Back in the day when you could earn 14 percent interest on a Certificate of Deposit (CD), paying your bills slower was a core tenet of good cash management. If you had an invoice amount of $100,000 due in 30 days, you could earn about $1,100 in interest by holding onto that amount of money until just before the due date.
These days, with interest rates hovering around 1 percent, leaving your money in the bank does next to nothing for you. But there’s another, better opportunity for savings: Get discounts by paying your bills faster. With APRs as high as 24 to 36 percent, there’s greater potential to make money paying bills than playing the float offered. Plus, you get the added bonus of being loved by your vendors—something every company should strive for.
There’s only one catch: You must have the ability to pay the amount owed fast. Playing the float worked well in a paper-based environment, and clinging to slow-pay culture is still a factor in keeping paper processing alive and well. Capturing discounts requires automation and a cultural shift to paying fast. You will need to automate all of AP—invoice ingestion, approval workflows, and payments—for maximum agility.
If you can do that, there are two opportunities to capitalize on: traditional early payment discounting and new technology-enabled dynamic discounting programs.
Early pay discounts have been around for a long time. These are discount terms that are either pre-negotiated by procurement or proactively offered by suppliers. For example, if a supplier offers 2/10, net 30 terms, the buyer can take a 2 percent discount, saving $2,000 by paying that $100,000 invoice within 10 days of receipt instead of the usual 30 days.
According to a 2014 report by PayStream Advisors, “AP & Working Capital,” suppliers have largely stopped offering these discounted payment terms due to companies’ inability to turn invoices around quickly enough to capitalize on them. Yet 25 to 30 percent of suppliers are interested in discount programs, PayStream estimates.
That makes sense. There will always be suppliers that need financing at one time or another. Discounting is a better route to fast cash than invoice factoring, where receivables are actually sold to a third party at discounts as deep as 20 percent, or borrowing for working capital, which impacts their credit rating.
Cash crunch or no, getting paid faster has universal appeal. There are a lot of companies willing to offer up a discount for avoiding cash flow problems.
The modern take on this is dynamic discount management. Using new technology and big data, buyers with electronic invoicing programs can push different discount offers to suppliers and enable an electronic negotiation to arrive at mutually agreeable terms.
Buyers can get the biggest yields from prompt payment if they have cash on hand, but that’s not actually necessary to run a discount program. There are a whole bunch of new supply chain finance technology companies who will provide the funds in exchange for a cut of the discount. Some online platforms even open discounts up for competitive bids from third parties such as banks and hedge funds, who find the high returns and relatively low risk attractive.
The way these programs work is, if you negotiated a prompt-pay discount of 2/10 net 30 for your $100,000 invoice, and you don't have the cash on hand to pay, the funder will step in and pay the invoice early and take the discount. Then in 30 days, you pay them $99,000. They take 1 percent of the discount you take 1 percent. It’s a win for everybody, even the supplier, who gets paid early instead of getting strung out as is the norm in slow-pay culture.
Adoption of dynamic discount management programs is still relatively low. According to the PayStream report, just eight percent of companies took advantage of them in 2014. The authors speculate that respondents are simply not aware of what’s available, “or they’ve simply given up on the unattainable task of posting payment within 10 days.”
In my experience, the latter is probably the bigger problem.
To take advantage of dynamic discounting, at minimum you have to have e-invoicing, so that immediately leaves out a lot of companies. But even with e-invoicing in place, there’s still an awful lot of paper processing going on because a lot of companies only enable their big suppliers for e-invoicing. Paper processing tends to lead to late payments.
To work with this new breed of supply chain finance programs, you need a track record of paying all of your suppliers on time, because these companies are actually loaning you money. It’s a short-term loan, but it’s still a loan. No one’s going to want to partner with you if you can’t pay your bills on time.
The key to taking advantage of these new digital opportunities is automating accounts payable all the way through to paid. A lot of companies have automated invoice scanning and workflow, but they haven’t automated the payment piece so the whole thing comes screeching to a halt at that point.
When you go to pay, if you have to cut a check, or send an ACH file, you’re costing yourself two or three days. When you’re trying to pay within ten days, that’s a big chunk of time.
Sending a wire is a possibility, but that’s a cumbersome manual process that doesn’t scale. Not only that, none of these payment methods give you the up-to-the-minute visibility into your cash position that you need to manage the discount program effectively.
What you really require is an automated payments solution that can pay invoices in real-time, while pushing the supplier all the remittance information they need so it’s clear what invoice is being paid and what discount is being taken. The goal is no loose ends on the back end.
Discounting programs are enticing for everyone because all parties are promised money—the buyer, the supplier and the program provider. You can leverage them to create more revenue, but automation is the first order of business.
For companies that haven’t automated AP yet, the ability to use these new solutions to cut costs and improve cash flow must be added to the already compelling case for AP automation. And for companies that have automated invoice ingestion and workflow, automating payments may be the missing piece to getting that payment into the supplier’s bank account in time for everyone's benefit.
**This article originally appeared on Payments Journal.