Don’t get Caught Comfortable in Today’s Economy [Part 1]

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Many Economists are speculating that interest rates have to rise from these somewhat artificially low levels.

My customers (Enterprise Companies) have expressed some concern that Janet L Yellen the new Chair of the Federal Reserve will turn her ship the ‘QE2’ back to port, and in turn that will lead to higher interest rates, borrowing costs and a weakened economic multiplier effect. My reference of “QE2” being short for the Quantitative Easing Program, which has been designed to keep interest rates and inflation at historic lows to aid economic recovery.

Days Sales Outstanding and Interest Rates

federal - reserve - money - automation - day sales outstandingI began thinking what would it mean if a company with revenue of $700 million per annum were able to shorten their order to cash cycle by shaving off 3 Days Sales Outstanding (DSO), and what would that mean if the US prime interest rate rose from 3.25% to 4.25%. It’s apparent to me that companies who borrow more are going to pay more, and companies with large cash savings would earn more interest. However, in both situations shorter DSO would free up cash flow, so less funds need to be borrowed. Alternatively, there would be more cash reserves upon which interest could be earned.

 

Even though the last two years have seen dramatic increases in the amount of cash reserves many blue chip companies have at hand, the vast majority of companies still borrow money to maintain cash flow.

And for You “Number-Crunchers” Out There…

Based on a 1% change in the interest rate my example company would pay an extra $7 million in fees, or save an extra $7 million if they had all the money in savings. I realize they would probably not have all their money saved in the bank or on loan.

Based on 65 days DSO being cut by 3 days, I calculated that could be worth as much as $186,984 at an interest rate of $3.25%—or $244,518 if the QE2 is returned to dry dock and the theoretical 4.25% interest rate existed.

In my next blog, I’ll turn my attention to a few vendors that provide automation solutions that aid DSO reduction. Their focus spans from receipt of the customer’s order all the way through to collecting and applying cash. Ultimately, this allows the CFO to have a better picture on where to invest and the ability to reduce borrowing/cost of capital or the ability to put more capital into an interest earning account.

More to come…

Daniel Reeve

Dan Reeve has been with Esker for 18 years. As Sales Director he helps companies streamline and improve visibility across order to cash and procure to pay. Transforming customer service and helping companies utilize digital transformation in order to compete via service/customer loyalty. For P2P it means accelerating invoice approval, paying suppliers faster, freeing up cash flow and leveraging supply chain finance opportunities.

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