Customer Portfolio Approach to Managing Cash Flow Variability

Abstract

Cash flow variability is driven by operational decisions, and it influences operating performance and valuation. Despite this, and the early role that operations management scholarship had on cash flow management theory, the prevailing approaches for managing cash flow variability focus on financial remedies such as accessing external capital and engaging in financial hedging, and to a lesser extent, operational remedies such as sourcing goods in currencies that align with revenues and implementing product or production flexibility. Our research extends this set of remedies by proposing customer portfolio management and selective trade credit as operational hedges for reducing cash flow variability. We empirically validate our proposal by studying new customer acquisition events using a large database of customer-supplier relationships that we join with quarterly firm financial reports. Our analysis shows that firms reduce their cash variability by (i) pursuing customers with desirable order patterns that offset the cash flow variability from serving legacy customers and (ii) selectively offering customers trade credit that harmonizes payment terms in the customer portfolio. We strengthen the inferences from this analysis by assembling random samples of customers for each firm in our study, and show that the firms' actual customer portfolios yield lower cash variability compared to the counterfactual sets of randomly sampled customers.

Keywords: Cash flow variability, Working capital, Supply networks, Trade credit