Cash on the meter. Electricity and gas utility receivables: performance and leading practice

Transcription

1 Cash on the meter Electricity and gas utility receivables: performance and leading practice

2 Contents Section Page 1 Key findings 1 2 Methodology 2 3 Quantifying the cash opportunity 3 4 Key drivers 4 5 Current performance 6 6 Historical performance 7 7 Future trends 9 8 Lessons learned 12 9 Opportunities for improvement 15 Glossary 17

3 1 Key findings In the current environment, cash management is becoming critically important. Improving receivables management can release liquidity and increase operational efficiency. Working capital: a changing priority Over the last decade, the attention paid to working capital by utilities has wavered. In the early 2000s, when balance sheets were overstretched by aggressive acquisition and diversification strategies, it was of prime importance, not only as a source of cash, but also as a strategic way to improve operational efficiency and drive customer service. Since then, however, working capital in general, and receivables management in particular, have been on and off the industry s priority list. As the effects of the economic and financial crisis spread to industry, receivables management is once again taking center stage. Concerns over customers solvency are growing among utilities, and anecdotal evidence suggests that corporate and household customers may fall behind and default on payments. Potential for releasing billions in liquidity In this credit-tight environment, our research shows that utilities could unleash significant amounts of liquidity by improving working capital performance: as much as EUR6 billion to EUR14 billion roughly equal to 3% to 7% of their net debt. The deteriorating economic conditions across Europe in the last year have already had a marked adverse effect on utilities receivables performance. One of the key indicators, Days Sales Outstanding (DSO), increased by some 4% in the year from December 2007 to 2008, reversing the previous trend of year-onyear improvements. A snapshot of cash management across Europe Against this backdrop, we have compiled this report to examine current working capital practices across leading European electricity and gas utilities and how performance can be improved. Our analysis covers: Lessons learned from the UK retail electricity market and the telecommunications industry Opportunities for improvement Plenty of opportunities to get cash under control The positive news is that there are plentiful opportunities for most electricity and gas utilities to release liquidity from receivables: Legacy billing systems and processes of newly acquired businesses can be integrated to improve receivables performance and reduce working capital E-billing, new tariff models and smart metering can be used to release additional cash and improve liquidity through a more timely collection of revenues Different approaches to new customer assessment can be adopted to dramatically reduce billing errors and payment issues By renewing their focus on working capital in general, and receivables specifically, utilities can respond to the pressures of customer solvency, debt recoverability and declining output. While utilities face accelerated change from increased volatility in energy prices, an ever-shifting regulatory environment, unfavorable economic conditions and investor pressure on performance they must not lose sight of cash management. Those who put working capital at the top of their agenda have a chance to outperform the competition and be best placed to seize any opportunities that arise during this time of adversity. An overview of the key drivers affecting receivables performance and how they differ across Europe Current effectiveness of receivables management An in-depth look at receivables management from 2004 to 2008 Future trends in the economy, customer solvency and billing Cash on the meter Electricity and gas utility receivables: performance and leading practice 1

4 2 Methodology Our analysis is based on the receivables performance of 12 of Europe s largest electricity and gas utilities (by sales). This report contains the findings of a review of the effectiveness of receivables management in some of the largest European electricity and gas utilities (by sales). To ensure consistent and meaningful results, the utilities were selected on the basis of common structures and features. Each utility is active in at least three of the five key components of the value chain: gas production, electricity generation, transmission and distribution networks, and supply to end customers. The analysis on which this report is based is company specific, and provides metrics to give a clear picture of overall working capital management, as well as identifying levels of cash opportunity. The receivables cash performance metrics are calculated from publicly available annual financial statements issued by the companies. In order to optimize the comparability and consistency of the figures, adjustments (see glossary in appendices) have been made to the data to reflect the impact of acquisitions and disposals and off-balance sheet arrangements. Centrica E.ON Electricite de France Endesa Enel Energias de Portugal Fortum Iberdrola RWE Scottish and Southern Energy Union Fenosa Vattenfall While individual performance of the electricity and gas utility companies is not revealed, our analysis is based on the following 12 utilities: 2 Cash on the meter Electricity and gas utility receivables: performance and leading practice

