While monitoring cash outflows has traditionally been a treasury function, a growing cash management role for AP has evolved in recent years. This is because automation is facilitating the AP profession’s increasing focus on analytics and spend visibility, and away from data entry and transaction processing.

Manual payment processing required a close attention to the physical verification and approval of invoice details. In contrast, automated environments require AP specialists to monitor data capture rates and cycle times on the one hand, and processing exceptions on the other. When most invoices are approved automatically or with minimal manual intervention, more attention can then be given to the question: when and how should we pay?

Payment Terms

Payment terms tend to vary by industry and distribution channel, which makes life more challenging for the AP staff processing invoices. On the one extreme, it is common practice for food manufacturers to sell their grocery and restaurant customers on weekly terms (Net 7 days) while at the other end of the spectrum exporters often offer Net 90 day terms or longer to cover the time it takes to ship merchandise overseas. And there are all sorts of variants in between. The auto parts aftermarket offers terms requiring payment of everything billed the prior month by a specific date the following month (e.g. Prox 10). However, the standard for the vast majority of US industries is some variation of Net 30 terms. Many vendors will also offer an early payment discount of 1 or 2 percent (e.g. 2% 10 Net 30) for payment within a certain number of days before the due date.

The bottom line for any AP function is that staff will most likely have to deal with more than a few different vendor payment terms. Another challenge is that suppliers start counting net terms from the invoice data not from the date on which the invoice is received in the AP department. Further, many invoices are associated to contracts and the contract terms reside in a different system from the one in which invoices are housed. Accommodating different payment cycle times and contract terms in addition to different discount periods and rates is indeed a big part of AP’s daily process.

Dealing with Varying Payment Terms

Some firms try to address the above issue by dictating payment terms to their vendors. The larger the enterprise, the more likely they will be able to convince all their suppliers to accept standard payment terms. Centralization is another key component of streamlining this process, which ensures that the AP department receives all invoices first and has complete visibility into all outstanding liabilities of the organization. Open lines of communication between the procurement payables departments is also critical to ensure that contract compliance is achieved, as a number of suppliers do not include contract terms on the physical invoice itself.

Automation is also driving a number of major improvements in this area:

• Electronic invoice receipt ensures that the invoice date and the date on which the invoice is received is the same or at least close enough.
• Dashboards and other analytical tools prompt AP users and field approvers about expiring discount windows and forthcoming payments that are due.
• Tight integration between procurement and AP systems ensures that contract terms are visible to all parties concerned and are complied with.
• Centrally storing invoice images and information facilitates real-time visibility into a company’s liabilities at any given point in time.

Payment Timing

Once we address the issue about payment terms, we get back to the question around actual payment timing. AP departments essentially have three choices: take advantage of any early payment discounts, pay promptly or pay late. Of course, when cash flow is constricted paying late may be not so much of a choice as a necessity. Alternatively, many organizations state that internal delays in reviewing and approving invoices is a major contributor to late payments. Whatever the reason may be, late payments negatively impact buyer supplier relationships, while adhering to the terms of sale strengthens the trading partnership. Further, an improving economy mandates that late payments be avoided at all costs, since many suppliers now feel more confident in walking away from late-paying partners.

Accordingly, there are a number of additional advantages to paying promptly:

• Prompt payments increase your firm’s available credit with its suppliers lessoning the chance of held orders or delayed shipments due to past due balances or lack of credit availability. Many suppliers set credit limits based on their customers purchasing needs assuming invoices are paid promptly. Also, in a tough economy, few vendors are willing to release additional orders when there are past due balances on their books.
• Consistent prompt payments improve your firm’s public credit rating. Many suppliers provide “trade tapes” reflecting your payment trends to the major credit bureaus as well as industry credit groups. In addition, they exchange payment references with other suppliers.
• Prompt payments build goodwill with your suppliers and go a long way in building a strong and mutually beneficial relationship.

If your suppliers’ standard terms are not compatible with your systems or cash flow environment, it is not unreasonable to negotiate extended terms. Most vendors are willing to extend payment terms, usually in the 45 to 60 day range, for large volume customers and other key accounts. It also helps if the customer has a strong credit rating and history of consistently paying on time.

Discounting Issues

The third option discussed above is paying early in exchange for a discount. When discounts are offered, they provide not only the opportunity to save money, but also the chance to further improve your firm’s status with its vendors in terms of each of the advantages listed above. A quick discount analysis that takes into account your firm’s cost of capital will show whether or not taking the discount makes economic sense. Another issue with taking discounts is your AP department’s ability to process payment within a shortened payment cycle. Delays in approval of authorization, delays in receiving an invoice, or the inability to get a clean match can all cause AP to miss a discount window.

Keep in mind that your vendors will measure the discount window from the date of the invoice, not the date you receive it. Most will cut invoices the same day or following day goods are shipped or services delivered and take no more than one additional day to send the invoice to you. If invoices are being delivered electronically, you should receive them within a day or two of the invoice date, but if they are being mailed, they may not arrive for another 3 to 5 days. That might leave AP with only 2 or 3 days to take advantage of a 10 day discount. That may not be enough time if you only process checks one or two days per week, which the preceding graph reveals to be the case for nearly two thirds or all companies.

Because discounts can be so attractive, some firms choose to still take discounts beyond the discount terms. Not surprisingly, this can cause vendor problems. In response, some vendors will contact AP to recover what they term the unearned discount. Another vendor alternative is to bring in an outsourcing partner that specializes in the aggressive collection of unearned discounts and other payment shortages. Failing to get AP to remit, they may accrue unearned discounts for a period of time, and then when they reach a critical threshold put the customer on credit hold. Continued abuse of discount terms can also result in the vendor revoking the discount terms on future orders.

If AP cannot physically process the discounts offered by specific accounts, it is still possible to negotiate discount terms that can be handled within the existing AP system. Vendors are biased towards customers that regularly take early payment discounts so they probably will be willing to listen to valid arguments. If you are willing to give up a small fraction of the discount in exchange for extended time, your chances of reaching an agreement will improve. If an agreement cannot be reached, you might want to simple flag large invoices that include a discount and manually expedite them through your approval process.

The Perfect Payment Index

Many organizations use electronic payment methods in order to cut costs, but highly efficient companies have gone a step further—they have eliminated standard payment terms. Instead, they employ a variety of payment methods to satisfy the diverse needs of their suppliers, all while optimizing their payment terms to maximize results. We call these organizations “Perfect Payers.”

When moving towards dynamic discount management and electronic payments, it is important to formulate a successful strategy. PayStream has built a tool to assist in this process called the Perfect Payment Index. A perfect payment is one that is made on time, uses the cheapest payment method possible, and achieves the highest possible discount.

 

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