Hello, presenting a perspective on the Order-to-Cash Cycle. I
have tried to demystify and simplify the process of Order-to-Cash or OTC or O2C.
So, what is OTC all about? Going by the generally accepting
definition “Order to cash (O2C or OTC) normally refers to the business
process for receiving and processing customer sales. It follows
"Opportunity to Order" and covers business-to-business (B2B) and
business-to-consumer (B2C) sales.” In simple terms, OTC refers to any business
right from the customer places the order till the cash / revenue received for
the product or the service delivered. Though this term is most prominent in the
design and improvement of Enterprise Resource Planning (ERP) systems such as
SAP and Oracle, this is an age old terminology which is prominent from post
industrial era in the 1950s.
A typical order to cash cycle consists of multiple sub-processes including:
A typical order to cash cycle consists of multiple sub-processes including:
- Customer order documentation
- Order Fulfillment or service scheduling
- Order shipment to customer or service is performed
- Invoice creation and dispatching to customer
- Customer remits payment /Amount Collection from the customer
- Record of Payment in general ledger
In many business models a contractual relationship is established first via a Contract or Subscription. Orders are then received via different sales channels, such as phone, fax, email, and internet or through a sales person. The contractual relationship is confirmed and the Orders are fulfilled through shipping and logistics. On completion of key events an invoice is generated and booked as Sales (subject to "Revenue Recognition" requirements). If payment has not already been received, the debt is recorded and pursued through dunning cycles until the funds are received. Order to Cash is completed by the Customer Care process (inquiries, requests and complaints).
Typical processes included in the OTC cycle are:
a.
Sales, who does the product / service selling on
behalf the company.
b.
Order drafting process, which drafts the order received
from the customer through Sales.
c.
Credit Validation, which validates the customer credit
worthiness, determines the Credit limit to be set, if any, and approves /
rejects the order based on the guidelines set.
d.
Fulfillment process,
which fulfils the customer’s requirement and customizes to meet requirements.
e.
Invoicing process (Or Billing), which generates
invoices for the products being delivered / services rendered and dispatches to
the customer.
f.
Collections process, which receives the payment for
the invoices.
g.
Cash Management Process, which typically applies cash
to the Ledgers and works on any disputes being raised by the customer and
resolve them.
Let’s consider the above Order to Cash process flow in a more
explanatory and a simple flow chart:
If we consider the ERP system flow, this is typically
categorized into the following eight sub-processes:
Customer presence
Order entry (creation of order / booking of order)
Order fulfillment (physical & digital fulfillment)
Distribution
Invoicing
Customer payments / collection
Cash Application
Deductions (If invoice Short Paid by Customer)
Order entry (creation of order / booking of order)
Order fulfillment (physical & digital fulfillment)
Distribution
Invoicing
Customer payments / collection
Cash Application
Deductions (If invoice Short Paid by Customer)
Order-to-Cash Metrics:
Like every theory requires a tool to measure the
effectiveness, Order to Cash also utilizes tools to review the Business cycle performance.
Although companies apply metrics at different stages of the order-to-cash process
(e.g. the number of days after order date/fulfillment that the invoice is raised,
proportion of invoices resulting in a query, speed of query resolution) the most
significant metric from liquidity and working capital perspective is Days Sales
Outstanding or DSO.
DSO is the average number of days between point of sale and
collection. Therefore, the lower the number of DSO, the fewer days it takes a
company to collect revenue.
DSO is calculated as:
Accounts Receivable x Number of
Days (i.e. 360/365)
Total Credit Sales
Total Credit Sales
Or:
Accounts Receivable/Total Credit
Sales
Number of Days
Number of Days
* Accounts Receivable = Amount of Cash Owing to Company (i.e.
invoiced and not received)
* Total Credit Sales = Annual sales where amounts are payable
after order/order fulfillment
* Number of Days = Number of Days in the year - i.e. 365
For example, assuming Total Credit Sales = €1,000,000 and
Accounts Receivable is €100,000
€1,000,000 / 365 = €2,739.70
DSO = €100,000 / €2,739.70 = 7.51 days
DSO can vary from month to month, and over the course of a
year with a company’s seasonal business cycle. If using DSO, it is important to
analyze trends.
For example, increasing DSO may be an indication of customer dissatisfaction or that extended payment terms are being offered (perhaps for competitive reasons or sales target pressures). It could also reflect inefficiencies in credit or collection processes.
For example, increasing DSO may be an indication of customer dissatisfaction or that extended payment terms are being offered (perhaps for competitive reasons or sales target pressures). It could also reflect inefficiencies in credit or collection processes.
However, DSO is not the most accurate indication of the
efficiency of the collections process. Changes in sales volume influence the
outcome of the DSO calculation.
For example, even if the overdue balance stays the same, an
increase of sales can result in a lower DSO. A better way to measure
collections effectiveness is to look at the total overdue balance in proportion
of the total accounts receivable balance (total AR = Current + Overdue), which
is sometimes calculated using the Days Delinquent Sales Outstanding (DDSO)
formula.
Metrics are available for “best in class” DSO for different
industries by companies such as The Hackett Group.
Please feel free to add on your comments and Reviews.
- Sunil Puppala
Please feel free to add on your comments and Reviews.
- Sunil Puppala