5 3 Quantifying the cash opportunity Focusing on receivables creates an opportunity to release billions of euros in cash. Our analysis reveals significant levels of cash are tied up in receivables across the electricity and gas utility industry in Europe: The aggregate cash opportunity for the 12 companies we analyzed is between EUR6 billion (low estimate) and EUR14 billion (high estimate), as shown in Figure 1. This range is defined as the sum of the receivables cash opportunity derived when comparing a company s performance to that of the average (low estimate) and the upper quartile (high estimate) within the sample group This amount represents between 9% and 19% of the industry s total receivables (see Figure 2) By eliminating this surplus, the utilities analyzed could reduce their net debt by up to 7% and enhance their enterprise value by up to 2.3%, as shown in Figure 2 The figures for cash surplus need to be treated with some caution. Firstly, they are based on an external view of each company s receivables performance and have not been adjusted to reflect each company s operational business model and strategy, customer terms, geographical reach or product mix. Secondly, there are differences in the accounting and disclosure of trade accruals. The evidence, however, suggests that significant funds are tied up in the working capital of the European power and utilities industry. In this time of stricter lending conditions, acting on this cash opportunity could generate substantial competitive advantages for utilities across Europe. Figure 1: A significant cash opportunity exists for utility companies improving receivables performance Euro billion Source: Ernst & Young analysis, based on publicly available annual financial statements Figure 2 6b Low estimate 14b High estimate Cash opportunity From To % sales 1.6% 3.5% % total receivables 9% 19% % net debt 3% 7% % enterprise value 1.0% 2.3% Source: Ernst & Young analysis, based on publicly available annual financial statements Cash on the meter Electricity and gas utility receivables: performance and leading practice 3

6 4 Key drivers Utilities receivables performance is affected by a number of drivers that vary widely across Europe, including customer portfolios, billing arrangements and contract terms. In the European utility retail market, receivables performance varies greatly from company to company, and is less dependent on national characteristics than may be commonly assumed. The three drivers for performance are: Customer portfolio Metering, billing and revenue collection Tariff innovation Customer portfolio residential retail Utility residential retail markets are generally characterized by: Large customer bases with relatively low annual energy bills A low priority for paying these bills High seasonality but low elasticity of demand Recent price hikes due to higher commodity costs have led to increased challenges in revenue collection. To address fuel poverty, utilities in some markets need to provide assistance to their low-income customers with their utility bills. Customer portfolio commercial retail (SME) Small and medium-sized enterprises (SME) are often single-site buyers, with price being the most important differentiator. This segment usually comprises a large part of business for many utilities and is characterized by increased competitive pressure. For SME customers, utilities usually offer a range of different tariff models, including green tariffs, light load tariffs and fixed price contracts. The individual offerings depend on annual consumption, and whether there is a need for real-time metering. Customer portfolio industry retail (key accounts) This segment has a limited number of customers with relatively high annual energy bills: most industrial customers require multisite access including real-time metering, bespoke load profiles and real-time reconciliation of projected and actual load. To compete successfully, utilities increasingly look at value-adding services such as maintenance of the power equipment on the premises. In a more challenging economic environment, utilities are not only affected by declining revenues, but also increased bad debt, or uncollectable revenues. Responding to these economic circumstances, as well as everincreasing competitive pressures, is resulting in concrete actions: utilities are optimizing their middle and back office functions, improving customer screening, and seeking to reduce complaints to ensure timely collection of revenues. 4 Cash on the meter Electricity and gas utility receivables: performance and leading practice

