Paying to Get Paid

How can you drive improvements to your bottom line? Check your accounts receivable function — it may have a leak

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.

¥ Exception Resolution. If an exception arises when the shipper is processing the invoice, the carrier's A/R department either attempts to resolve the differences with the shipper's A/P department, or the shipper simply short-pays. The primary source of direct administrative costs in exception resolution involves the cost of telephone calls to shippers to check on the status of invoice payments, as well as the time spent by personnel in making these calls. The Ernst & Young study documented a solid $0.58 per invoice, which reflects both the cost structure and exception rates of the study population.

¥ Cash Receipt and Application. This process encompasses all the activities associated with receiving cash and posting it against the correct open items and was estimated at $0.30 per invoice, perhaps reflecting the move to Electronic Funds Transfers (EFT) by carriers.

Collections. Collections represent the single biggest component of administrative costs, averaging nearly $1.28 per invoice. The primary administrative costs are related to the numerous follow-up phone calls before overdue accounts are handed to a collections agency or written off. There are also material costs associated with printing, stuffing and mailing the multiple reminder notices and balance-due statements.

The total administrative costs per invoice, summing all the above, is $3.68. This represents 30 percent of the $12.42 it costs to process a freight bill. Of course, as this cost is fixed per invoice, for smaller invoices amounting to $50 in value (i.e. smaller air shipments), the administrative costs account for nearly 80 percent of the total, fully loaded costs of freight receivables.

Financial Costs

We now delve into more detail on the two main components of financial costs: DSO carrying costs and bad debt expenses.

¥ DSO Carrying Cost. The financial costs of processing a freight bill include the cost of financing the receivable until payment is received, which takes 37 days on average (35 days, on average, for commercial accounts and 49 days for government accounts). According to the results of the study, many carriers were effectively invoicing a day or two after delivery but may not have been including this additional time in their DSO calculations. Also, certain personnel at the carriers had some misperceptions of the true "cost of funds;" some of the carriers perceived the cost of their funds to be in the range of 6 to 10 percent because their frame of reference was tied to the current short-term fund rates. In all actuality, they should have been using enterprise-weighted average costs of capital (WACC) to discount accounts receivable carrying costs. WACC factors debt structure, risk premiums, return on commercial paper and return on equity into total funding cost. In this broader view, freight carriers' DSO carrying cost is between 12 and 15 percent, and DSO carrying costs represent 1.4 percent (140 bps) of the invoice value.

¥ Bad Debt Expenses. Bad debt expenses, another component of financial costs, also are frequently omitted from carriers' A/R costs. Bad debt expenses apply to commercial shippers, since the government is generally not considered a credit risk. Currently, freight carriers' bad debt write-offs range from between 0.05 to 1.0 percent of total sales, with average bad debt expenses of approximately 0.7 percent (70 bps). One explanation for these figures is that bad debt expenses are treated as normal business losses, part of the risk undertaken to attract, service and maintain customers. The study showed that rigorous due diligence on account set-up, as well as the continual monitoring of account portfolios, could help to mitigate the possibility of bad debts.

In aggregate the bad debt expenses and the DSO carrying costs for the average carrier amount to 2.1 percent of total invoice value. So, for the average invoice value of $416, financial costs consume nearly $8.74 of total invoice value. Unlike administrative costs, these financial costs, which are a constant percentage of the invoice amount, increase as invoice sizes gets bigger.

A/R and Payment-processing Solutions

Several options are currently available to transportation companies seeking to lower their A/R costs. The most visible may be the use of traditional third-party payment providers (3PPs), which develop solutions aimed at the shippers' payables problem rather than the carriers' receivables problem. These providers typically bill the shipper either a percent of the payment processed or a per-invoice fee. These solutions also generally address the shippers' administrative costs through economies of scale, but their use is not without risk, as illustrated by the collapse of three 3PPs last year: Computrex, United Traffic Management Systems and Strategic Technologies Inc. (STI).

Moreover, third-party payer solutions do not address the carriers' administrative or financing costs. In fact, some solutions may add another layer of complexity for the carrier, as the 3PP often has to communicate with the shipper for guidance on resolving payment problems.

For freight carriers, software solutions can significantly automate the processing of BOLs and the generation of freight invoices (X04s, X10s, X14s, etc.). But one drawback of these solutions is that carriers need to develop communications interfaces with every shipper, which can be costly. In addition, these solutions involve shipping messages back and forth, with the result that shipper and carrier can still be working off of different views of the transaction  a common cause of disputes.

In an attempt to lower the costs of invoice delivery, some carriers are trying to implement electronic bill presentment and payment (EBPP) extensions to their Web-status tracking systems. However, customers may not prefer to access multiple systems to get their bills. Quick to identify an opportunity, EBPP aggregators have developed Web-based bill presentment solutions focusing exclusively on carriers.

State-of-the-art Internet-based payment solutions can provide carriers with sophisticated collaborative tools for document management, payment processing and exception handling. Shippers and carriers can feed documents directly to the solution provider, through electronic data interchange (EDI) or Web interfaces. When the carrier's invoice matches with the shipper's and proper notification has been provided regarding required physical supply chain events, the carrier is paid automatically. When matches fail, electronic payment solutions provide real-time collaboration capability for shippers and criers to resolve exceptions.

Through use of the collaborative workspaces and their automatic invoice payment capability, such Web-based solutions can lower the financial and the administrative costs associated with accounts receivable. The Ernst & Young study estimates that by implementing such solutions carriers can reduce lifecycle A/R costs by between 1.6 percent and 2.8 percent of invoice value.

Ashish Garg and T.J. Ijjima are senior managers in the Ernst & Young's Economics and Business Analytics Practice. Howard K. Bass is a partner in the New York Global Accounts group. They focus on deploying robust financial analytics to validate strategy/business models, as well as on creating integrated solutions that drive value for global companies.