Early payment discounts – a lucrative cash management tool

Stretching accounts payable is an old-school strategy long considered common sense cash management. The advent of "business settlement networks”, which electronically process invoices and payments, is questioning this premise. By compressing the settlement cycle from weeks or months to just days, business settlement networks dramatically expand early payment discounts programs to deliver treasury managers double-digit, risk-free returns on cash.

For many Fortune 2000 companies less than one percent of suppliers offer discount terms today. Yet, in a survey of JPMorgan Business Settlement Network suppliers, 85 percent of respondents stated a willingness to occasionally or always accept discounts for faster payment. This gap highlights one of the great earnings opportunities in corporate finance.

Business settlement networks transform financial settlement operations to bring virtually all discount opportunities within reach. This goes beyond strategic suppliers – the focus of most traditional early payment discount initiatives ¬– to include non-strategic suppliers that may represent 80 percent of suppliers and more than 20 percent of spend. A business settlement network makes it easy to extend terms to all suppliers, reaching those hungriest for cash and willing to offer discounts as high as 4 percent 3 net 30 – a remarkable 54 percent annualized return.

Results from over $170 billion of spend processed in JPMorgan Xign's business settlement network show that on average 30 percent of suppliers will select discount terms if offered to them. With a business settlement network, the remaining net-term suppliers can tap discounts opportunistically by requesting early payment on any approved invoice that meets a predetermined hurdle rate set by the buyer.

Energizing working capital performance
KeySpan Corporation, the largest distributor of natural gas in the Northeast, was using a manual process to handle more than 22,000 invoices per month. With an estimated five percent exception rate, more than 90 percent paper-based invoices, and millions of dollars of paper check payments, KeySpan’s processing costs were an area of focus. In response, the company sought an electronic settlement solution, and achieved impressive results.

More than 750 suppliers enrolled during the first phase of implementation, including 27 percent that agreed to early payment terms, representing more than $450 million in annual spend. Within its first year KeySpan realized significant cost savings. Annual accounts payable spend fell by nearly $500,000, while vendor discounts rose dramatically, earning a 36 percent annualized cash return. In addition, KeySpan was able to pay participating suppliers 14 days faster on average, further strengthening vendor relationships.

Memorial Sloan-Kettering Cancer Center (MSKCC), the world's oldest and largest institution devoted to prevention, patient care, research and education in cancer, has been at the forefront of business settlement automation, having deployed a solution in 2003. Since that time, the institution has signed up over a thousand strategic and non-strategic suppliers to accept early payment discounts and generates discounts on more than 50 percent of invoice volume and 25 percent of spend. On average, the electronic settlement network’s discount management functionality has accelerated payments to suppliers by 45 days, in return for discounts of two percent.

Turning accounts payable into a profit center
Business settlement networks are truly transforming the accounts payable function. Savvy CFOs, financial directors and AP managers are emerging as a new kind of portfolio manager and can earn double-digit annualized cash returns just by paying bills earlier. Here are some tips on how to turn your accounts payable department into a profit center:

• Put an electronic settlement infrastructure in place – First, your AP team will need to add a level of speed and visibility to your settlement process that makes it possible to identify opportunities for early payment discounts, and execute them successfully. That’s where new web-based electronic settlement services come in. Today’s on-demand services make it easy for businesses to extend an existing ERP or financial system with little or no IT involvement. With an electronic settlement solution your AP team can process and pay electronic invoices in days compared to the standard weeks or months with paper-based processing. With paper-based systems companies might capture pre-negotiated term discounts about 20 percent of the time. Organizations that settle B2B transactions electronically can capture these discounts more than 95 percent of the time.

• Proactively recruit suppliers – Even the most efficient settlement networks won’t get you discounts without suppliers participating in early payment programs. JPMorgan Xign’s research shows that large buyers typically have early payment terms with far less than five percent of their suppliers. Yet more companies are taking charge and driving early payment discounts across their supplier bases, quickly growing the number of suppliers from tens to hundreds or thousands. And the rewards build quickly. Don’t wait for suppliers to offer you early pay discounts ¬¬– take charge and drive. Improving cash collections and days sales outstanding (DSO) are mission-critical for your suppliers and many will welcome the opportunity to participate if you simply ask.

• Segment your suppliers for maximum impact – When it comes to rolling out early payment programs, it’s important to remember that one size doesn’t fit all. You need to consider the amount of discount ‘leverage’ you have with a particular supplier and define the payment terms appropriately. For example, strategically sourced suppliers, such as mobile handset, or other technology providers, handled by your purchasing organization, are likely to be much bigger and financially sound than smaller non-strategic suppliers, such as maintenance vendors. Other categories such as telecom, taxes or rent may simply not be discountable.

Strategic suppliers may include early payment discounts in the contracts that are negotiated by your procurement organization, but according to a report from Aberdeen Group, a market research firm, 60 percent of procurement managers stated that up to 75 percent of savings negotiated at the time of sourcing did not get realized at execution. So for agreements with your strategic suppliers, a business settlement network helps to enforce discounts struck by your procurement team by getting invoices paid on time.

There is another large pool of suppliers typically not managed by the procurement organization – the non-strategic suppliers. These suppliers are typically small to mid-size suppliers. While these companies represent a smaller portion of a company’s total spend, they are also the hungriest for cash and much more likely to accept discounts versus strategically sourced suppliers. Understanding your supplier’s need for cash is a key to success. Collaborate with your purchasing and supplier recruitment teams to segment your suppliers appropriately and develop an effective plan of attack.

• Give your suppliers every opportunity to participate – Not every supplier is willing to sign up for an early payment term. According to a JPMorgan Xign supplier network survey, on average 20 to 25 percent of suppliers will accept early payment terms – leaving the remainder on net terms. Are these net terms suppliers a lost cause? Absolutely not. In fact, it turns out that 65 percent of survey respondents indicated that they occasionally work with their customers to accelerate payments for discounts.

Some electronic settlement systems offer a ‘Pay Me Now’ option that gives suppliers in need of cash the ability to accelerate payment on any approved invoice in return for a nominal discount. Because it’s done electronically, the invoice on the customer side is updated with the newly discounted terms instantly. And both sides benefit – the buyer saves, while the supplier gets needed cash flow.

• Set the right metrics and promote your value – The key to any company initiative is to set the right metrics and promote performance. With an automated system it’s easy to set metrics and track them on an ongoing basis. But most importantly, metrics need to go beyond traditional “processing”-related numbers to the more important “bottom-line” statistics – impact on earnings, cash return and working capital. Over time, businesses are tuning their systems to be able to process invoices in hours as opposed to the norm of 42 days or more, and are regularly capturing upwards of 90 percent of potential discount opportunities to drive annualized risk-free returns of 36 percent or more.

As I mentioned earlier, early payment discount opportunities won't always apply. For spend categories such as telecommunications, utilities, employee expenses, taxes and rent, moving settlement from paper check to corporate purchasing cards provides another way to earn discounts through lucrative purchasing card rebates. In the new world of electronic settlement, stretching payables is the road to low return. To maximize cash earnings, a comprehensive early payment discount strategy is essential. As companies are discovering, these discounts drive lucrative, risk-free returns on short-term cash, improving corporate earnings with no impact on DPO.

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