7 Key drivers Metering, billing, and revenue collection Metering in the residential segment ranges from annual meter reads (e.g., Netherlands, Germany), to quarterly meter reads or estimates (e.g., UK), to monthly meter reads or estimates (e.g., Spain). Large consumers usually have monthly or even real-time automated meter reads, providing greater accuracy to consumers and reducing the administrative burden for suppliers. In terms of revenue collection, the three most common methods are direct debit (DD), standard credit (SC), and prepayment meter (PPM). DD is the preferred form of payment for utilities, as DD customers are generally the cheapest to serve and PPM customers the most expensive. For SC customers, there are some additional costs related to higher levels of working capital (because payments are recovered in arrears). According to Datamonitor 1, SC customers are charged up to 6% more than customers that pay via direct debit. For prepaid meters, higher administrative costs offset the lower working capital requirements. Tariff innovation as means to improve revenue collection To avoid cash peak demand and failed revenue collection, utilities generally prefer DD and/or budget plan payments, with monthly payments rather than bi-monthly or quarterly payments. However, switching to DD terms depends on the generally accepted payment principles in a given market. Electronic invoicing or online bills have gained some traction recently and have enabled utilities to save up to two days in revenue collection. Marketing electricity and gas as products rather than commodities raises customer awareness and may help improve revenue collection due to higher payment priorities for products compared to commodities. Billing and revenue collection processes differ by geography: utility bills may be reconciled on an annual basis for DD customers on monthly budget plans (Netherlands, Germany, Nordics); SC, occasional PPM and budget plan contracts (UK); DD on a monthly basis (Spain); or newly introduced monthly or bi-monthly bills on a budget plan (Italy). The disadvantage of the less frequent payments is the potential build-up of bad debt due to a peak demand for cash. Industrial and commercial (I&C) customers are divided by volume of energy usage. For smaller volume customers, the approach is similar to residential, with monthly meter reads and bills. For sales to large volume customers, utilities offer bespoke billing solutions, including automatic half-hourly metering, DD payments, and usage-related unit costs. A key accounting concept in the utilities payment cycle is unbilled debtors. This relates to energy which has been used by the customer but not yet billed (or paid for). Unbilled debt is a key component of overall receivables performance and partly reflects a utility s billing cycle, but is also driven by energy usage that cannot be billed due to inaccurate metering or customer information. 1 Source: Tariff Innovation: a compromise of practice and potential across liberalized and liberalizing markets (2008) Cash on the meter Electricity and gas utility receivables: performance and leading practice 5

8 5 Current performance The industry currently exhibits a wide variance in receivables performance, with the key metric of Days Sales Outstanding (DSO) ranging from 45 to 111 days. To enable comparability across the industry as accounting methods vary, the DSO calculation for each utility has been based on total trade receivables net of customer advances (excluding connection fees) in relation to pro forma sales. As shown in Figure 3, DSO performance varies dramatically across utilities, from 45 to 111 days. This wide array in receivables performance suggests significant potential for improvement across the industry as the best practice performance (upper quartile) is 53.2 days. We also note that the results vary, in part, due to different types and levels of integration of assets (supply, generation, transmission and distribution); customer base (commercial and residential); country sales; and local payment terms and regulations. To some extent, this divergence may also reflect variations in the proportion of revenues generated by trading operations, compounded by differences in the way these operations are accounted for. Contrary to expectations, there is no strong relationship between individual performance and country location, which may suggest fundamental differences in process efficiencies between companies (barring any variations in accounting methods). Days Figure 3: Receivables performance varies dramatically across utilities, with average DSO 1 of 66 days Average Average Sales weighted refer to glossary for calculation methodology of DSO Source: Ernst & Young analysis, based on latest publicly available annual financial statements 45 For the companies included in our review, 61% of their sales are still achieved in the home region, with only a quarter making less than 50% of sales in their home region. Europe (including Central Europe) represents over 90% of sales. Most of the gas incumbents are only active in one or two markets beyond their home region (over 90% of total sales). The data suggests that those companies which are currently below average on the DSO metric, or that wish to improve their performance, could gain valuable insight into leading practice processes and systems from looking at both peer companies and similar industries around Europe. 6 Cash on the meter Electricity and gas utility receivables: performance and leading practice

