As discussed in the previous post, understanding the need to optimize working capital requires AP and Treasury to work together.

So how can a historic cost center like AP become a profit center?

The approach to optimizing AP must be different from driving costs out of the department and the processes. Certainly, unneeded costs must continue to be exercised prudently, thoughtfully, and consistently over time. However, that is not enough. No matter what is done, costs cannot be driven below zero.

  • Examples of Generating Yield in AP. Generating financial value that can exceed the cost of accounts payable.
    • COST OF CAPITAL. Extending payment terms frees up capital for other purposes. There is real, measurable financial value to the organization for this activity. This capital, if the change is long-term, can be valued as the weighted average cost of capital (WACC) or the cost of long-term debt. If the extension if not sustainable or is one-time in nature, then an overnight or short-term bond rate would need to be applied.
    • PUTTING CAPITAL TO WORK. There are several ways to generate discounts in AP.
      • Accepting discount payment terms. (1/10, n/30) allows you to pay invoices earlier while realizing an effective 18% annual value for that action, which could be netted against a capital cost measure. Some percentage of the company’s vendors may offer this (2-10% is a typical range), so the amount of profit that can be generated via this method is limited by your vendors and whether they offer this consistently. The overall process for payment and receivables management between the two organizations remains approximately the same.
      • Dynamic Discounting. This involves driving vendors to longer terms to receive the full amount of the invoice. But, they are offered the ability to receive their funds earlier in the process by accepting a discount, which is offered on a sliding scale based upon how early it is requested.

        The overall process for managing the receivables side of the business is normally quite different and may create some inefficiencies through manual interactions and the A/R posting process depending u[on the technology that is deployed.

      • Card Rebates. If their vendors accept card payments, companies can take advantage of rebates offered through a purchasing card program. The sums, for larger organizations, can become substantial. Similar to accepting trade discounts, the level of card acceptance limits the amount of payables subject to these rebates.
      • Integrated Payment Rebates. This involves the use of a payment network that will register vendors and typically makes Payment via an ACH. The terms are the same as before entry into this program or slightly faster. AP will receive a rebate which is typically targeted at below the rate a vendor would have to pay for accepting credit card.

        The overall process for the payment side is adjusted once and becomes more streamlined. The receivables end of the trade also has a change but has some build-in capabilities for automating the A/R posting process.

These examples of generating yield within AP can provide substantial financial benefits that cover part or all of the cost of AP. In some cases the financial benefits can surpass the entire cost of AP, turning the department into a profit center.

Posted by Craig Jeffery

Craig Jeffery, Managing Partner of Strategic Treasurer, has 20+ years of financial and treasury experience as a practitioner and as a consultant helping organizations craft realistic goals and achieve significant benefits quickly.