Making Early Payment Discounts Pay
As a buyer of goods and services, you will likely have two goals: First, to improve cash flow by extending your days payables outstanding (DPO) – the average time it takes for your company to pay creditors. Second, to reduce costs by qualifying for discount savings. Achieving your goals will put some pressures on your suppliers, who need to accelerate their receivables to reduce their days sales outstanding (DSO) – the average time it takes to collect revenue and turn it into cash after making a sale.
However, the appeal of expediting collections and reducing DSO is a strong motivator for suppliers to offer early pay discount terms – and a catalyst for you to expand your payables strategy, giving you options to:
- Pay early to capture discounts that meet your acceptable hurdle rate for cash use (the minimum rate of return for an organization to undertake a project). For example, 2 percent 10 Net 30 is equivalent to about a 36 percent APR.*
- Pay past the discount date, but before the net-term date, to capture sliding scale or prorated discounts (a cash management option not possible with traditional discount terms).
- Pay on the due date to preserve cash and maximize the return on the float.
- Establish a new term policy. For example, extend net terms from 30 days to 45 days to stretch DPO and increase the float and working capital from suppliers who do not accept an early payment discount term.
Get your 'dynamic discounts'
As the end of key fiscal periods approach, it’s common for organizations to make last-ditch efforts to find residual dollars buried in their receivables and payables. To generate cash flow before deadlines hit, more organizations are employing “dynamic discounting” by providing a sliding scale of discounts depending on how early the buyer pays.
Suppliers with a need for cash at critical points in their financial cycle, such as quarter end, can use dynamic discounting to leverage their receivables as an alternative source of funds. Offering discounts on approved net-term invoices in exchange for accelerated, "pay-me-now" terms satisfies both buyer and supplier.
Along with commercial card programs, which also help manage working capital needs and supply chain finance (See Winning at the Commercial Card "Game"), dynamic discounting represents a best practice to meet the needs of your suppliers. Bundled together, they become an integrated strategy for optimizing your working capital.
Applying Analytics to Supplier Management
The success of your discount capture efforts depends on how effectively you engage and manage your suppliers. Using supplier spend analysis benchmarking and performance measurement metrics, including supplier payment terms, spend frequency and volume of business, to evaluate your payables operation and supply chain, can help you evaluate your supplier management techniques. The business intelligence you gain can be invaluable. For example:
- Many strategic suppliers falling into the “direct spend” segment already have a contract or fixed purchase order with you. Despite these pre-negotiated agreements, research from the Aberdeen Group indicates approximately 75 percent of all pre-negotiated savings are never captured.
- A significant percentage of your spending is likely made with non-strategic or indirect suppliers. Chances are, many of these suppliers include small businesses with limited access to capital, creating an attractive opportunity for capturing incremental discounts.
- Utilities, government organizations and insurance companies generally do not offer payment discounts. Leveraging an automated payables process will ensure these suppliers are paid on time, thus avoiding fees.
Supplier spend analysis can help establish supplier participation in an accelerated receivables program, gauge your suppliers' willingness to come aboard and participate in discounting, and measure discount penetration and credit card acceptance rates. Identifying high-volume/low-dollar suppliers you currently pay via paper checks but who accept credit card payments creates additional opportunities. You can convert them to purchasing cards for settlement, thereby further streamlining your payables and working-capital management.
Chase can help
Chase understands the financial needs of the business and public sectors. That's why more organizations are turning to us for cost-effective payables solutions that promote working-capital efficiency.
Whether your situation requires enabling electronic payments using ACH, a card program that offers electronic settlement or a total payables processing solution, Chase can help. We'll work with you to design, implement and support an efficient and effective payables strategy.
By leveraging our financial and industry-leading technology resources, your Chase commercial banker can help you accelerate funds availability, reduce risk exposure and increase bottom-line performance.
For more information about putting our family of treasury products and services to work for your organization, contact your Chase Commercial Banker.