9 6 Historical performance: by utility While overall progress has been achieved, analysis of individual performance reveals major differences in results. As shown in Figure 4, of the 12 utilities analyzed, 7 were able to improve their performance from 2004 to 2008, while the remainder experienced a decline. Overall, the average Day Sales Outstanding (DSO) reduced from 73 days in 2004 to 66 days in Despite this, the DSO metric required to be in the top quartile of our sample population deteriorated from 51 to 53.2 days. This illustrates that the improvement was driven by isolated instances, rather than industry-wide efforts. A likely explanation for this pattern is that utilities attention, over the period under review, was focused on revenue growth activities such as gaining customer share, entering new markets, responding to increasing competition in the market, and improving performance in the key areas of price and customer service. Working capital in general, and DSO in particular, has not been a key area of focus in recent years we expect this to change in the coming year as new pressures around customer solvency, debt recoverability, and declining output emerge. The main caveat behind analyzing individual performance is that the industry has experienced substantial consolidation and expansion in the last five years; these changes, too, may have significantly affected performance. Figure 4: Significant variations in sales weighted DSO performance by utility between 2004 and 2008 were unconnected to M&A or other one-off factors 1 Days Average 2008 Average Source: Ernst & Young analysis, based on publicly available annual financial statements 2004 and However, our analysis of performance during 2004 to 2008 shows that the 7 companies that improved their performance which accounted for 55% of the total industry sales managed to reduce receivables by 16% on a sales-weighted basis. None of the four largest improvements in terms of percentage gains in Figure 4 (Utilities 2, 6, 8, and 12) were related to major M&A events. Similarly, among the three companies showing the sharpest deterioration in receivables performance, only one result can be explained by the impact of a significant change in the scope of consolidation. The implication is that major utilities can, with the correct focus and strategies, drive significant cash gains from improvements in debtor management. Cash on the meter Electricity and gas utility receivables: performance and leading practice 7

10 Historical performance: average DSO From 2004 to 2008, the industry improved its average Day Sales Outstanding (DSO) by 9%. As shown in Figure 5, utilities have made some progress in cutting the level of receivables since 2004: DSO fell by 9% between 2004 and 2008, from 73 days to 66 days. Several factors have contributed to the improved performance: Stronger management focus on receivables Increased build-up of good working capital practices into the design of new products and services Improved credit management processes, harmonization and consolidation of billing systems, increased numbers of customers using DD and the development of e-billing However, the data pattern suggests that while some quick wins have been generated in the past, receivables performance has slipped down today s utilities agenda. For the industry as a whole, there is no firm connection between nationality and receivables performance, suggesting that, more than anything else, general management focus and efforts are driving receivables performance. A general note of caution on the analysis of receivables performance is required, as year-on-year comparisons may have been affected by energy price movements and changes in the degree of consolidation due to M&A activity. There was heightened volatility in electricity and gas prices during this period, the extent of which was determined by each company s relative exposure to regulated and unregulated businesses and by the degree and speed with which the utilities were able to pass costs through to end customers. Figure 5: Average DSO 1 performance improved by 9% in the 4 years from 2004 to 2008, from 73 to 66 days Days DSO Sales 1 DSO metrics are sales-weighted Source: Ernst & Young analysis, based on publicly available annual financial statements Sales ( m) 450, , , , , , , ,000 50,000 - From 2005 to 2006, there was an accelerated reduction in DSO, resulting largely from the positive impact of exceptionally mild weather conditions in the last quarter of the year (the warmest autumn since records began); this led to much lower quantities of unbilled energy. In contrast, the return to more normal cold weather conditions affected the 2007 performance, along with increased wholesale and retail commodity prices which may have led to less significant DSO improvements compared with previous years. In 2008, however, it appears that the pan-european deterioration in economic conditions and personal and corporate solvency started to affect the recoverability of utilities debts. Certainly, the provision levels achieved in previous years have started to increase again in Cash on the meter Electricity and gas utility receivables: performance and leading practice

11 7 Future trends: economic development Looking ahead, the recession is likely to have a negative impact on receivables performance; utilities must adopt best practice and encourage innovation to offset this. So what can we expect in the years to come? A number of diverging trends look likely. As a result of the negative financial and economic environment (see Figures 6 and 7), companies can expect to be hit by both a deterioration in the level of trade receivables and declining electricity consumption. While it remains to be seen how severely the recession will affect the payment behaviors of corporate and household customers, lower consumption may result in decreased revenues, downward pressure on power prices, lower quality trade debtors, and higher levels of bad debt. As a counter to these, receivables performance should continue to benefit from ongoing management initiatives and advancements in market and payment methods. Further improvements may emerge with the adoption of leading practices, process thinking, technologies and innovation, as well as benefits from previous industry consolidation. The caveat to these forecasts lies in the degree to which utilities will be able to pass on to customers any rises in energy prices and if they are allowed how quickly they can do this. The trend will also be influenced by changes to the level of costs to serve customers and quality of service. In the longer term, receivables performance will increasingly depend on utilities finding the right balance between operational and cash excellence with the need to protect and develop business against a background of increased competition. Figure 6: EU GDP at constant prices (annual % change) GDP change (%) % 0.9% -4.0% -0.1% Source: Ernst & Young, based on European Commission (Directorate General for Economic and Financial Affairs): EU Spring Economic Forecast 2009 Figure 7: EU27 confidence indicators GDP change (%) Industrial confidence Consumer confidence Source: Ernst & Young, based on Eurostat Cash on the meter Electricity and gas utility receivables: performance and leading practice 9

