Supply chain finance covers a multitude of tools and facilities that enable buying organisations to optimise their working capital management and ensure the sustainability of their supply base by getting cash into vendors’ hands.
There are some basic good practices, however, that can serve as an entry gateway to more advanced supply chain finance programmes. Here, Andy Gifford, senior director of treasury in EMEA for Level 3 Communications, the company that owns one of the biggest fibre optic telecoms networks in the world, offers a few words of advice as to how businesses can take advantage of the early payment options already at their disposal.
(1) Study your contracts. “A top priority is to take advantage of any early payment discounts and to avoid late payment charges,” Gifford says. The problem, he cautions, is that it’s entirely possible that supplier contracts already in place have early payment terms that are simply being overlooked. Typical terms are of the ‘bullet’ variety – a discount of, say, 1% is available if the invoice is paid on day 15. But if you miss that date, then the full price has to be paid. (Dynamic discounting early payment programmes more typically allow for a sliding scale of discounts depending on when the invoice is paid.)
At the same time, avoid late payment charges which in some jurisdictions, such as France, are automatically imposed by law. (In the UK, a supplier would have to decide for themselves whether or not to claim such penalties from the buyer).
(2) Examine the procure-to-pay process. If attractive early payment discounts are regularly being missed or late payment charges accidentally incurred, then something could clearly be wrong. Understanding the process and fixing it can have a material impact on the P&L by ensuring that “untapped opportunities” are caught and needless penalties avoided.
“You have to be certain that if you are not going to take advantage of the early payment discounts available you are at least not going to incur late payment charges,” Gifford says.
It’s advisable to study your procure-to-pay processes to identify where any delays and bottlenecks are that result in these missed discounts and late payment penalties. “Look, for example, at the purchase process to see who engages with the supplier up front,” he says. “At what point in the acquisition of equipment or services do you actually make a commitment to that supplier and then how do you document that commitment and then recognise receipt of the goods so it can be matched to an invoice and be paid?”
It can be a very manual process. “You have to go back to individuals and ask them why they waited two days to record goods received as opposed to doing it on the day,” Gifford says.
(3) Identify suppliers that would be interested in early payment. Focusing on the largest vendors could well yield the biggest opportunities. Within that group, study a few key facts about them. The cost of capital is an important KPI to know about suppliers. “The higher their cost of capital the more attractive early payments are to them,” Gifford says, “provided that your dealings are significant enough for them to take advantage of early payment and reduce their cost of capital.”
There are two reasons why cost of capital is interesting. The first is that if a vendor has a very high cost of capital “that very often means they don’t have the confidence of their investors in terms of their ability to generate cash, so companies like that would be very interested in having early payments,” he says. Secondly, of course, “The higher their cost of capital relative to your own, the more benefit there is to them if they can get cash in early.”
This is something that needs to be kept under regular review, however. While the current low-interest rate environment seems likely to prevail for some time, it won’t last forever. Moreover, as companies’ fortunes change over time, so, too, can their cost of capital. Because the differential between the vendor’s and the buyer’s cost of capital is a large part of what drives the early payment discount rate, Gifford cautions against negotiating a discount rate “and then leaving it in situ for evermore.” He adds, however, that if circumstances change such that it’s appropriate to try to negotiate a bigger discount with a supplier, “that will be a difficult conversation to have with the vendor if you start having to edge these percentages up.”
Ironically, Gifford adds that buyers in cash-rich organisations might actually find it a bit more difficult to negotiate discounts. “Suppliers may not be willing to give a premium for creditworthiness if they don’t need to,” he says.
Gifford suggests that knowing suppliers’ financial year-ends, half-year-ends and quarter-ends is good information to have. Timing the offer of early payments around these key dates could prove attractive as they can “keep their books clean”, he says. Also take into account any large debts that are about to mature.
(4) Watch out for discount price creep. “One of the dangers when you start regularly asking suppliers for early payment discounts is that they start building that into their normal pricing structure, edging up their prices to take account the fact that you’re paying them early,” Gifford says. “You have to be very careful to make sure they don’t start edging down those volume discounts to accommodate the extra early payment discount they’re now giving.”
One way of keeping an eye out for this is to be aware that many vendors have price books and typically will be agreeable to negotiating discounts for their best customers. How the volume discount trends over time can be tracked alongside the early payment discounts they are giving. If the former narrows while the other grows, the benefit of paying early is being eroded.