Posted by Steve Wilcox on Wed, May 27, 2009 @ 08:50 AM
I attended The Hackett Group's 19th Annual Best Practices Conference a few weeks ago.
There were a lot of very smart executives and insightful presenters at this conference. Of the many informative sessions that I attended, here was the best quote:
"A company can lose money for years and years ... but you can only run out of money ONCE."
Mark Tennant
President, REL Americas
How true.
The gist of Mark's presentation was that with shrinking sales and margins, generating increased cash flow from operations is critical but very tough to do in this economic environment.
Of course, selling off assets and reducing capital expenditures can yield one off benefits but at what cost? At the very least, such short-sighted measures will hurt the capability of the business to capitalize when the economy recovers.
Instead, the most effective way to increase cash flow in these times is to focus on the processes that directly affect working capital:
- Customer to Cash (AR)
- Forecast to Fulfill (Inventory)
- Source to Settle (AP)
Here's the slide that really caught my attention:
Although AP makes the smallest contribution to cash flow, it is still significant. By properly managing payment terms and increasing DSO, there is almost $28M of cash opportunity per $1 Billion of sales!
I have written about AP's role in managing cash in these previous blogs:
-Rakesh Shukla
@rakesh170
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Posted by Steve Wilcox on Wed, Dec 10, 2008 @ 04:37 PM
Paris, 16 July 1900. Games of the II Olympiad
Credit: IOC/Olympic Museum collections
Yes, believe it or not, Tug O' War used to be an Olympic event!
In the financial supply chain, the classic tug o' war is buyers (AP) vs. sellers (AR) -- HOW FAST OR SLOW are invoices paid.
Discounts notwithstanding, buyers want to pay as late as possible while sellers want payment as early as possible. Each party is trying to optimize working capital and when it comes to managing working capital - TIME IS MONEY. The fact is that more businesses fail due to cash flow issues than due to lack of profits.
In my last blog post, I made a compelling case for paying invoices early to take advantage of early payment discounts. The annualized yield on terms of "2/10 Net 30" is very compelling (37%!!!). But in today's environment where bank credit & loans are getting harder and harder to obtain, cash is king once again. Lending standards are getting tighter and tighter and some banks have stopped lending and extending credit altogether.
The days of easy credit to help fund operating expenses is over. If a company does not generate cash surpluses, it may run out of money - even if it is making a profit! So even though a 37% yield is appealing for paying early, managing cash and keeping it for as long as possible may be more important.
So how can AP improve working capital? By stretching payments - holding off payments till the last second or even paying late to bolster cash flow.
Stretching payments can be tricky, however. Paying vendors late can cause many problems:
So ... should you take every discount or stretch payments for as long as possible to maximize cash flow? The answer depends on how badly cash is needed and the current working capital needs and policies at your company.
-Rakesh Shukla
@rakesh170
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Posted by Steve Wilcox on Thu, Dec 04, 2008 @ 12:11 PM
Check out this amazing chart of the 13 week T-Bill Treasury rate since 1960:
3 month T-bills at ZERO? Are you kidding me???
The yields are at never before imagined levels ... all-time record lows across the entire yield curve:
... 2-year notes at almost a jaw-dropping 3/4%
... 5-year notes at an amazingly low 1.5%
... willing to lock up your money for 30-years at a miniscule 3.0%?
At these yields, you are basically donating your money to the Treasury rather than lending it. But what if you could earn 37% in this low interest environment?
How?
By taking your AP invoice discounts.
If your vendor offers you a discount of 2% if you pay within 10 days (2/10 net 30), you'd save $2 on a $100 order ... if you simply pay 20 days earlier than usual.
To figure out how this translates into an annual interest rate, use this formula:
Discounted amount /(Discounted price/100) X 360/N =
Effective annual interest rate
where 360 = days in the fiscal year, and N = the number of days between the discount date and the final payment deadline.
So, in the "2/10 Net 30" case, 2/(98/100) X 360/20 = 36.7%.
37%!!!! In an economic climate where t-bills are earning 0.05%, 37% seems like a no-brainer.
Even if the discount terms are slightly different, the yields will blow away anything you can safely earn in the bank. For reference, here's a list of effective annual interest rates for some common discount terms, as calculated by the American Institute of Professional Bookkeepers:
- 1/10 net 30 = 18.2%
- 1/10 net 45 = 10.4%
- 1/10 net 60 = 7.3%
- 2/10 net 30 = 36.7%
- 2/10 net 60 = 14.7%
- 2/20 net 90 = 10.5%
- 3/10 net 30 = 55.7%
- 3/10 net 60 = 22.3%
- 3/20 net 90 = 15.9%
Now, none of this is possible if your AP cycle times are too long or if you don't have visibility into AP discounts that are coming due ... common problems with paper-based AP processes.
This is where a robust AP Automation solution that tracks upcoming discounts can provide some real value. By shortening invoice processing cycle times and knowing which discounts are about to be lost if invoices aren't paid promptly, you can take those negotiated discounts and save your company a lot of money.
Now, there is one twist to consider -- the need to increase working capital. AP can increase working capital by stretching payment terms and foregoing the discount. In general, it's difficult to justify not grabbing that 37% annual discount yield but there are some working capital tradeoffs. I will have more to say on this topic in my next blog entry.
-Rakesh Shukla
@rakesh170
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