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- January 15, 2015
- Donna Wilczek
- Finance & AP
Sequential invoice processing—paying invoices in the order they come in--is the default practice for many Accounts Payable organizations. But is it a best practice? No, because it eliminates the ability for AP to be strategic, and potentially save millions of dollars.
Here’s why: If your AP department is processing invoices sequentially, you're operating under the assumption that every invoice is equally important to your company. That's simply not the case. Invoices with pre-negotiated early pay discount terms or dynamic discount payment offers associated with them are exponentially more important to your company. It makes sense to do everything you can to process those invoices faster so you can get those discounts.
Through the lens of Annual Percentage Return (APR), capturing early pay discounts generates an astronomical return. If we're talking 2/10 net 30, meaning a 2% discount if paid within ten days, you’ll realize a more than 36% APR by taking that discount instead of paying the full amount in 30 days. Don’t believe me? Take a look at the math:
APR = Discount %/(1-Discount %) x 360/(Full allowed payment days – Discount days)
Here’s the math for that same 2/10 net 30 scenario discussed above:
APR=2/(1-.02) x 360/30-10)
APR=2/.98 x 360/20
36.72=2.04 x 18
Here’s how that plays out for other discount offers:
As you can see, depending on the size of your organization, early pay discounts can add up to millions in savings that fall right to the bottom line, and do a good job of boosting net income.
If your business has the ability to pay--if you have cash in the bank that’s not earmarked for something else, or can borrow at low rates—you should do everything possible to take the early pay discount every single time it is offered by a supplier. The strategy here is simple: in a low interest rate environment, holding cash to “earn the float” simply doesn’t make sense. Treasury teams focused on liquidity availability are in a pitched, up-hill battle to generate fractions of a percent of return.
So why do AP organizations cling to FIFO processing instead of prioritizing invoices according to the size of the early pay discount opportunity? In my experience, there are a couple of reasons.
A Simple Misunderstanding
The first is simple misunderstanding. When I propose this strategy to an AP department, they often tell me “My CFO told me to stop paying early, so procurement stopped negotiating early pay discounts.”
My response goes something like this: “Your CFO likely meant to suggest you ‘stop paying early if there isn't a discount that makes early pay compelling’ and message got distorted along the way.” A quick conversation with the CFO usually clears that up.
The other big reason AP departments don’t aggressively pursue early pay discounts is that they are bogged down by massive amounts of paper and manual processes.
Maybe it’s a flood of paper invoices that need to be manually keyed in. Or, maybe they ‘upgraded’ to an OCR system that lets them move from a horse to a horse and buggy—from manual processing to semi-manual processing. Or they have a system for electronic invoicing but suppliers hate it, so they send paper instead of using the electronic option.
Layer in inefficient invoice workflow processes and you have the all-too-common situation of an AP department challenged just to pay on time.
If you can’t even get invoices paid by the original due date, how can you possibly pay before a shorter discount deadline? You can’t do it without throwing more people at the problem, negating the savings you are working so hard to realize. The solution is technology.
Two keys to capturing early pay discounts
To take advantage of early pay discounts without adding headcount, you need an electronic invoice processing system that automatically prioritizes the AP team’s workload based on the bottom-line impact of the early payment discount and lets them take fast action.
And, you need both suppliers and employees to adopt your e-invoicing solution. This doesn’t work if you still have to deal with manual or semi-manual processes. Adoption boils down to two key elements:
1. Suppliers must be able to submit electronic invoices easily, with no technology requirements, contracts or fees as a barrier to adoption, and
2. Employees must be able to review and approve invoices from any mobile device
It’s important to remember that the vast majority of suppliers in the world have fewer than 100 employees and don’t have advanced technology, so the easier you can make it, the more likely it is they’ll invoice you using your electronic system. If your solution works on the lowest common denominator--email and mobile phones--you’ll significantly increase the level of participation from your suppliers as well as AP’s ability to process invoices any time, anywhere.
That’s why Coupa recently introduced supplier actionable notifications to make it easy for your suppliers to break away from paper invoicing. When the time comes for a supplier to invoice, they go to the PO email, click a link in the email and are automatically taken to a screen that has all of the PO data entered in invoice format. All they need to do is fill in the invoice number, amount, and additional charges, i.e. taxes, and click send, which they can do from their mobile phone.
What’s key here is that your supplier does not need to join a network, or sign a contract and so no supplier enablement is required.
The fee hurdle
Supplier fees also reduce adoption of your electronic invoicing initiatives. It still boggles my mind that some companies actually charge their suppliers for the privilege of invoicing them.
Imagine if you took your invoices to the post office to mail, and the clerk looked at the amounts on all of them and sold you a stamp based on 1% of the amount of the invoice. For a $500 invoice, they would sell you a $5 stamp. For a $500,000 invoice, they would sell you a $5,000 stamp, even though they’re providing you the exact same service – delivering your invoice. It makes no sense and suppliers don’t see the value. They’d rather mail you a piece of paper for $.49 and be done with it.
When you think about the amount of money you could save by taking advantage of early payment discounts, it makes sense to invest in systems to free up AP time, break down barriers between buyers and suppliers, and create win-win partnerships that can have a massive positive impact on your company's bottom line over the long term. Not only will you be able to start capturing all the discounts you're entitled to, you will position yourself to negotiate more and better discounts with your suppliers, a topic I will discuss in my next post.