CFOs tend to focus on procurement initiatives for cutting finance costs and optimizing working capital. However, an area often overlooked is Accounts Payable (AP). A few non-invasive tweaks to AP can return huge dividends. In our experience, a global organization with a spend of $10MM per week can generate cash float of up to half a million dollars simply by understanding how and when to rationalize payment terms by five days, and for which vendors.
Attaining this sort of bottom-line impact comes from a tight AP operation and an effective operating model that provides deep insight into vendor databases, AP processes, and supplier behavior. The following three simple and effective interventions do not involve heavy investment or long-term implementation cycles, and will pinpoint where issues occur at scale, provide clearer guidance for how to correct deficiencies, and produce significant working capital impact.
1. Attain a snapshot of current processes
When companies make no distinction between the relative value of payments, paying vendors even slightly early can negatively affect working capital. Therefore, understanding payment behavior is essential for improving cash flow. Perform a quick analysis of gaps/opportunities that impact working capital. They might include the following:
- Restoring payments to what the contract/PO calls for (60 vs. 45 days, etc.)
- Evaluating payments for vendors operating on shorter payment terms
- Extending favorable vendor terms on invoices agnostically across vendor categories
- Controlling urgent payments through a well-defined global policy
Harmonized payment terms generally lead to better vendor relationships as well as significant financial impact. Five percent of entries in one major company’s vendor database had incorrect payment terms, which resulted in five days of early payments. This led to a nearly $2 million loss of float.
2. Optimize payment schedules by logically prioritizing opportunities by the nature and value of the disbursements
A tight operating model eliminates problems by spotting them, correcting them, and preventing recurrences. However, when it comes to AP, few companies track working capital–specific KPIs that could provide visibility and help cut costs. Implementing analytics capabilities will support more effective processes for tracking cash flow and controlling how and when vendors get paid. Companies can then prioritize their improvement efforts based on parameters of ease and impact. For instance, establishing a measurement mechanism for Days Payable Outstanding (DPO) shows where large payments may be going out too soon, and which companies will tolerate a slight delay in payment. Moving DPO just two to three days on a spend of $500 million can generate additional cash flow of $4 million.
3. Use bank accounts to best advantage
Negotiating with the bank can garner handsome returns. The excess cash obtained by floating DPO a few days can easily be put to work. Ask the financial institution to sweep those funds to an interest-bearing account for the two or three days of float.
The interventions described here are non-invasive and do not require extensive re-negotiation with vendors. Partnering with a provider to quickly and efficiently overhaul existing databases and reengineer processes will provide even faster returns. The Finance organization benefits from impartial recommendations for improvement as well as speedier overhaul of data, deeper analytics expertise, and best practices that produce an operating model that is efficient and designed to prevent future backsliding and drift away from contract terms and AP policies.
Optimizing AP is a viable way for CFOs to improve working capital in a short timeframe. Running a tight AP operation is a good start; the rest depends on a delivery model that provides end-to-end visibility into the entire process and enables flexibility in adjusting processes to maximize profitability. This is one case where CFOs can “think small”, choosing minor tweaks with huge impact rather than years-long improvement projects that suck up time, resources, and capital.