Cash Optimization-AP Can Play a Role

While finance and treasury departments are arming themselves with tools and processes to help monitor and conserve cash, Accounts Payable can play a prominent role in this process. In most companies after all, accounts payable is one of the largest, if not the largest, dispenser of a company’s cash.

Do You Know your DPO? 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 (Days Payables Outstanding) is. DPO, by the way, is often a number that is not tracked by AP departments and many AP Managers do not know their companies DPO. This is a very important number to understand however as it is a key metric in cash management and finance people as well as the investment community will often track this number. A DPO that is too low may indicate a company’s payment policies are not sufficiently focused on preserving cash. A number that is too high may indicate a company that is having a hard time paying its bills and may be on unsound footing or is hoarding cash at the expense of its suppliers. Whatever your companies target DPO is, it is important to understand that AP has a big role in influencing that number and the first step in making yourself a value to your organization in the cash management discussion is understanding how your AP operation is affecting it.

So what are the tools and techniques at your disposal to affect DPO? The most obvious area that will impact your DPO number is payment terms. But payment terms are often negotiated by procurement who are using terms as lever to negotiate favorable pricing. But even if that is the case and you want to get that DPO number up a bit 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. Comparing the invoice terms, PO terms (if it is a PO based invoice), vendor master terms and contract terms, 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 department 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.

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 off of the amount due. The discount gets smaller as the time goes by and the invoice gets closer to its natural due date. As was the case with random stretch discussed earlier, you control the amount of discount and what 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 phenomenal. While it will cause a lowering of your DPO to some degree the level of cash savings will be a trade off worth taking.

In order for your AP operation to be able to take advantage of Dynamic Discounting you need to have an efficient operation where invoices are through the system and ready for payment fairly quickly. 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” that may be days away. Also worth noting here that if dynamic discounting is not a fit for your organization, there are other supplier 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 can provide that.

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” (you AR folks may want to skip this section). This tool can be a fairly simple automated piece of software using a payment algorithm that you control that determines how long and how many. Let me explain. How long refers to how long will you stretch payments of randomly selected vendors beyond normal terms.

Say your normal terms are net 30, you can set the stretch algorithm to stretch select, random vendors a given number of days beyond the thirty, say for the sake of this discussion 5 days. Now the how many refers to what percentage of your vendors do you want to apply this random payment stretch to. For illustration purposes let’s say you set that number to 5%. By randomly stretching 5% of your vendor’s payments by 5 days you will have an 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. To be sure, this is not for everyone, but for those who choose an aggressive path to increasing their DPO without onerous changes to all suppliers’ terms, 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 operation as much as possible to keep payroll and operating costs as low as possible while still delivering world-class service.

Remember, your suppliers have the same challenge. When considering the various tools and techniques that can help you to contribute to your company’s cash management strategy keep in mind that your suppliers are in the same boat and they too are looking to manage their cash going out. Sometimes accounts payable departments in their desire to play a role in managing cash will implement procedures that have unintended consequences that may negate the result they are trying to receive. 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, but upon closer investigation they noticed that their 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 adverse consequences and it is important that you do your due diligence and try to avoid creating those situations.

You can be part of the solution. Cash is a critical component in the health of a company and that is not going to change. Those who 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 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.