What Can Accounts Payables Do To Improve Cash Management?
As the current economic landscape continues to unfold, cash management has become a major factor in the decision-making of business heads. Companies are establishing a strong focus on Accounts Payable (AP) to search for any and all opportunities pertaining to cost savings initiatives.
Regardless of company age and maturity, cost management should be an integral component in all procurement and sourcing strategies. While typically not an area of focus in the past, companies are now turning over every rock to look for any additional efficiencies. If you are seeking to improve your cash management, there are key areas you need to focus on and methods that should be implemented.
Pushing Out Payment Terms
If your payment terms are below 60 days, then there is likely an opportunity to push out terms while avoiding noise from your supply base. There may be exceptions based on supplier diversity and business size, but the overall majority of supplier payment terms should be considered pushed out. Let’s take a look at an example of how this would be conducted:
Current Payment Terms: 30 Days
Push Out Payment Terms: 45 days
Annual Spend: $500M
Cost of Capital: 5.5%
Improvement in Average Days Payables with Push Out: 10 Days
Assumption Not All Suppliers Extend 45 Days Due to Existing Contract Agreements
Now we will compute the annual cost savings:
(Improvement In Average Days Payables/365) * Annual Spend * Cost of Capital =
(10/365) * $500M * 5.5% = $13.698M * 5.5% = $753,000
The company’s cash position improves by $13.7M, and at a cost of capital of 5.5%, the annual savings is $753,000.
For a company with $500M in spend, it is safe to estimate the cost to implement this project would be for six months with one program manager and one data analyst. This is likely a cost estimated not to exceed $120,000. Safe to say, this is not a bad deal.
Dynamic Discounting
Dynamic discounting is when a supplier provides a discount on an invoice for faster payment.
This concept is enticing to suppliers, especially when the standard payment terms are high. If
the payment terms are 45 days, then a supplier may want to get paid 30 days earlier by paying
a 1.5% discount. Let’s take a look at an example:
Annual Spend: $500M
Payment Terms: 45 Days
Average Discount Payment Terms: 15 Days
Average Discount Paid: 1.5%
Annual Spend at Discount: $50M (10%)
Cost of Capital: 5.5%
The savings with this discount:
(Annual Spend At Discount) * (Average Discount Paid)
$50M * 1.5% = $750,000
The cost with the discount:
(Annual Spend At Discount) * ((Payment Terms - Avg Discount Payment Terms)/365) * Cost of Capital
$50M * (30 days/365) * 5.5%
$4.11M * 5.5%
$226,027
The savings less cost for the discount is $523,973.
The process for dynamic discounting can be conducted in a manual mode through your supplier portal, or you may want to consider a Dynamic Discounting toolset to implement what is available in the market. You will need to account for the administration cost of AP processing the discounts which would fall under negligible cost. The last step would be validating that AP has the ability to pay under five days after receiving the invoice.
Accounts Payable (AP) Payment Frequency
While many Accounts Payable (AP) departments pay invoices on a weekly basis, considering AP switching to a bi-weekly payment schedule. Let’s take a look at an example:
Annual Spend: $500M
Cost of Capital: 5.5%
Current Payment: Weekly
New Payment: Bi-weekly
Now we compute our potential savings:
(Days Improvement/365) * Annual Spend * Cost of Capital
(3.5/365) * $500M * 5.5% = $4.795M * 5.5% = $263,698
This would be a simple implementation and there would be a need for messaging suppliers on the change in payment policy. There is likely no impact on terms in existing contracts.
Using an Average Days Payable Metric
In order to ensure compliance, establish a metric to measure average days payable on a quarterly basis. The metric computation is the weighted spend multiplied by the actual payment days. Here is an example:
As you can see here, the weighted actual days are 24 days. When the team is looking through payments, questions may arise on why AP paid ABC Semis ten days early. This is why this metric is key for AP, as this quarterly report is a scorecard for the AP department.
Auditing Invoices
Business owners (PO requestors) for indirect spend on the audit workflow approval likely do not validate invoices and simply auto-approve. This leaves open the question of whether the invoice and what was delivered actually coincide. In order to ensure that invoice accuracy is achieved, there will need to be periodic invoice audits. When suppliers are aware that their invoices are being audited, you will quickly witness the change in behavior from suppliers.
Let’s take a look at some scenarios that may occur and result in inaccurate invoices below:
Legal Matter - Legal matters often take up long periods of time and will result in multiple months. It is essential to look over all of your invoices and ensure that the business is not being charged duplicate service charges and that the agreed-upon rate is remaining the same. For a legal timekeeper’s hours, confirm that the total hours are legitimate. (e.g. if total hours are greater than 160, is that legitimate when there are 20 days in the month?)
Marketing Communication Services - Marketing communication services usually have multiple people involved, so you will need to validate the invoice with everybody and confirm that the agreed-upon rate is being charged.
Service-based contracts are notorious for adding extra fees and charges, which is why it is essential to look through every invoice that comes through. You could easily be paying for services that are automatically being added but not actually being conducted or approved.
Optimize Your Cash Management
Overall, there are plenty of opportunities to increase cost savings with Accounts Payable (AP), and optimizing your cash management will be key to the success of your business - especially during uncertain economic times. If you are seeking to optimize your cash management but don’t know where to start, it may be beneficial to seek advice outside of the company and have another set of eyes look into your cash management strategy.
Mike Glass runs GPC (Glass Procurement Consulting), a procurement consulting firm focused on optimizing a company's spend. Mike has worked in senior procurement management positions at NVIDIA, Google, Meta, Fitbit, and Flextronics. Mike would enjoy getting your insight on any procurement topic, feel free to contact Mike at mike@glassprocurementconsulting.com.
