The reclassification of inventory as unbilled A/R occurs because ASC 606 accelerates the recognition of revenue associated with customer contracts. The repercussions of ASC 606 for inventory management It takes time to build the necessary capabilities, however, and companies should act now to maximize their advantage. optimizing billing and performance milestones during customer negotiationsīy following this approach, defense companies can become more agile partners to government customers because they will have more cash on hand to respond to customer requests, such as those for new products.rightsizing production-cycle times to accelerate material through the factory floor.optimizing the end-to-end material-management process to reflect production needs.simplifying product portfolios to match customer demand.
Our experience leading working-capital transformations has allowed us to develop a new approach to managing inventory and unbilled A/R. We estimate that the top 50 defense companies worldwide could free up over $32 billion in cash that is currently tied up as unbilled A/R on their balance sheets. The defense industry has been under a higher regulatory burden than many other sectors because most of its business involves large products for which the government allows it to recognize revenue and bill costs over time. Now with a broader group of executives rightly involved in managing inventory, a relook at everything from incentives to processes and key performance indicators (KPIs) is needed to optimize cash. With ASC 606 creating much higher unbilled-A/R balances, inventory management morphs fromĪn operations task to a cross-functional challenge requiring the close involvement of CFOs, chief procurement officers (CPOs), COOs, and contract leaders. Both categories reflect revenue for products or services for which a customer has not yet been billed. For simplicity’s sake, this article will just refer to unbilled A/R, although the same principles apply to contract assets. Items fall into the unbilled-A/R category if the customer has not paid any consideration, but the right to reimbursement is unconditional and depends only on the passage of time. The right to reimbursement depends on something other than the passage of time, such as satisfactorily meeting performance standards. 1 A contract asset is an item (either a good or service) for which a customer has not yet provided any consideration. Under the updated guidelines, companies must reclassify much inventory held on balance sheets into one of two new categories that were previously less relevant: unbilled accounts receivable (A/R) and contract assets. But a new revenue-recognition framework, Accounting Standards Codification (ASC) 606, has complicated their strategy. A disciplined approach, they reasoned, could quickly generate enough cash to satisfy their obligations and provide a cushion against tough economic times. Traditionally, defense companies have tried to optimize working capital through strong inventory management. Adding to the attention, the COVID-19 pandemic has prompted governments, investors, CEOs, and others to take a closer look at the working capital of any potential contract partners, since this can serve as a proxy for their resilience. These ventures, requiring vast amounts of cash, have recently put working capital in the spotlight. With competition growing, defense companies have been increasing R&D investments, boosting capital expenditures, and aggressively pursuing inorganic growth through M&A.