12 Future trends: customer solvency Utilities are responding to the economic downturn by taking another look at bad debt provisioning. In the last few years, utilities have paid much more attention to credit management, resulting in an improved customer debt profile and lower provisions and write-offs. Yet utilities still exhibit a wide range of bad debt performance at both the profit and loss account (P&L) and the balance-sheet level, raising questions over policies and their efficiencies. As shown in Figure 8, there has been an across-the-board reduction in the level of bad debt on the balance sheet from 2004 to 2008, from 1.3% of sales to 1.1% respectively. This has been due to: Improved credit management processes (notably with low income and vulnerable customers) Figure 8: Provisions for bad debt on the balance sheet have increased slightly since % Sales De-provisioning Write-backs from excessive levels Clearly, management actions in this area from 2004 to 2008 were helped by the favorable economic conditions across Europe during that time period. In 2008, the level of provisions for bad debt in the balance sheet averaged 1.1% of sales, with a range of 0.7% to 2.5%, while the level of bad debt in relation to sales charged to the P&L averaged 0.5% among those disclosing this information Source: Ernst & Young analysis, based on publicly available annual financial statements These differences in performance across utilities can be attributed to provisioning policies as well as country and service line exposure; however, they also reflect differing customer debt profiles, commercial strategies, and credit management process efficiencies. A more granulated analysis per payment type reveals a much higher level of bad debt for standard credit (SC) than for direct debit (DD). There are also additional costs to serve SC customers, which explains why companies seek to encourage greater take-up of DD. While it is still too early to detect hard evidence of corporate and household customers falling behind and defaulting on payments, there is no doubt that concerns over customers solvency are growing among utilities. In fact, many utilities are budgeting for a greater level of bad debt and trying to mitigate these higher provisions through performance improvements. 10 Cash on the meter Electricity and gas utility receivables: performance and leading practice

13 Future trends: billing systems Much more attention has been paid to billing systems but evidence suggests that there are still many issues associated with this area. Most utilities have been dedicating a lot of resources and effort towards harmonizing, integrating and consolidating billing systems to allow multi-services, data accuracy, cost effectiveness, speed and simplification of delivery and easier bill understanding, while driving up customer satisfaction. Evidence, however, suggests that utilities are facing a number of challenges, not least the growing complexity in billing. Extended service offerings are on the rise, resulting in a far wider range of contracts and extra demands on billing systems. Furthermore, the introduction of smart metering will require supplier billing systems to allow more sophisticated tariffs. Secondly, there is generally little coordination or integration of business processes and communication systems between utilities and their commercial partners (retailers, distributors and other services providers). In addition, acquisitions have created a number of isolated legacy systems, which struggle to deliver services in a rapid and cost-effective way. Thirdly, costs to serve vary widely across the customer base by type and by country. And lastly, the regulatory environment has shifted towards greater customer orientation and protection of consumer interests (e.g., providing more generous payment terms for low income customers). As a consequence, utilities are starting to consider how best to leverage billing to improve cash performance, for example by: Minimizing the gap between service delivery and bill issuance to ensuring bills are produced and issued to customers on a timely basis Aligning billing cycles with customer payment behavior, to ensure bills reach customers at the points in the month when payment is most likely Facilitating flexible risk-based payment requests by being able to accommodate customer categorization and support a variety of credit control steps and timelines Highlighting high usage so that timely interventions can be made Allowing better management information around receivables and collections performance Cash on the meter Electricity and gas utility receivables: performance and leading practice 11

