Treasury s Role in Transforming Accounts Payable Into a Profit Center

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1 Treasury s Role in Transforming Accounts Payable Into a Profit Center SYNOPSIS A white paper written & produced by Accounts Payable ( A/P ) is rarely funded at a level that matches other finance areas. The moniker of cost center is hung around A/P s neck and can be accompanied by limited resources. Treasury typically owns working capital and needs to help drive and support the right type of organizational emphasis on A/P. This is due to the fact that while A/P manages or influences several key levers of working capital, which can have disproportionate impact on the financial strength and flexibility of the firm, they do not occupy a seat at the executive table. By trying to make adjustments on their own, such as paying vendors late, A/P can destroy critical vendor relationships, costing the firm more than just money. A/P can be turned into a profit center while optimizing working capital usage, but they need a strong partner. Treasury is an ideal partner to help transform A/P into a profit center. In order to accomplish this, treasury must take a lead role in moving the levers with the right level of corporate support to ensure that the levers are not just pushed to one extreme or the other in a way that ignores key relationship elements Strategic Treasurer. All rights reserved. 1

2 RECOGNIZING A/P S PLIGHT It is no secret that A/P departments are viewed as cost centers operational and not strategic a necessary administration function. Typically, this translates into organizations making a minimal investment in A/P, sufficient to keep it operating, in compliance, and out of trouble. If this negative perception surrounds an A/P department, it becomes particularly difficult for A/P leaders to get the level of attention and the investment required to make changes for a significant impact. When A/P seeks to move from being a cost center to a profit center, they may find themselves caught in the middle trying to realize significant value for the organization, while being viewed as a necessary overhead. View as Cost Center A/P Trying to Realize Value for Organization ĵĵcost Center Label. That label reflects a relatively diminished view of the department compared to areas or divisions that generate revenue. A/P may be under-appreciated, overlooked, and therefore underleveraged. This is a lost opportunity. ĵĵhistorical Failure to Invest Beyond the Minimum. Investment in A/P is typically provided when it is necessary to comply with government rules, tax requirements, or to support new payment types. These required changes absorb all available funding. After compliance, the competition for additional funding is won by profit-generating areas and cost-reduction efforts. ĵĵintent to Spend. There is some good news that this attitude of minimal spending has been changing. Intent to spend significantly for payments remains elevated at 27%. While this certainly reflects new payment types 2017 Strategic Treasurer. All rights reserved. 2

3 50% We intend to make significant information technology investments in the next year in the following areas: % 40% 35% 30% 36% 37% 41% 33% 31% 27% 25% 20% 19% 22% 21% 20% 15% 15% 14% 10% 5% 0% TREASURY INVOICING PAYMENTS CASH REPORTING that have been developing, it also reflects, in some measure, an improved view of what A/P can do for the organization. ĵĵfocus on Expense Management. Many A/P projects have been justified by expense savings and not linked to key organizational financial goals in the past. This is a recipe for ongoing rejection, frustration, or partial funding. Providing cost savings is quite helpful. It just isn t enough. Treasury, in conjunction with A/P, needs to establish the link between vital corporate goals and A/P s role. To help facilitate this change in organizational thinking, treasury can provide the financial data to support the initiative in the form of liquidity gains, working capital improvements, and return or profitability. Treasury s effort and support in this area can be the driving force that helps A/P break free from being viewed solely as a cost center within an organization and pave the way for real, meaningful change Strategic Treasurer. All rights reserved. 3

4 THE TREASURER S STAKE IN A/P Different metrics have different purposes. Some questions, especially those that drive us toward faulty choices, can be unhelpful and distracting. What are some of the financial goals related to A/P? Do we care more about days payable outstanding (DPO) or working capital? Are we concerned about liquidity or some other departmental metric? Do we need to make a distinction between measurements that focus on efficiency and those that emphasize financial return and profitability? Treasury understands that each of these items impact the working capital results. Accordingly, their stake in the success of A/P is high. ĵĵdpo and Liquidity. Month-end numbers and liquidity needs. EEMEASURE OF EFFICIENCY. Cash Conversion Cycle (CCC). The CCC is a measure of efficiency. It helps us understand how quickly an organization Cash Conversion Cycle: Opportunity Areas ORDER FLOAT INVOICE FLOAT DISBURSEMENT FLOAT ORDER TO PAY Order Placed With Vendor Goods Received Invoice Received Invoice Disputed Invoice Processed Payment Sent Discounts Taken/ Missed ACH P Card E Debit Terms/ Payment Method Funds to Clear EDI/ EFT ORDER TO COLLECT Customer Order Received Customer Order Entered ORDER FLOAT Review of Customer Credit Goods Prepared Goods Shipped Invoice Cut Electronic Invoicing Invoice Mailed Invoice Disputed Payment Method: Check, Wire/ ACH Payment Applied to Account Payment Received Collection Method: Lockbox Paper Electronic Check Deposited Funds Available INVENTORY FLOAT INVOICE FLOAT COLLECTION FLOAT Reconcile 2017 Strategic Treasurer. All rights reserved. 4

