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Working capital management: driving additional value within AP; Treasurers typically face the dilemma of trying to balance early payment discounts with maximizing float from short-term cash. Adding a purchasing card settlement capability within an EIPP program can be a major help.

Regardless of the economic climate, companies are always seeking new and innovative ways to reduce costs and increase revenues. One approach attracting attention from leading financial executives lately involves maximizing working capital--or extracting more value from short-term cash.

Accounts payable (AP) and procurement professionals often help their organizations realize working capital opportunities by streamlining processes for paying suppliers and securing the best supplier discounts and terms. Treasury professionals typically manage working capital through days payable outstanding (DPO) and by optimizing the use of cash.

Reaching these goals on a consistent basis, however, can be a daunting task as companies are forced to strike a balance between capturing the best early payment discounts and maximizing the "float" from short-term cash. Organizations can now leverage innovative methods to better utilize their working capital while balancing the needs of suppliers, procurement, finance and AP and treasury.

Challenges in Managing Working Capital

Companies striving to improve the way they manage working capital often struggle with paper-based, manual invoicing processes that result in lengthy invoice cycle times, which in turn makes it difficult to qualify for and capture early payment discounts. Because these companies allocate so much time and energy to simply processing invoices, they are unable to devote the resources needed to strategically identify and work with suppliers.

Multiple groups, including treasury, finance, AP and procurement, impact an organization's ability to manage working capital effectively--but often work in silos. While each of these groups has its own goal, the entire organization must be aligned to receive maximum working capital efficiencies.

Treasury, for example, wants to maximize working capital and optimize the use of cash by managing days payable outstanding and capturing negotiated discounts. AP professionals seek to streamline payments, gain processing efficiencies and increase controls and compliance. The procurement department is interested in maintaining good supplier relationships, rationalizing the supply base and negotiating better contract terms.

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While these goals may be similar, they are not perfectly aligned. A few--such as managing DPO and paying suppliers early to capture discounts--must be carefully balanced if an organization is to make optimal working capital decisions.

Many companies are now turning to electronic invoice presentment and payment (EIPP) solutions as a starting point for increasing process efficiencies to drive working capital initiatives, while some are combining EIPP with early payment discounting strategies or new, innovative forms of settlement.

The Benefits of EIPP

For all departments to work together toward the same goals, it's imperative that invoices are processed quickly. When this happens, companies maximize options for managing working capital.

Because EIPP allows companies to process invoices from suppliers electronically and handle electronic payments on the back end, they no longer have to struggle with manual, paper-based payment processing. EIPP also captures full invoice details, providing additional controls over both non-purchase order (PO) and PO-based spending.

With the streamlined, accelerated invoice processing enabled by EIPP, companies are in a better position to capture the early payment supplier discounts that they have already negotiated with top strategic suppliers. In addition, they can negotiate early payment discounts with a larger population of the supply base--strategically determining which suppliers to target for negotiation. However, they must also balance the objectives of the treasury department for managing to a target DPO with allocating a specific amount of cash to pay suppliers.

Early Payment Discounts Within an EIPP Framework

Within the EIPP framework, some companies are using dynamic discounting as an option for managing working capital. Most companies will have negotiated and clearly defined early payment discounts with their top strategic suppliers. However, dynamic discounting refers to the practice of buyers working with suppliers to capture discounts on a sliding scale when no early payment terms exist or when the payment falls out of pre-negotiated terms.

For example, let's say a company has negotiated early payment discounts with a supplier. With dynamic discounting, the supplier can offer payment discounts that are pro-rated between the discount due date (day 10) and the net due date (day 30). This means that the buyer can elect to settle on day 20, and benefit from a pro-rated discount of approximately 1 percent.

Before implementing a dynamic discounting program, there are issues that companies must consider and address to receive optimal working capital benefits. First, pushing all or a large portion of suppliers to some form of an early payment discount is not necessarily the best approach to managing short-term cash--most companies neither have nor want to employ that much liquidity for supplier payments.

Many would rather negotiate discount terms with a specific number of strategic suppliers so they have a set amount of short-term capital working against their AP balance, while assisting their most important vendors with managing cash flow.

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Secondly, prompting all or a substantial portion of suppliers to offer some form of an early payment discount takes the control of DPO out of the hands of the treasury department because the supplier dictates the date of payment. This loss of control is not acceptable in most organizations.

