Introduction

In 2024, businesses throughout the chemical industry are witnessing a startling rise in accounts receivable (A/R). On average, businesses are experiencing an 8% increase in Days Sales Outstanding compared to the same quarter last year, as detailed in our Q2 ’24 Working Capital Spotlight: Chemicals. Economic uncertainties and changing market dynamics are forcing companies to adapt their financial strategies, leading to increased payment terms and extended A/R periods. This trend poses several risks, including cash flow constraints and downstream unsuitability. Understanding the reasons behind rising A/R and the associated dangers of increased Days Sales Outstanding (DSO) is crucial for effective financial management.

Why is my accounts receivable rising in 2024?

Businesses throughout the chemicals industry are experiencing a rise in accounts receivable throughout 2024. If you have been struggling with a rise in A/R, the below may help to explain some of the issues currently at play.

Economic uncertainty.

The chemical industry, a cornerstone of the global economy, is grappling with an 8% year-over-year decline in sales.

What is driving this downturn?

As outlined in Deloitte’s 2024 Chemical Industry Outlook, economic uncertainties and fluctuating market demands have led to tighter budgets and cautious spending. In response, companies are adopting stricter working capital management strategies.

How does this impact A/R?

Your larger customers are critically focused on their cash conversion during periods of uncertainty. As a result, they will err on the side of caution for any invoice that needs payment. You may start to experience friction around invoice due dates including additional emails back and forth, excuses on why invoices are late, and even hints of longer payment terms.

Note: Don’t be surprised if experience some slight hiccups with your standard invoice processing throughout the second half of the year. Companies, even large, publicly traded enterprises, may still employ various techniques to delay their payment by just a few days to meet their working capital goals.

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Industry-wide extended payment terms.

What do extended payment terms mean for your A/R? Your competitors may be offering deeper seller terms to stay competitive and retain customers amid economic challenges. This may lead to an updated expectation on industry norms which can impact negotiations with new contracts.

Warning: this practice can impact cash flow and puts additional strain on financial resources. For small and medium-sized distributors, the balance between offering favorable terms and maintaining healthy cash flow is delicate and critical. Be careful on following competitors into offering extended terms without first addressing your working capital cycle.

Inventory levels near the lows.

How does industry inventory levels affect A/R? In efforts to shorten cash conversion cycles, companies have been reducing inventory levels over the last twelve months. This is evidenced by the large drop in Days Inventory Outstanding, or DIO, found in the Q2 Chemicals Index. While this strategy frees up cash tied in stock, it can also lead to supply chain inefficiencies.

Delays in fulfilling orders due to lower inventory can cause delays in customer payments, thus extending A/R periods. Your downstream customers likely have lower inventory levels than last year, which can lead to supply chain shortages and thus delayed payments.

Collection challenges

The complexity of managing collections has increased, particularly for companies with a diverse customer base that includes smaller retail and distributor accounts.

Despite technological advancements, the high volume and varied nature of transactions add to the challenge. Efficient collection processes and robust credit management systems are essential to keep A/R under control and reduce DSO.

According to the Atradius Payment Practices Barometer, 42% of invoices in the chemicals industry are paid late, which directly impacts DSO and cash flow.

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What Are the Risks of a Surge in DSO?

Cash flow constraints

Why is an increase in DSO a concern for cash flow? Longer DSO means companies take longer to collect cash from sales, creating cash flow constraints. This can hamper a company’s ability to meet operational expenses, pay suppliers, and invest in growth opportunities.

Your DSO is a key benchmark for the financial health of your organization. When A/R increases, your DSO will increase and you run the risk of not meeting your monthly cash expenses.

Importantly, not all A/R will be collected. A study by Euler Hermes found that businesses in the chemicals industry write off an average of 1.2% of their receivables as bad debt annually. This percentage might seem small, but for a company with $3 million in monthly sales, it translates to $432,000 annually.

Damaged supply chain relationships

How can rising DSO affect vendor relationships? Increased DSO can strain relationships with vendors who rely on timely payments to manage their own cash flows. Consistent delays in payments can lead to a loss of trust and reliability, resulting in less favorable terms or reduced willingness to do business. Maintaining strong vendor relationships is crucial for operational efficiency and negotiating better terms in the future.

As detailed in a recent McKinsey & Co report, long DSO cycles can strain the supply chain, leading to delays in procurement and production processes, ultimately affecting the timely delivery of goods and services to customers.

Long DSO cycles can strain the supply chain.

McKinsey & Company Improving the Business-to-Business Customer Experience

Inventory log jams

What impact does high DSO have on inventory management? High DSO can lead to inventory log jams, where projects stall due to lack of funds to purchase necessary materials. This can create bottlenecks in production and delivery schedules, further exacerbating cash flow issues and delaying revenue generation.

Efficient inventory turnover is essential for maintaining production schedules and meeting customer demands.

Staff retention risk

How does DSO affect staff retention? Prolonged DSO can result in cash flow problems that may lead to missed or delayed paychecks for employees.

This can significantly affect staff morale and retention, as employees may seek more stable employment opportunities. Ensuring timely payroll is critical for maintaining a motivated and productive workforce.

Missed financial opportunities

Effective A/R management provides valuable insights into customer payment behaviors and financial health. A poorly managed platform fails to capture and analyze this data, resulting in missed opportunities for financial optimization.

In fact, companies using advanced A/R analytics report a 10-20% improvement in cash flow management, according to McKinsey & Company. Remember, missing out on financial optimization opportunities means your business is not operating at its full potential, leaving money on the table that could be used for growth and investment.

Conclusion

Understanding why A/R is rising and the risks of increased DSO is crucial for small and medium-sized distributors in the chemical industry. Economic uncertainties, extended payment terms, inventory management adjustments, and collection challenges contribute to rising A/R. The risks associated with increased DSO include cash flow constraints, higher financial costs, reduced investor confidence, and operational inefficiencies.

To navigate these challenges effectively, companies must implement robust credit policies, leverage technology for better collections, and maintain optimal inventory levels. By doing so, they can enhance liquidity, improve investor confidence, and sustain operational efficiency in a volatile economic landscape. Proactive financial management and strategic planning are key to mitigating risks and driving growth in 2024.

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Learn how you can get paid upfront on your sales invoices.

Learn more→

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