Ensuring a business’s financial well-being is crucial for its success. This is particularly pertinent in the healthcare industry, where navigating reimbursement complexities and dealing with rising interest rates has made financial management increasingly challenging. Unsurprisingly, 2024 annual reports from medical device companies of all sizes have focused on improving cash flow to support ongoing operations and drive growth.

One way to improve cash flow is for companies to streamline their processes with their trading partners, such as automating contract dissemination, efficient invoicing, and prompt discrepancy reconciliation. By optimizing cash flow, the medical device industry can more closely align itself with the successful practices seen in other sectors, such as consumer-packaged goods.

In considering ways to improve financial health, companies must examine their practices of two key metrics: days sales outstanding (DSO) and days inventory outstanding (DIO). Both affect cash flow and working capital and represent the primary pain points of many medtech firms. 

DSO measures the average days to collect payment after a sale. DSO is often 30-60 days in the healthcare industry, and it’s not uncommon for some manufacturers to get paid 60 days late. The goal should be to get DSO below 30 days. DIO measures the average number of days it takes for a company to sell its entire inventory. By reducing DIO, companies can improve their inventory turnover, thereby reducing the amount of money tied up in inventory and freeing up cash. In the healthcare industry, achieving a proper balance in DIO can be tricky but is critical for maintaining financial stability and ensuring operational efficiency. 

Optimizing DSO can positively affect cash flow, reduce risk, and enhance a business’s creditworthiness. DSO is interconnected with other key metrics, including accounts payable (DPO), liabilities, and DIO. These metrics provide a comprehensive view of a company’s financial health.

The main goal is to improve cash position, which focuses on how much liquidity a business has relative to its liabilities. Combined with cash flow forecasting, it provides a clear picture of how much an organization can invest in growth without jeopardizing its ability to meet short-term obligations. Investors often look at a business’ cash position before buying stocks, and banks do the same before providing loans. A strong cash position can improve access to financing.

Steps to Lower DSO

Companies must embrace a continuous improvement mindset to adopt best practices for improving financial metrics. They can direct their efforts to several foundational areas.

Let go of outdated payment terms: In the 1980s, payment terms in healthcare were regularly set up at 2%, 20, net 30. Surprisingly, these terms are often still in place. Many customers automatically take the 20-day deduction without paying within the designated time frame. This is not a sustainable financial model. We’d never expect to rely on outdated technology from more than 40 years ago, so we shouldn’t expect to do the same for payment terms in an industry as dynamic and complex as healthcare. 

Organizations can still offer volume discounts, but the goal should be to drive greater accountability and partnership early in the negotiating process. As a best practice, sales teams should focus on negotiating prices, not payment terms, which should be set with the company’s overall financials, including cash flow, in mind. Sales teams and the C-suite should collaborate more closely on pricing and payment terms and, crucially, ensure customers’ enterprise resource planning (ERP) systems support those terms. 

Moving away from familiar terms may initially involve potentially uncomfortable conversations, but it’s time for companies to consider new payment rails that better meet the needs of both suppliers and their healthcare customers. The specific terms that are appropriate will vary across suppliers and customers, and there is no one-size-fits-all solution. 

Simplify go-to-market processes: Companies should also seek to reduce the complexity of some group purchasing organization (GPO) agreements, which often have 10-12 pricing tiers. Complex pricing results in errors on purchase orders (PO) and invoices, causing disputes and necessitating credit management and rebilling. Organizations with an exception rate of more than 2%—the standard for all other industries—should rethink their contract pricing. DSO can improve by simplifying pricing practices and getting winning prices out to customers.

Issue invoices promptly: To improve DSO, companies should also submit invoices promptly and accurately, aligning with the healthcare customer’s purchase order and including the PO number. In addition, most hospitals require manufacturers to upload invoices into an automated accounts payable (AP) system, and timely submission is essential, since it initiates the payment process. To meet the hospital’s requirements, it’s important to provide the invoice in the required format that matches the purchase order at a line level.

Companies should also use technology to immediately resolve discrepancies, which occur repeatedly. If it’s wrong once, it will be wrong 60 times. It’s not uncommon to have an inordinate number of credit memos managed at any given time, which negatively affects cash flow. The goal should be to minimize the number of credit memos.

Encourage electronic payments: The healthcare industry still relies too much on paper checks and credit cards. The problem with checks is that it’s challenging to match the payment with the corresponding invoices to close out the open accounts receivable (AR). The same is true for credit cards. Automated clearing house payments offer clear advantages, including automatic cash application. 

To encourage electronic payments, companies can offer customers discounts or rebates to pay within a shorter period of time—for example, 15 days or less, although the specific terms that make sense will vary—and set up clear, consistent credit policies to support them. This can be a win-win situation if both sides are aligned. At GHX, one of our largest manufacturers has witnessed a significant reduction in its DSO from 40 days to 11 days by offering such incentives. 

A measured approach to DIO: There isn’t a quick fix to improving DIO. Instead, medical device companies should consider implementing a five-year strategy. As a first step, companies should consider reducing the number of SKUs, especially if there are overlaps in the portfolios. No one wants to give up a single dollar of revenue today, but companies that take steps to optimize inventory and improve visibility are better able to focus on best-performing products, provide better services to their customers, and achieve better profitability through lower costs while managing inventory effectively.

Addressing the financial health of the medical device industry requires a back-to-basics approach. Prioritizing best practices, such as updating payment terms, simplifying pricing, and issuing invoices promptly can significantly improve cash flow and working capital.

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Denise Odenkirk is a vice president at GHX, working with manufacturers, distributors, and hospitals to improve their business processes. Odenkirk brings more than 20 years of experience in healthcare from a manufacturing, distribution, and third-party logistics perspective. Her career began in IT leadership roles at Warner-Lambert and Aventis and expanded to include operations while at Bracco Diagnostics, Owens & Minor, and Symmetry Surgical. Her passion is to improve healthcare supply chain business processes and help companies improve their overall healthcare supply chain efficiency.