A Better Way

A better approach involves adding a purchasing card program as an alternative settlement vehicle within an EIPP framework. This strategy offers companies a unique opportunity to maximize returns, align departmental objectives and better control working capital without dedicating additional short-term cash to pay suppliers.

Reducing invoice approval times through EIPP allows a company to segment suppliers into two categories:

* Those that have early payment terms should be paid via ACH within the discount window to capture the high return that this provides. Again, this will typically involve a specific number of strategic suppliers so Treasury knows how much cash will be utilized against the company's AP balance.

* Suppliers that do not have early-payment terms (typically the majority of the supplier population) can be offered the option to accelerate their cash collection by accepting a purchasing card as settlement on approximately Day 10 in a net-30 environment.

The charge to the purchasing card is initiated by the company after the approve-to-pay cycle, thus providing controls not previously available in a traditional card program. This makes the purchasing card a viable alternative to check and ACH settlement.

In addition, paying suppliers with whom a company does not have a negotiated discount through a purchasing card can offer a more appealing financial option than dynamic discounting. By using EIPP in tandem with purchasing card settlement, companies pay suppliers quickly, yet benefit from the float generated of the billing terms on their purchasing card.

Take the following example. A company has net-30 terms in place with most of its suppliers. It is implementing EIPP and contemplating dynamic discounting with an average settlement at Day 20 for suppliers that do not have early pay terms in place.

As illustrated in the chart at the left, using EIPP and dynamic discounting, the company will receive approximately a 1 percent discount if the supplier is paid on day 20, but it will lose 10 days of float on its short-term cash.

In contrast, by utilizing EIPP and settlement on a purchasing card, the company can gain 10 days of float over its net-30 term through the billing terms on the card. The rebate received on the card volume will be commensurate with the forgone discounts. This provides both a significantly higher return than dynamic discounting, and more control for all internal constituents.

Suppliers also receive an additional 10-day cash acceleration benefit over the dynamic discount model by receiving settlement on Day 10 vs. Day 20. Thus, by settling invoices with suppliers via a purchasing card, the company can offer benefits to the supplier that help strengthen supplier relationships--a key objective of the procurement department.

EIPP presents companies with several options for maximizing their working capital. One option, dynamic discounting, can require significant amounts of short-term cash to pay suppliers and force treasury to relinquish control of DPO. Alternatively, companies can use EIPP to maximize the capture of early payment discounts with some suppliers, and settle with a corporate purchasing card for others.

Taking this approach can help a company improve the management of working capital, better control DPO and benefit financially from the increased float and purchasing card rebate. Not only does this strategy simultaneously help treasury and AP achieve their objectives, it supports procurement's goal of strengthening supplier relationships by providing suppliers with faster payments and improved DSO.

Aligning the objectives of these groups will allow best-in-class companies to maximize value from their short-term cash--and make a significant contribution to the bottom line.

DENNIS BAUER is Vice President in the Global Commercial Card division at American Express Co. He can be reached at den nis.m.bauer@aexp.com.

RELATED ARTICLE: TAKE AWAYS

** Accounts payable (AP) and procurement professionals often help their organizations realize working capital opportunities by streamlining processes for paying suppliers and securing the best supplier discounts and terms.

** Reaching these goals on a consistent basis can be daunting, as companies are forced to strike a balance between capturing the best early payment discounts and maximizing the "float" from short-term cash.

** Adding a purchasing card program as a settlement vehicle within an EIPP framework offers companies an opportunity to maximize returns, align departmental objectives and better control working capital.
Working Capital Benefits of Using EIPP with Settlement to a Corporate
Purchasing Card

For the buyer For the supplier

* Settlement through a purchasing * Supplier that typically is not
 card maximizes float offered early payment terms is
* Treasury can better manage DPO offered cash acceleration
* AP can offer faster payment to * Potential for 20-day or more cash
 suppliers acceleration (e.g., receives
* Rebate for purchases made on payment in 10 days vs. net 30-day
 corporate purchasing card will terms)
 be about the same as a dynamic * Improve days sales outstanding
 discount (DSO) and cash forecasting
COPYRIGHT 2007 Financial Executives International
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 2007, Gale Group. All rights reserved.

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Title Annotation:CASH MANAGEMENT
Author:Bauer, Dennis
Publication:Financial Executive
Date:Oct 1, 2007
Words:1627
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