CFO Bridge Insights August 2023

Charting the Course: Driving Tech's Growth through Data Insights

Editor’s Note:

Subbu, CFO Partner

Thanks to all readers, our last issue on PAT Waterfall did create curiosity amongst various readers to reference and benchmark one’s company & also to explore where they could improve.

We have chosen “Cash is the King” as a theme for this month with a focus on DSO. We have applied the below formula to arrive at the DSO of the 10 major companies based on information gathered from their Annual reports of FY23 which has FY22 comparatives.

Formula to compute DSO:

• Billed DSO: Billed Receivables /Revenue * 365

• Unbilled DSO : Unbilled BR / Revenue * 365

• Total DSO : (Billed+ Unbilled BR) / Revenue * 365

We have computed the weighted average of the 10 major companies to depict which companies are above and below these averages. Readers can take reference to this and assess what should be their ideal DSO for their company.

Further we are explaining various good/best practices to monitor the receivables and improve your DSO. Hope you will find the same useful and take benefit of the same.

As always, we value your feedback and comments, so please feel free to write to us.

Note: Unbilled BR of CoForge not available separately

“Red” refers to cases where the FY23 are higher than FY22 and if “Green” means the FY23 is lower than FY22.

Focus on DSO Reduction: Improvement of DSO gives tangible increase in cash/working capital.

Few inputs and suggestions to improve DSO

• Thumb rule Check: Weighted Average Credit Period + 30 days should be your ideal DSO, if you are marginally higher by a few days it is fine, else there is a need for improvement.

• Aging analysis of the Receivables: Do not slacken ensure you review debtors by overdue aging buckets. Any overdue debt above 30 days is a clear red flag, do follow through to collect.

• Debtors outstanding reconciliation is a very essential activity to avoid any disputes. Avoid having unadjusted credits, match invoices when you receive money and revert to customers if money is part paid or missed out. Knowing the reason for the deduction/skip is essential to be sure the debt is good or turning bad. When an outstanding statement becomes unreconciled with customers then we are in for a potential mess in that account.

• The invoicing process should be robust with zero error. Worst case, if it happens, the in-house team should give utmost priority to correct and resubmit the same without a delay and ensure it gets accepted by the client and not miss their accounts payable cycle. Do always keep track of the customers Accounts Payable (AP) process to get payment on time. Further do a six-sigma or root cause analysis and fix the internal process to avoid recurrence of this problem.

• Raise the invoice a few days before the month close and get the same duly accepted and if customer pays on time, then the DSO in those cases can be brought to 30 days tactically (exception to the rule of thumb). This must be enabled at the contracting stage by defining the methodology for adjustment in the next invoicing to achieve this.

• All recurring monthly billing ensures they are raised well before month closes so that they are paid before next month (if 30 days cr.)

• Unbilled BR is another major issue in IT companies – client wise one must do a root cause analysis (RCA) and fix the process to see how contractually the billing can be done ahead of month close. In Fixed Price Projects (FPP), the payment milestone gets married to Project milestones (which may have elongated gaps), explore how we can delink the same and structure the payment cycle in the contract with shorter payment milestones so that every 30-45-60 days there is a point of sub-reference to major milestones to get a steady cash flow from the project. Many times, the project delivery may be happening to meet the milestone, revenue will be accrued on % completion. In parallel, we may end up missing to note that our unbilled receivables are bloating with a potential invoicing and collection risk. In a shorter milestone the bad news will come out quickly and mitigation action can also be taken in a timely manner.

• Unbilled BR in T&M projects more than 30 days puts revenue at risk, and one might have to take the hard call to reverse the revenue if there is no line of sight for billing since it only means the revenue was not there in the first place to accrue.

• In case of FPP projects, if there is effort over run, one may consider pausing the revenue and stop the increased unbilled if they foresee a revenue at risk situation. Do note the delay in unbilled receivables conversion is also an indirect credit period for the client, so it is essential we get this math in our mind and ensure proper tracking and monitoring is in place. 

• Requests for cash discount, supplier financing wherein we can collect the money faster is tempting. It is essential to study the cost of borrowing, borrowing needs and its easy availability and take a balanced call and not blindly decide if money is paid early.

• A word of caution: Few companies sell their BR, this would cost money but do remember when the sale happens it benefits bringing DSO down with a skew and a skew on opposite side will happen when the company stops this activity. So, if this is done consistently without a break it should not impact but a yoyo will impact investor confidence for being inconsistent.

• To re-iterate, receivables management process is a process which can never go into a pause / sleep mode it will be on continuous follow up play mode only.