14 8 Lessons learned: UK retail energy market As the UK utilities market is the most deregulated in the world, it offers relevant insights on market structure and payment practices. Analysis of the UK utilities industry provides useful insight into the different payment terms across the energy value chain. The UK energy market is generally accepted to be the most deregulated and competitive market in Europe, as accounting unbundling between the generation/retail services and the transmission/distribution networks has been in place since As such, the key themes and issues from its development may become relevant to the rest of Europe as competition in the utilities industry increases. Consolidation has created six main electricity players The UK electricity and gas retail markets have consolidated in the last 10 years. There are now six main energy suppliers (Centrica, E.ON UK, EDF Energy, RWE npower, Scottish Power and Scottish & Southern Energy) active in the household market, with additional companies active in the large user sector. Essentially, these suppliers are vertically integrated in electricity (although with accounting separation in place), while this is less of a feature for gas (with only one of the big six having significant gas production capability). At the end of 2008, there were around 27 million domestic electricity accounts with the six suppliers, accounting for nearly all of this market; each had a similar market share. There were also around 23 million domestic gas customers, with one supplier holding a much higher market share than the others. For residential and commercial customers, terms are generally 14 days. Longer credit periods are known to be granted to companies with good credit records, although there is also often a cost impact in respect of this. Equally, companies with poor credit ratings are likely to be on shorter payment terms than the standard, with guarantees in place in some cases. Billing is quarterly for residential customers (although monthly statements for DD customers are produced) and monthly for I&C customers. Larger industrial and commercial (I&C) customers tend to be on half-hourly meters for electricity (daily for gas) with consumption data transmitted automatically to the supplier. Our analysis of the retail operations of the big six UK utilities indicates a range of days for billed DSO. This comprises a nominal payment period of days for both DD and SC customers, plus the time taken for processing and a proportion of overdue bills. This has tended to decrease since 2004, although across the sample significant variations in performance exist between companies. Unbilled receivables varies widely between companies but averages just under 30 days, being partly financed by payment on account. Payments: Fixed terms and Direct Debit (DD) the most common Certain payment terms in the UK system are fixed, either by the regulator (transport networks, electricity balancing system) or by contract (offtake agreement, I&C customers). The typical terms in these cases are shown in Figure 9 (see page 13). Key constituents of the overall Days Sales Outstanding (DSO) balance not shown in Figure 9 are unbilled receivables and non-energy debtors such as new connections. Direct debit (DD) is the most common form of payment in the UK, accounting for 43% of total accounts for both fuels. Its takeup grew steadily from 2004 to 2008 (up by over 1% per year), primarily to the detriment of standard credit (SC), which remains a significant payment method (40% of total). Prepayment meters (PPM) are less common at 16%. 12 Cash on the meter Electricity and gas utility receivables: performance and leading practice

15 Lessons learned: UK retail energy market The highest annual churn rate in Europe The UK has by far the highest annual churn rate in Europe, at 18% for both electricity and gas supplies, reflecting its advanced stage of deregulation. France and Belgium, by comparison, have the lowest scores at around 2%. Price remains the largest factor affecting a supplier s churn rate, but consumer behavior surveys also mention a far wider range of factors than relative prices, such as customer service and product offerings. This provides strong incentives for energy providers to deliver in those areas. According to Ofgem, the UK energy market regulator, the cost to serve energy customers in the UK is between 40 to 80 per customer per year. This variation results from differences in customer types, business models and corporate strategies across energy providers. Lessons learned Some of the key lessons learned in the UK s competitive energy market include: Getting new customer details right first time is central to effective billing and debt recovery Effective credit rating checks of new customers are far more efficient than trying to chase non-payment The drive for costs and efficiencies, along with ongoing M&A consolidation, is not always conducive to maintaining system and data robustness Timely and accurate meter reading for residential and small business customers is vital Figure 9: Typical DSO terms in the UK electricity market Electricity Generators Transmission networks Distribution networks Counterparty Suppliers Balancing system Generators and suppliers Standard terms Contracted Fixed Fixed Typical period 30 days 28 days 14 days Suppliers Fixed 14 days Suppliers Consumers I&C - contracted Domestic - variable Figure 10: Typical DSO terms in the UK gas market Gas Gas producers Transmission networks Distribution networks Counterparty Power generators Suppliers Gas storage Standard terms Contracted I&C - 14 days Domestic - DD, SC, PPM Typical period 30 days Suppliers Fixed 14 days Suppliers Fixed 14 days Suppliers Consumers I&C - contracted Domestic - variable I&C - 14 days Domestic - DD, SC, PPM Accurate calculation of DD values to ensure payment adequacy is critical, but clear and transparent communication with customers is also important to ensure that changes to monthly DD values are understood and accepted Basket/portfolio deals for groups of business customers are becoming more common Trade associations, agents, and brokers are increasing in importance and present new challenges for utility companies Cash on the meter Electricity and gas utility receivables: performance and leading practice 13

