Paying to Get Paid

Rising cost pressures and the slowing economy have put significant pressure on the already slim profit margins of the transportation industry, which has long been plagued with sluggish growth and low returns. As management teams continue their search for hidden fat in corporate budgets, the frequently neglected accounts receivable (A/R) function represents a prime opportunity to reduce costs. In an industry where the operating margins are in the single digits, reducing accounts receivable costs can deliver noticeable improvements to the bottom line.

A recent Ernst & Young study titled "What is the True Cost of Processing a Freight Bill" (2002) found that accounts receivable costs within the transportation sector can consume anywhere from 2 to 4 percent of the total invoice, depending on the mode of transportation and invoice value. The actual range maybe a bit higher, as these were estimates for large and efficient carriers with highly automated operations. All modes of transportation (rail, intermodal, etc.) were represented in the study across a carrier group with annualized revenue ranging from $35.6 million to $11.9 billion. However, as the average revenue was $2.1 billion per carrier, the results reflect a predominance of larger carriers.

The Ernst & Young study estimates the combined administrative and financial costs of a freight invoice to be $12.42, based on an average invoice of $416. While pure processing costs are estimated at $3.68 per invoice, regardless of invoice value, financial costs, such as receivable carrying costs, can run three or four times higher and may account for as much as 85 percent of the total A/R costs.

Administrative and financial costs can be thought of as the "visible" and "hidden" A/R costs. Administrative costs include the pure processing costs of creating and delivering invoices, receiving payment, applying payment, and resolving disputes with the shipper. These costs are quite visible as they include the fully loaded costs of personnel in the A/R departments, as well as general document handling and material costs. They are fixed per transaction and do not vary with the size of the invoice.

Financial costs are less visible as they are generally recognized only at the aggregate enterprise level and not by the individual functional units. Financial costs include two components: day sales outstanding (DSO) carrying costs and bad debt expenses.

DSO carrying costs are those costs associated with financing each additional day of receivables and, in turn, depend on two key parameters: the number of days the invoice is financed and the enterprise's weighted cost of capital. Current estimates of DSO carrying costs are about 1.40 percent (140 bps) of the invoice value.

The other primary financial cost component is bad debt expense the pure financial cost of eventually writing off a non-collectable invoice amount. The financial burden of writing off the bad debt is in addition to the time and resources spent in chasing the debt prior to write-off (such as collection notices, calls to the shippers), which have already been included in the administrative costs. Bad debt in the industry is estimated at 0.70 percent (70 bps) of invoice value.

Therefore, calculating the financial cost, which is not completely obvious; understanding the drivers; and focusing on the drivers all combine to deliver a significant impact on the bottom line.

Administrative Costs

Transportation carriers incur administrative costs throughout the life cycle of an A/R transaction. The major administrative processes and sub-processes in the A/R function are:

¥ Invoice Creation, Rendition and Delivery. This includes three major sub-processes: Data Entry for Billing, which includes detailed shipment data and such support documentation as Proof of Delivery notice, signature and tally sheet; Rating, which includes calculating the total invoice amount based on the proper contract/rate sheet and the specifics of the shipment being rated; and Invoice Rendition and Delivery, which includes all activities required to generate a well-formatted invoice and deliver that invoice to the correct billing address. Total invoice creation and rendition was found to cost $1.16 per freight invoice.