5 Cash Conversion Cycle DI L DSO K DPO K CCC Traditional Working Capital = CA - CL Inventory L A/R K A/P K Net Adjusted Working Capital can secure inventory, turn it into finished goods, sell the goods, and convert the sale into cash. This covers DI (days of inventory), DPO (days payable outstanding which covers your efficiency of stretching out when you pay for the inventory), and DSO (days sales outstanding, which measures how quickly you can collect on what is owed). For all organizations, even those without inventory, efficiency in the CCC process provides a helpful measure for organizations to determine how well they are running their operation. It is a measurement in days of efficiency. This measurement also gives a good indication of their ability to handle increases in volume and other organizational changes. An inefficient CCC means more financial capital than necessary may need to be deployed into A/R and Inventory. This can seriously obstruct a firm s working capital metrics over time. EEMEASURE OF FINANCIAL REQUIREMENTS. Net Adjusted Working Capital (NAWC). Working capital has two formulas. The traditional formula is current assets less current liabilities. This is a measure of liquidity that bankers and accountants enjoy. It provides a general guideline that the more this number is positive, the more likely the organization can pay their current bills as they come due. This measurement is effective for that purpose. The alternative formula is inventory plus accounts receivable less A/P. This is a measurement of the financial capital that is used and provided by the business processes that we see operating in the cash conversion cycle. It is a measurement of amount of capital needed for operational activities Strategic Treasurer. All rights reserved. 5

6 DPO & I/S L B/S K Number of Days in a Period Cost of Sales M Accounts Payable BALANCE SHEET INCOME STATEMENTS WHY THE PARTNERSHIP BETWEEN TREASURY & A/P MATTERS Problems can arise when an organization pits one KPI against another. Understanding the need to optimize working capital and liquidity requires that A/P and treasury work together. This is important when we consider how vital it is to both departments for A/P to succeed in linking their activities and projects to the organization s strategic and tactical objectives. It is treasury s partnership and influence that can create an environment where these A/P initiatives can be taken seriously. Regarding A/P, there are important considerations for treasury that cannot be ignored: Understanding how measurements are made can help us understand what uninformed operational conclusions we need to avoid. ĵĵdpo versus Liquidity. Month-end numbers and liquidity needs. EEDPO. Month-End Numbers. The CCC numbers are provided as a measurement in the form of days. These numbers come from month-end financial reporting. DPO, for example is the payables outstanding at the end of the month (or, more commonly the average of the most recent month-end and the month prior). This does not show or reflect the actual payables outstanding every day of the month. Each CCC element (payables, inventory, and receivables) can have high 2017 Strategic Treasurer. All rights reserved. 6

7 or low points during the month. A/P and treasury may love the financial statement driven measurements for the purpose they were created. However, they are not created to measure liquidity needs directly. $16 MILLIONS USD $14 $12 $10 $8 $6 $12.5 mm $7.5 mm $4 $ TIME (DAYS OF MONTH) EELIQUIDITY NEEDS. Continual View. The old joke that ends with the statement: I can t be out of money; I still have checks! is a consumeroriented example of the business situation that could be phrased as We can t have a liquidity issue on the 15 th since our month-end working capital metrics are great! A firm that has significant payments due on the 5 th can run into liquidity problems even if their month-end accounts payables balances seem to provide significant working capital. The balance of cash (increased by collecting receivables and decreased when A/P makes the payment) can vary greatly throughout the month. Liquidity is the domain of treasury, and A/P has some important levers that impact liquidity on a daily basis Strategic Treasurer. All rights reserved. 7

8 Optimizing working capital and liquidity needs to be front and center of any major A/P project or initiative to ensure it garners the right type of attention and support. This is an effective way to manage relationships and expectations while also providing significant value to the organization as a whole, including treasury. Treasury must not undervalue their role in this process and help make the case for A/P by highlighting the value their projects bring to the organization s financial goals. TRANSFORMING A/P INTO A PROFIT CENTER How can a cost center like A/P become a profit center? The approach to optimizing A/P 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. A strategic approach to the payments process allows an organization to generate capital, payment rebates/discounts, and also allows A/P to generate profits in excess of their costs. ĵĵexamples of Generating Yield in A/P. Generating financial value that can exceed the cost of accounts payable. EECOST 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 is not sustainable or is one-time in nature, then an overnight or short-term bond rate would need to be applied. EEPUTTING CAPITAL TO WORK. There are several ways to generate discounts in A/P. 1. 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 2017 Strategic Treasurer. All rights reserved. 8

