Accounts payable often offer the unutilized potential to improve your company’s cash flow and, thereby, it’s profitability. I often hear that payment terms are a part of every supplier negotiation a company conducts. However, the facts usually tell a different story. In this blog post, I represent three viewpoints you should consider when optimizing accounts payable and net working capital.
3 aspects to consider in payment terms and net working capital optimization
1. Optimizing accounts payable is more than just payment terms and flows
Payment term in its simplest form is, e.g., 30 days net: Goods or service is received and payment needs to be conducted in 30 days.
However, payment terms must typically be understood not only as a certain number of days to manage the payment from the delivery of a product or service. You should take into account the following aspects:
- freight terms
- agreed-upon payment schedules for annual rebates and license fees
- understand the trade-off between cash discount term and net term
- optimize cash flow in international project industries with complex milestone billings tied to bank guarantees and with letters of credit tied to complex document requirements.
How about payment flows? Is it only about optimizing payment delay, or should one also consider effects on VAT payments?
2. Change management is the key, also in optimizing accounts payable
Policies, processes and guidelines are important tools when guiding people in organizations. But they only take you as far as you implement them.
For example, when you create a policy to pay all invoices with a weekly rhythm, your job has just started. Next week, a person from the finance department will ask about the interest invoices suppliers are sending. And a week after that, the member of the sourcing team complains about you destroying her relationship with the company’s most important supplier. And more often than you would like to think, the policy was not even followed for most of the purchase spend, because the head of sourcing sent a list of exceptions directly to the payables department.
Guidelines and training must be provided to all functions involved while considering the reactions and incentives of all parties involved.
See also: Dreaming of change
3. A clear focus on profitability, not only on parts of it
I often hear that improving payment terms is easy if you are willing to agree on worse discount terms as an exchange. Agree and disagree. If you are willing to give up on price, you are sometimes able to negotiate better payment terms. However, that is not the way to improve company profitability.
Improving capital efficiency while improving, or at minimum maintaining, the price level is the challenge, we want our customers to tackle. And that is not easy. It is about creating a sense of urgency. Aligning incentives and targets. Creating and meaningfully communicating a story that supports negotiations. It is about tools, such as best practice tendering processes, negotiation checklists, and customized financial analyses.
Before taking improvement actions, it is essential to know what the actual problems and root causes are. Our eBook How to execute a working capital optimization project help you to investigate your current state and execute a whole project. Download an eBook by clicking the image below:
Mikko Myllys is Capacent's sales and marketing director in Finland. Mikko holds over 15 years of experience in working capital management, management consulting and change consulting from various industries.