Cash & Liquidity ManagementCash ManagementAccounts PayableUnlocking All the Cash

Unlocking All the Cash

Improved productivity and reduced costs are the most obvious and well-understood benefits resulting from accounts payable (A/P) automation. There is also a less obvious benefit that, in light of extremely tight credit markets, has become almost as important to most chief financial officers (CFOs): the ability to maximise working capital. Managing cash flow is critical for the smooth running of business operations, as well as for managing future growth.

The most astute finance managers are recognising that A/P offers significant opportunities to manage cash in two strategic ways: better discount capture and improved payment terms with suppliers. Payment processes and systems can be optimised to provide greater visibility and real-time performance management needed to achieve these goals. Once in place, these technologies result in a system of best practices in cash flow management that can continue to be leveraged, regardless of the economic cycle. This article describes technologies and strategies that can be applied to optimise working capital and detail the trade-offs to be considered in light of a company’s working capital needs and policies.

Figure 1. High Priorities for 2009

Source: Aberdeen Group, February 2009

Improved Discount Capture – or How to Earn +30% on A/P Invoice Discounts

Even in this low-interest environment, it is possible to earn up to 37% annually simply by taking available A/P invoice discounts.

For example, if a vendor offers a discount of 2% for payment within 10 days (2/10 net 30), savings would be US$2 on a US$100 order, if you simply pay 20 days earlier than usual. To figure out how this translates into an annual interest rate, we can use this formula:

Discounted amount/(Discounted price/100) x 360/N = Effective annual interest rate, where 360 = days in the fiscal year, and N = the number of days between the discount date and the final payment deadline.

So, in the ‘2/10 net 30’ case: 2/(98/100) X 360/20 = 36.7%.

Even if the discount terms are slightly different, the yields will far exceed any bank yields. For reference, here’s a list of effective annual interest rates for some common discount terms, as calculated by the American Institute of Professional Bookkeepers:

Table 1: Annual Interest Rates for Common Discount Terms

Source: American Institute of Professional Bookkeepers

Now, none of this is possible if invoice processing cycle times are too long, or if there is limited or no visibility into A/P discounts that are coming due, both common problems with paper-based A/P processes. In fact, according to The Hackett Group’s most recent A/P performance benchmark, the worst performing companies that have adopted minimal A/P workflow and process automation average well over 30 days to process an invoice. In contrast, top performers, whose operations are characterised by advanced A/P process automation, average three days.

A/P automation enables the prioritisation of invoices so that both A/P staff and approvers know which invoices need to be processed by when to capture those discounts. Most robust A/P automation solutions can also alert approvers with e-mail reminders and escalation procedures to prevent tardy approvals.

A robust A/P automation solution that shortens invoice processing cycle times and, beyond that tracks and sends alerts about upcoming discounts, can provide real value, enabling every negotiated discount to be taken and significant money to be earned.

Some A/P automation solutions will allow the attachment of supplier documentation, including contracts to the vendor master record. This helps to ensure contract compliance since contract payment terms can be easily checked for discount information.

Improved cycle times can also generate cash savings through reduced late payment penalties. Reduced cycle times, priority management, alerts and escalations can virtually eliminate late payments. Achieving fast payment-ready status also positions A/P to support procurement in the effort to further extend discounts, negotiating the traditional ‘2/10 net 30’ with additional suppliers, as well as dynamic or sliding-scale discounts.

Maximising Working Capital

A/P can also increase working capital by stretching payment terms and foregoing the discount. While it may be difficult to justify not taking advantage of an annual discount yield of more than 30%, there are some working capital tradeoffs.

In the financial supply chain, the classic tug of war is between buyers (A/P) and sellers (accounts receivables – A/R). The outcome determines how fast or slowly invoices are paid. Discounts notwithstanding, buyers want to pay as late as possible while sellers want the payment as early as possible. Each party is trying to optimise working capital, and when it comes to managing working capital, time is money. In fact, more businesses fail due to cash flow issues than lack of profits.

In today’s environment, where bank credit and loans are generally hard to obtain, ‘cash is king’. Lending standards are tighter and some banks have stopped lending and extending credit altogether.

The company that does not generate cash surpluses may run out of money – even if it is making a profit. The appeal of 37% yield notwithstanding, managing cash and keeping it for as long as possible may be more important.

A/P can improve working capital by deferring payments until due dates or even paying late. Stretching payments can be tricky, however. Paying suppliers late can cause many problems:

  • Higher prices: late payments may undo the favourable prices negotiated by purchasing. Suppliers may simply raise prices to cover the costs of financing tardy payments.
  • Vexed vendors: more inquiries and complaints from disgruntled vendors may increase an already significant drain on the productivity of A/P staff lacking in automated tools for responding to supplier inquiries.
  • Supply chain headaches: late payments may result in delayed shipments of goods and services. If these delays adversely affect core business, the benefit to working capital is questionable.

Rather than stretching payments, an A/P automation solution can help improve supplier credit terms. Paper-based processes frequently result in unpredictable and late payments while automated processes result in predictable payment timeframes. When supplier payments are accurate and on time, relationships are supported and strengthened. This can actually lead to the extension of payment terms (e.g. 15-20 days), allowing companies to hold on to cash longer and benefit from the improved cash flow.

In today’s economy, the decision to take every discount or negotiate better payment terms to maximise cash flow has strategic impact on an organisation. The decision is based on how badly cash is needed, the current working capital needs and company policies. But with all approaches and decisions, the A/P automation solution’s process efficiency and increased visibility pave the way to optimised cash management.

Whitepapers & Resources

2021 Transaction Banking Services Survey

Banking 2021 Transaction Banking Services Survey

CGI Transaction Banking Survey 2020

CGI Transaction Banking Survey 2020

TIS Sanction Screening Survey Report

Payments TIS Sanction Screening Survey Report

Enhancing your strategic position: Digitalization in Treasury

Payments Enhancing your strategic position: Digitalization in Treasury

Netting: An Immersive Guide to Global Reconciliation

Netting: An Immersive Guide to Global Reconciliation