Rethinking Working Capital Leverage

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With Covid-19 and the upcoming U.S. Presidential election—not to mention continued tariff and trade issues—economic uncertainty is here to stay. To navigate effectively, CFOs must be vigilant. Visibility is key, but so is vision —specifically, the ability to think outside of the box and get creative when it comes to working capital strategies.

Real-time visibility is critical to monitor and navigate changing parameters. The Net Income Statement, cash flow, and balance sheet provide an accurate representation of a company’s financial position, to support strategic planning and fiscal management. However, Accounts Payable (AP) information, driven by month-end closing reports and on regular intervals, is vital to reflect payables on the income statement, cash flow, and balance sheet. This is so organizations can get their arms around real-time spend transparency – what is owed and when – to support creative working capital strategies.

While historically AP has been viewed as a “bill paying” back-office function and is often overlooked as a source of competitive advantage, today this is changing.

Challenging the Status Quo for Working Capital Leverage

Paying suppliers late to foster more available net working capital has been part of the finance playbook for many years. In this new world of economic complexity and uncertainty however, many organizations are challenging the age-old assumption that the best way to increase available net working capital comes from Days Payable Outstanding (DPO) extensions. And many are waking up to realize the significant opportunity that exists within their payables to achieve risk-free returns, in lieu of, or in addition to more traditional working capital strategies.

There are significant savings opportunities to be had through early payment discounts, volume rebates or trade spend initiatives. It’s not necessary to accept all early payment discounts. If cash on hand is deficient or the capital outlay exceeds the benefit of the discount offered, it may make sense to pay later. However, if this is your only play, you are missing out on significant risk-free returns in a low growth/low interest economy.

For example, the terms of 2%10NET can be thought of as lending suppliers the full invoice amount for 20 days if the invoice is paid on day 10 rather than on day 30, at the cost of 2% up front. Consider that you can lend suppliers that same amount every 20-day period in a year (there are 18 such periods in any given year); this means you can earn 2% returns on the same amount of money, 18 times each year. This, alone, is a 36% return. By putting the earnings from each period back into your money-machine (putting 102% of your original principal to work in period 2) and continuing to do so each period, will net 43% returns in a year.

Aside from producing significant returns, paying suppliers early can also play a vital role in de risking the supply chain. The average small-to-medium business today has 24% of its monthly revenue held up in AR, terms or trade credit, making their existence tenuous at best.

All Systems Go: Speed, Agility and Supplier Segmentation

Having in place the requisite technology and processes can enable organizations to execute on spend management strategies. Automating AP operations with the goal of “touchless,” or fully automated, invoice processing can help organizations gain the speed and agility necessary to capture significant savings via available discounts or rebates.

Additionally, clear supplier segmentation is key, as different working capital tools and strategies can then be applied to these different segments. The tables can also be turned, where organizations find margins being squeezed by tariffs. Whatever the scenario, having the visibility to understanding the real-time cash impact and return on payables supports clear decision-making around capital strategy execution.

Success Favors the Bold

Organizations have limited control over external inevitabilities, such as political climate changes; however, companies can gain greater confidence during uncertain times through progressive financial strategies.

Visibility to understand a company’s true financial position is paramount; AP data can bolster this visibility by providing clarity on invoices outstanding. Now is the time to challenge the traditional practice of extending Days Payable Outstanding, as paying early can offer significant risk-free returns.

Automation to foster speed and agility is necessary when pursuing innovative approaches to accounts payable and treasury, and prudent organizations will also look to apply supplier segmentation so they can strategically monetize payables. In this way, organizations can access new and creative sources of working capital to fuel significant competitive advantage.

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