pie charts typically express the average of the benchmark group results for each data element. Another type of chart is the quartile chart. A quartile is a columnar chart divided into four sections, with each section representing 25% of the benchmark responses. In using quartiles, a baseline approach to analyzing results would be to first look at the median. The median is the line on the graph representing the point at which 50% of the respondents reported higher values and 50% of the respondents reported lower values. In the graphs specific to this report, the median is the line between the 2nd quartile and the 3rd quartile. Quartile charts are oriented so that responses higher on the y-axis are generally indicating better performance. Please refer to the graphic below for additional interpretation. Your organization's individual responses are indicated by the diamond symbol on the graph. Quartiles divide the data into quarters (25%) of the population. Each quarter is denoted by a different shading. The median (50% quartile) is where 1/2 the companies reported higher values and 1/2 the companies reported lower values. Thickness of each quarter is based upon the degree of dispersion within that 25% of the population. The thicker the quarter, the greater the dispersion. Quartiles that appear compressed indicate very little dispersion in the data series. Company XYZ statement of responsibility: Company XYZ has exercised professional care and diligence in the collection, processing and reporting of the information submitted by respondents for this report. However, the data used is from third party sources and Company XYZ has not independently verified, validated or audited the data. Company XYZ makes no representations or warranties with respect to the accuracy of the information contained in this report. It was the sole responsibility of each respondent to ensure the data that they provided was accurate and reliable to the best of their knowledge. Company XYZ shall not be liable to any client or any other person or entity for any inaccuracy or inauthenticity of information contained in this report or any errors or omissions in its content, regardless of the cause of such inaccuracy, inauthenticity, error or omission. Furthermore, in no event shall Company XYZ be liable for consequential, incidental or punitive damages to any person or entity in any matter relating to this report. Company XYZ will not disclose the name of any respondent without the prior approval and under no circumstances will Company XYZ disclose individual company data. Appendix C: Benchmarking - Accounts Receivable Diagnostic Tool
65 Appendix D - Proposed Credit & Management Systems (CMS) Software Implementation Cost Analysis The cost summary above displays the cost estimates for an integrated credit evaluation solution. The proposed software package will be able to perform the following tasks automatically: Receive real-time financial information (statements and ratios) from a market guide data feed. Any new information is integrated into the application on the issue date. Receive Pay-Dex information from Dunn and Bradstreet. This information includes a companys recent payment activity, days payables outstanding and other valuable credit information. Incorporate all information from the various data feeds and generate a risk rating. Algorithm used to generate these ratings can be modified by the user by changing weights of each variable. (Variables receive different weightings depending on the economic environment and specific customer risk attributes.) The current process is very qualitative and subjective. Integrate historical payment information from ERP system in order to continually assess a customers credit standing on an ongoing basis. Other benefits of using an CMS software include: Facilitate the credit evaluation of more new and existing customersincluding orders < $100K. (See issue #4.) Sharply reduce the amount of time currently spent gathering information from various sources. (See issue #3.) Decrease the possibility that an order will be booked and shipped within a quarter prior to a credit review. (See issue #5.) Only one additional credit analyst would need to be hired instead of two (approximate annual cost per credit analyst = $100K). The purpose of the analysis below is to detail the proposed software solution that will automate many of the manual processes currently in place in the credit evaluation process, resulting in a more consistent, streamlined process.
66 Appendix E: Acknowledgements Internal audit would like to thank all Company A employees who assisted us in our work during this project. We received input and assistance from the following persons: Person A Person B Person C Person D Person E Person F Person G Person H