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Dynamic Discounts & Reverse Factoring: the Bottom Line

How purchase-to-pay automation can give closer control of payment cycles – and over 30%  annual return on capital.


If you were offered a way to get a 30+% annual return on your capital, and more efficient financial processes, would you be interested? I’m guessing yes, especially now as businesses are tempted to hold onto their cash for as long as possible. While UK firms have reduced the time it takes to settle their bills, according to Experian’s Late Payments Index, they are still paying 21 days after agreed terms. Everyone’s doing it, but it isn’t good for supplier relationships. Nor does it make the best financial sense – so why do firms persist with it?


CFO versus CPO
Viewed from the traditional CFO viewpoint, the only levers they have on suppliers are payment terms and retention of working capital. In contrast, the view of the head of purchasing is NOT to squeeze suppliers, because of the risk this presents to the company’s supply chain.
So the arm-wrestling contest between purchasing and payment continues. What’s more, it’s usually over very small percentages. A typical business reserve account gives around 3% interest, or just 0.25% per month. Better than nothing, but does it compensate for the squeeze on suppliers and the risk it causes?

Doing the maths

The alternative is dynamic discounting. While paying suppliers early to improve your own cashflow seems counter-intuitive – and may cause some internal controversy – the figures certainly add up. Let’s assume that by offering to pay invoices in 10 days instead of 30, a company negotiates an average discount across its suppliers of 2%. That’s six times the interest earned by delaying payments. Furthermore, the return on capital would be 2% in 20 days, or over 36% annually. Even if the negotiated early-settlement discount was half of the above – just 1% — that’s an 18% annual return on capital, which is far higher than alternatives, such as delayed payment.


Capturing the discounts
Of course, you need to be able to track and hit early settlement deadlines. How do you ensure your payment systems are capable of this? The secret is gaining control of the purchase-to-pay process, which gives you the choice of how and when to pay in line with your working capital strategies. Having an automated invoice processing solution is a key first step - to ensure that invoices are received electronically, or scanned to enable electronic processing. But it’s vital to look beyond simply scanning and capturing of invoice data, and uploading it onto the accounting system. The most vital stage is what happens after the invoice is digitised – matching the invoice to its corresponding PO or other documents, so that all evidence for prompt approval and payment is available to AP staff.


The second issue is ensuring that those who approve invoices can do so quickly and easily. Manual tasks like finding supporting documentation, checking and consolidating can cause delays that put early settlement deadlines at risk.

So, automation is critical, as is the ability for AP staff to access their invoice workflow wherever they are. A cloud-based solution is ideal for these circumstances. Integration with core business systems is also critical, so that any exceptions (invoices without orders or incorrect coding) can be highlighted, and escalated where needed. This means that settlement deadlines can be built into workflow to ensure savings are captured.

Benefiting from your banking
Many organisations already have the building blocks in place for integrated purchase-to-pay solutions, enabling the deploying  of dynamic discounting to suppliers and partners, boosting capital and reducing costs.

Another option is to look at Reverse Factoring, working with your bank. Where traditional factoring uses an invoice as the underlying asset for financing, Reverse Factoring brings the qualified invoice into play. And instead of dealing with the supplier’s receivables from many ‘unknown’ buyers, Reverse Factoring deals with the payables of one known buyer.

In traditional factoring, the factor company does not know whether the supplier delivered the promised goods or services, or whether the invoice will be contested – so only about 70% of the invoice value is normally financed. But with Reverse Factoring, the buyer approves the invoice prior to the financing organisation settling with the supplier, enabling financing of 100% of the invoice value.

The keys to success with AP automation or P2P are control and choice. With control over your processes, you have the choice of how and when to pay your supplier. This in turn allows you to maximise the return on your capital. For those companies that have that integration and control over their cycle, purchase-to-pay automation offers a real payback for paying forward.

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