9 Discount Techniques: Industry Coverage 100% INDUSTRY COVERAGE 75% 50% 25% DYNAMIC DISCOUNTING INTEGRATED PAYMENTS CARD REBATES TRADE DISCOUNT $1,000 10, ,000 SPEND AMOUNT 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. 2. 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 interaction and the A/R posting process depending upon the technology that is deployed. 3. Card Rebates. If their vendors accept card payments, companies can take advantage of 2017 Strategic Treasurer. All rights reserved. 9

10 AMOUNT USD $400K $300K $200K $100K $0 -$100K -$200K -$300K Payment Rebates $400K $300K $200K $100K -$300K -$300K -$300K -$300K -$300K Q1 Q2 Q3 Q4 Q1 QUARTERS 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. The overall process for payment and receivables management between the two organizations can be quite different and may create some inefficiencies for generating payments and the A/R posting process on the other side. 4. 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. A/P 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 built-in capabilities for automating the A/R posting process. These examples of generating yield within A/P can provide substantial financial benefits that cover part or all of the cost of A/P. In some cases the financial benefits can surpass the entire cost of A/P, turning the department into a profit center. KEY TAKEAWAYS: INCREASING THE VALUE OF A/P ĵĵunderstand Capital. Capital is the core driver for most companies. The board and executive team understand the importance of it since it also heavily influences the valuation of the firm. The A/P process is quite operational and won t gain much attention if the focus is on the operations side. A/P needs to know how to 2017 Strategic Treasurer. All rights reserved. 10

11 frame their plans and actions in a way that generates more excitement up the management chain. A/P can impact capital in positive and negative ways. Throwing around the word capital isn t enough. Understand capital and how A/P initiatives and actions, or inactions, can have an impact, and you can get far better attention. ĵĵrecognize the Time Value of Money. Discounts missed and taken are terms largely unknown outside of A/P and some treasury circles. Few care about these things. But, this is just one example of how the time value of money intersects with working capital. The time value of money is a different way of recognizing the cost and value of capital. If A/P can move out payment terms on some clients, they can often free up enough cash to take all financially viable discounts. This allows A/P, in conjunction with treasury, to see where their levers add financial value and, add to the profit center calculation. Offering the option to your vendors, or making it part of the business model, to get paid earlier at a discount, ensures you can leverage all or most of A/P instead of a small percentage of the payables universe. ĵĵfree Up Cash without Killing Your Trading Partners. Simply pushing out payment terms may seem like a sure way to push the capital-raising requirements out to your vendors. This can harm or imperil some vendors who may not have ready access to inexpensive capital. Making life difficult for key vendors can backfire creating a lose-lose situation. Instead, A/P can pay earlier at a discount or A/P can extend terms, while providing the flexibility of taking money earlier for those who need it. This flexibility can free up cash without killing your trading partners. The cash that is freed up, or the reduction in costs, all contribute to the profit center calculations. Take these critical steps to help transform your A/P group into a profit center. The movement from cost center to profit center changes how the rest of the organization will look at and invest in A/P Strategic Treasurer. All rights reserved. 11

12 ABOUT BOTTOMLINE TECHNOLOGIES Bottomline Technologies (NASDAQ: EPAY) helps businesses pay and get paid. We make complex business payments simple, secure and seamless. Businesses and banks rely on Bottomline for domestic and international payments, effective cash management tools, automated workflows for payment processing and bill review and state of the art fraud detection, behavioral analytics and regulatory compliance. Headquartered in Portsmouth, New Hampshire, we delight our customers through offices across the United States, Europe, and Asia-Pacific. Businesses around the world depend on Bottomline solutions to help them pay and get paid, including some of the world s largest systemic banks, private and publicly traded companies and Insurers. Every day, we help our customers by making complex business payments simple, secure and seamless. 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13 THE TIME IS NOW: TREASURY & AP DEPARTMENTS CAN COLLABORATE TO ACHIEVE PROFIT CENTER STATUS Discover how 3 organizations use the Paymode-X payment network to elevate efficiency and improve the bottom line. Read the case study ebook to learn how: A manufacturing company overcame its ERP integration and remittance delivery challenges to scale payment automation in response to growth demands A hospital finance team got out from under its pile of paper checks and improved vendor relations A healthcare management company with 44 properties and 95 bank accounts reduced complexity and cut costs by more than $75,000 CLICK HERE TO READ MORE ABOUT STRATEGIC TREASURER Since 2004, Strategic Treasurer has helped hundreds of corporate clients face real world treasury issues. Our team of senior consultants is comprised of former practitioners with actual corporate treasury experience who have hopped the desk to support their former peers from the consulting side. Strategic Treasurer consultants are known not only for their expertise in the treasury space, but also for their responsiveness to client issues, thorough follow-through on each project, and general likability as temporary team members of your staff. 525 Westpark Drive, Suite 130 Peachtree City, GA strategictreasurer.com info@strategictreasurer.com Our focus as a firm centers on maintaining true expertise in the treasury space. Through constantly refreshing our knowledge and intentionally learning about leading solutions, we ensure that our understanding is both global in scope and rich in detail Strategic Treasurer. All rights reserved.