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It’s All About CA$H!

Accounts Payables key role in contributing to a companies cash flow.

In these uncertain economic times AP can play a prominent role in the cash management process by deploying a number of tools and processes that will impact their companies cash flow. After all, accounts payable is one of the largest, if not the largest, dispenser of a company’s cash.

Do You Know your DPO (Days Payables Outstanding)? If you want your AP operation to play a prominent role in the cash management equation, it is important to know and understand what your companies DPO is. DPO, by the way, is a number that is often not tracked by AP departments and many AP Managers do not know their organizations DPO. This is a very important number to understand however, as it is a key metric in cash management and finance, and the investment community will often track this number as one measure of a companies financial health. A DPO that is too low may indicate payment policies are not sufficiently focused on preserving cash or getting a reasonable return on cash. A number that is too high may indicate that a company is having a hard time paying its bills and may be on unsound footing, or is hoarding cash at the expense of its suppliers, which could have negative downstream supply chain ramifications. Whatever your target DPO is, it is important to understand that AP has a big role in influencing that number. The first step in making yourself a value to your organization in the cash management discussion is understanding how your AP operation is affecting DPO and what an ideal DPO would be for the cash goals of the treasury and finance managers.

Let’s take a look at some of the tools and techniques that are at the disposal of the AP organization to affect DPO? The most obvious area that will impact your DPO number is payment terms. But payment terms are often negotiated by the procurement department who are using payment terms as a lever to negotiate favorable pricing. But even if that is the case and you want to get that DPO number up a bit, or trade off a slightly lower DPO for a big return on cash, there are a couple of ways you can get there.

One relatively easy to implement strategy would be to use a best of terms calculation. Compare the invoice terms, PO terms (if it is a PO based invoice), vendor master terms, and contract terms, then you take the most advantageous and pay based on those terms. In larger AP operations you may be surprised at how significant the impact can be by using this business tool. And the best part is, neither the supplier nor your procurement managers have an argument against it (not that they won’t try) since you are simply accepting a term offered by the supplier, either contractually or as stated on an invoice. There are ways of automating this process so you are not inundated with manual calculations to achieve this goal. ICG’s can help you to understand how to implement and automate this “best-of-terms” process.

One tool that is gaining a lot of traction these days, and for good reason, is Dynamic Discounting. Dynamic Discounting, at a high level, is a method whereby you the buying company offer select suppliers early payment of their outstanding invoice(s) for accepting a discount amount you choose off of the amount due. The discount gets smaller as the time goes by and the invoice gets closer to its stated due date. You control the amount of discount and which invoices and/or suppliers, and/or commodity types get offered the discount. The impact to cash flow of implementing this kind of a program can be significant and the positive impact to the bottom line phenomenal. While it will cause a lowering of your DPO to some degree, the level of “return-on-investment” of cash used in this program will be a trade off well worth taking! In addition to dynamic discounting, there are many other supply chain finance programs that are worth looking into that may offer a better fit for your organization.

In order for your AP department to be able to take advantage of Dynamic Discounting you need to have an efficient operation where invoices are processed through the system and ready for payment quickly. Dynamic discounting will not work if invoices become ready to pay only a few days before the due date. You must also have an efficient disbursement process as someone accepting a discount for quick payment will not want to wait for the next “check run” or “ACH run” that may be days away. Also worth noting here that if dynamic discounting is not a fit for your organization, there are other third party supply chain finance solutions that you can take advantage of that can have a positive impact on your company’s cash position. One group within your company that will likely help you champion a dynamic discounting program is treasury. That is because dynamic discounting is a risk free, high return use of short-term cash. In this day and age of low interest rates, treasurers are looking for higher yield without the higher risk and dynamic discounting provides just that dynamic.

A more aggressive tool, and definitely one that requires buy in from the finance side of house, is a method I will refer to as “random stretch”. This tool can be a fairly simple automated piece of software using a payment algorithm, that you control, which determines how long? and how many?. Allow me to explain. How long refers to how long will you stretch payments of randomly selected vendors beyond normal terms. Say your normal terms are net 45, you can set the stretch algorithm to stretch random vendors a given number of days beyond the forty-five, say for the sake of this discussion 10 days. Now the “how many” refers to what percentage of your vendors do you want to apply this random payment stretch. For illustration purposes let’s say you set that number to 5%. By randomly stretching 5% of your vendor’s payments by 10 days you will have a significant impact on your DPO. Based on how much you are looking to “move the needle” of your DPO, and the makeup and size of your vendor population, you can adjust the days and the percentages accordingly. The random nature of this process is designed to make it statistically unlikely that any particular vendor would be stretched in consecutive months or even within any relatively close proximity to avoid creating ill will or other issues with your vendors. You can also select key vendors who you want excluded from the program so that they would never be included. This is important if there is a subset of vendors where early or on-time payment is required or desired. To be sure this is not for everyone. For those who are looking for a more aggressive alternative to increasing their DPO and cash position without onerous changes to all suppliers’ terms that can cause issues with your vendor community, this can be a very effective technique.

A few other tools and techniques that will impact cash that are worth mentioning are P Card and many of the other card programs that are out there that allow you to defer payments longer than normal; rebate programs from banks and card providers that give you cash back; and of course streamlining and automating your AP operation as much as possible to keep operating and processing costs as low as possible while still delivering world-class service.

Remember, many of your vendors and suppliers have the same challenges and issues when it comes to managing their cash. When considering the various tools and techniques that can help you to contribute to your company’s cash management strategy keep this in mind. Sometimes finance managers in their desire to better manage cash will implement procedures that have unintended consequences which may negate the result they are trying to achieve. One example that comes to mind was a company that decided it would unilaterally impose 2% 10 terms on all non-contract purchases. While on the face of it the result seemed to have been a net positive since they were reducing their cash out by 2% on a significant amount of spend. But over a period of time they saw that this was not having the intended benefit the were looking for. Upon closer investigation they noticed that many of theses suppliers were passing along price increases or implementing “creative” fees that were greater than the discounts they were taking. The end result was a net negative in terms of the impact on cash. So be aware that any program you put in place can have unintended, adverse consequences and it is important that you do your due diligence and try to avoid creating those kinds of situations.

Be part of the solution! Cash is king and the most critical component in the health of a company and that is not going to change. Those people and/or departments that can contribute to their organizations cash management strategies will not only add value to the company but to their own status within that organization. Accounts payable departments and their practitioners have a number of tools, techniques, and processes at their disposal to bring to the table so there is no reason for you to not be part of the solution.

ICG Consulting has a number of services and cloud hosted solutions that can help your organization to streamline the entire procure-to-pay process and become a positive force in helping manage your companies cash. Please come to our site and learn about these solutions ICG can offer to help your organization to be more, efficient and maximize your use of cash:

For more information Contact ICG today or schedule a demonstration of one of our world-class solutions.

Posted on October 17, 2022