16 Lessons learned: telecommunication Utilities may identify further opportunities for receivables improvement by examining the practices of telecommunications operators. With regard to customers, utilities and telecommunications services share common features and business issues. Lower DSO in the telecommunications industry However, as shown in Figure 11, European telecommunications operators exhibit a much lower level of receivables (DSO of 53 days in 2008) than their vertically integrated energy peers (DSO of 66 days in 2008). These comparisons are based on a parallel review of the receivables performance of the largest European telecommunications operator (by sales). DSO in utilities appears to be both higher in absolute terms and more volatile than in the telecommunications industry. Interestingly, overall performance improvements in the period have been similar, with 6% reduction in DSO in both the utilities and the telecommunications industry. Lower deferred revenues On a receivables cycle basis, both industries also differ on the nature and level of deferred revenues carried in the balance sheet. For the telecommunications industry, deferred revenues relate to amounts billed in advance for line rentals and subscriptions, with a significant proportion coming from PPM customers. For the utilities industry, deferred revenues mostly relate to the fees paid by customers upon connection to the network and transferred to sales over a period that depends on the useful life of the assets, or the estimated term of customer contracts. For the latter, their levels vary widely across the industry, depending on local and accounting requirements and choice of methods. For telecommunications operators, current deferred revenues represented 4.2% of sales on a sales-weighted average in Explaining the performance gap? What can this performance gap between the two industries be attributed to? The following factors undoubtedly play a role: Variations in payment terms and methods, with a higher proportion of unbilled receivables (longer periods in arrears) and a lower number of PPM or DD customers among utilities More stringent regulations on debt management for utilities, affecting customer payment behaviors and leading to higher recovery costs (resulting in companies balancing the risk of bad debt against the cost of managing this debt) Differences in credit management and provisioning policies, with similar levels of bad debt expensed annually in the profit and loss account (P&L) at 0.5% of sales, but with much higher levels of provisions for bad debt for telecommunications operators (15% of gross receivables) than for utilities (6%) Other relevant factors include seasonality and weather variations in demand, the partial absence of real-time information on usage and an ever-shifting regulatory environment. Yet all these factors alone are not enough to explain the size of the gap, suggesting that utilities could benefit from examining the practices of telecommunications operators in this area. Lessons learned Key lessons learned from the telecommunications industry include the need to: Build good cash practices into the design of new products and services Conduct robust credit vetting, which is then used to manage collection risk Tailor credit control cycles according to customer risk profiles and prior payment behavior The key lesson is that the telecommunications industry has, over time, put in more effort at managing receivables and continuously improving its practices and processes. Figure 11: DSO performance across European utilities and telecommunications operators, Days Source: Ernst & Young analysis, based on publicly available annual financial statements 14 Cash on the meter Electricity and gas utility receivables: performance and leading practice

17 9 Opportunities for improvement There are a number of areas that offer significant opportunities for improvement in utilities receivables. Realizing the full benefits of a comprehensive approach to receivables management requires: Implementation of leading practices (with the associated challenge of identifying, adapting and improving best practice solutions) Management s full commitment, including balanced financial incentives Achieving true collaboration with retailers, distributors and other service partners to provide better products and services to the market and reduce time to raise and collect invoices generated by joint activities Typically, we would expect the full cash and cost benefits realization within months from the launch of a working capital program. Changing behaviors and developing competencies within the organization at all levels An effective receivables management strategy will focus on the following actions that offer the best opportunities for improvement: Building cash up front by reducing billing in arrears (unbilled debtors) and by moving back the invoice trigger time Incentivizing cash performance as a meaningful key performance indicator (KPI) Better communication with customers (including enhancing call center efficiency), improved customer segmentation, tailored payment offerings and effective credit rating procedures Getting the right balance between standard credit (SC), direct debit (DD) and prepayment meter (PPM) for your particular customer base Performing robust and accurate customer acceptance procedures, to minimize incorrect payee data Conducting timely, easy-to-read, and accurate billing, as well as more proactive and targeted collection processes Dealing with disputes effectively namely by resolving them in a timely manner, while also eradicating the root cause of issues that give customers a genuine reason to defer payment Effectively managing payment terms for customers, including renegotiation of terms Moving non-paying customers to PPM promptly Increasing billing frequency (noting, however, the extra IT and administrative costs associated with this) and e-billing Cash on the meter Electricity and gas utility receivables: performance and leading practice 15

18 Opportunities for improvement How truly effective is your working capital management strategy? Some typical questions you should be asking include: 1. Are you doing anything differently today to optimize your working capital? Is there a strong cash culture within your organization? Do you use predictive rather than historical indicators for cash and working capital performance? Do you invoice all revenues on a monthly basis and non-usage charges in advance? Do you raise and collect customer invoices in less than 30 days and interconnect billing in the same month? Have you changed your collections strategy to reflect credit risk in the current environment? Are levels of customer disputes rising and have you seen any increase in the level of credit notes issued? Is the level of overdue accounts below 10%? Do you measure and target unbilled revenues? Are the majority of your customers on direct debit? 11. Do you consider the impact of longer terms on the viability of key suppliers and, if so, do you have alternative suppliers in place? Are all suppliers on terms of 60 days or greater? Do you consider product or tariff design as one of your key tools in improving your working capital position? 16 Cash on the meter Electricity and gas utility receivables: performance and leading practice

19 Glossary DSO (days sales outstanding): year-end reported trade receivables net of provisions, including VAT, added-back unbilled/ trade-accrued income and securitized receivables, and work in progress, divided by full year pro-forma sales and multiplied by 365 (expressed as a number of days of sales, unless stated otherwise). Receivables cycle: trade receivables (net of provisions) + unbilled/trade-accrued income + work in progress deferred income customer prepayments. Unbilled/trade-accrued income: usage, subscriptions, and installations which have been supplied but not yet billed. Unbilled receivables when reported separately have been added back to the trade receivables. Deferred income: amounts billed in advance, commonly including new connections revenue which is spread over the life of the asset or the customer contract. Pro forma sales: reported sales adjusted for acquisitions and disposals when this information is available. DD: Direct debit SC: Standard credit PPM: Prepayment meter I&C: Industrial and commercial (customers) SME: Small and medium-sized enterprises Cash on the meter Electricity and gas utility receivables: performance and leading practice 17

20 Ernst & Young Assurance Tax Transactions Advisory About Ernst & Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 135,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential. For more information, please visit Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. About Ernst & Young s Global Power & Utilities Center In a world of uncertainty, changing regulatory frameworks and environmental challenges, utility companies need to maintain a secure and reliable supply, while anticipating change and reacting to it quickly. Ernst & Young s Global Power & Utilities Center brings together a worldwide team of professionals to help you achieve your potential a team with deep technical experience in providing assurance, tax, transaction and advisory services. The Center works to anticipate market trends, identify the implications and develop points of view on relevant industry issues. Ultimately it enables us to help you meet your goals and compete more effectively. It s how Ernst & Young makes a difference. Contacts Jon Morris Working Capital Services Direct tel: +44 (0) jmorris10@uk.ey.com Marc Loneux Research Director Working Capital Services Direct tel: +44 (0) mloneux@uk.ey.com Dan Gambles Power & Utilities Transaction Advisory Services Direct tel: + 44 (0) dgambles@uk.ey.com Jens Grabow Analyst Global Power & Utilities Center Direct tel: +49 (0) Jens.Grabow@de.ey.com 2009 EYGM Limited. All Rights Reserved. EYG no. DX0057 This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor indd (UK) 04/09. Artwork by London DPD.