Paystream Voices : supply chain financing

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Supply Chain Financing is Growing | Innovative Finance Managers are Learning How With the Receivables Exchange

Posted in PayStream Analyst, Purchase to Payment, Voices by PayStream Advisors on January 28th, 2009

Did you ever wonder why business-to-business transactions are typically settled in 30 days? Why not when goods or services are delivered? Ironically, the concept of trade terms were invented by the Greeks who needed a system to allow for transportation delays. In today’s economies, we have eliminated many of these delays — and drastically improved the information flows about trade. In fact, a new set of tools — Supply Chain Financing and Dynamic Discounting are rapidly changing the options around supplier payments.

Supply chain financing is demonstrating value in the weak economy as more organizations and suppliers learn how to use it, experts say. It’s most prevalent in retail and manufacturing, but ANY industry can take advantage of these tools due to the availability of new solutions. “Supply chain financing is still in the early stages”,” says Henry Ijams, managing director of PayStream Advisors research and consulting firm in Charlotte, N.C. “However, this intriguing concept is gaining lots of interest in 2009 due to the ability to extend early payments to suppliers based on the strength and credibility of the payer.”

Accelerated payments for a discount are not new. In fact, tools such as asset based lending and factoring have been in use for many years. In a factoring relationship, early payment is based largely on the credit of the vendor who’s trying to discount the receivable. With supply chain financing, whether the customer is Electrolux or Joe’s plumbing they get the same discount rate for accelerated payments. Moreover, a new internet based marketplace, called The Receivables Exchange, is now making it much easier for suppliers to access early payments from a variety of lenders.

The Receivables Exchange
This new twist to supply chain financing, Ijams says, is the concept of a non-bank third party lending the money for the supplier. For example, The Receivables Exchange www.receivablesxchange.com in New Orleans bills itself as “the world’s first electronic marketplace for trading accounts receivable.” Online, lenders that might include private individuals or hedge funds can compete to buy the invoice a major corporation has guaranteed to pay a vendor. Ijams describes the Receivables Exchange as a supplier friendly marketplace for selling receivables to investors and other lenders. “This is a brand new capital source that utilizes the Internet to facilitate transactional transparency fostered by buyer and seller ratings. Think eBay for receivables financing.”

“What we like about the Receivables Exchanges is its powerful ability to allow more people to participate in the financing of trade payables,” he says. “Our analysts think this has some powerful dynamics in 2009. While the credit markets have been disrupted, those who still have cash, like hedge funds, are looking for places to invest money.”
“Supply chain financing is becoming more significant as invoices are approved faster with automated matching and workflow,” he says. So far, the concept seems to be a win-win for everyone involved. “With SCF, once AP has approved a payable, and know they’re going to make payment, the buyers shouldn’t care if someone else is using a promise to pay to swap that for early payment. In fact, buyers should promote the use of SCF because it means someone else can potentially lend that supplier money at lower risk and zero cost to us, the payer.”

Future trends
Finance professionals need to stay up to date with the trends happening in supply chain financing – including its “cousin,” dynamic discount management, says Ijams. The concept involves paying suppliers early in exchange for an attractive discount, which lowers the cost to the organization. It goes against the old adage “Collect early and pay late.”

Staying ahead
The changes in trade payables present a major opportunity for AR, Billing Managers and AP departments to shine, Ijams says. “Innovative billing and treasury managers must continue to insert themselves into finance opportunities to help their companies find ways to speed up the invoice approval and cash receipt processes. Effective collection strategies will be based on a continued contraction of the invoice-to-approval time.”

Research by PayStream Advisors shows the average approval time for invoices (from Invoice Date to posting or approval date) for F1000 businesses is 20 days. That leaves only 10 days of potential early payment time for a supplier, minimizing the opportunity for early payment, he says.

Many organizations will not realize how supply chain financing can serve them until innovative finance professionals bring it to the forefront, Ijams says. “It’s a way for finance and treasury managers to heighten their credibility and improve their importance in the organization. … in order to be a value-added players, today’s finance managers have to be the eyes and ears of an organization by looking for new opportunities to focus billing and collections organizations on continuous improvement.

Discounting Turns Dynamic

Posted in PayStream Analyst, Purchase to Payment, Contributed, Voices by PayStream Advisors on November 1st, 2007

This article comes from The Accounts Payable Network, and features Henry Ijams, Managing Director of PayStream Advisors. It discusses Dynamic Discounting.

Vendors for years have used invoice discounts as a means to entice buyers into paying sooner. Under standard discounting terms, such as 2/10 Net 30, buyers receive a 2 percent discount for paying their invoices 20 days early. Since suppliers control the discounting process, buyers hoping to pay invoices early at a reduced price have little option to hope their suppliers offer a discount.

However, like with most accounts payable processes, improvements in technology are changing the way companies look at invoice discounting. Technologies such as electronic invoicing and electronic payment are giving buyers more control over the discounting process. This new form of discounting, which allows buyers or vendors to initiate discounting terms, is known as dynamic discounting.

What is Dynamic Discounting?

The phrase “dynamic discounting” describes a variety of solutions offered by software providers that allow buyers and suppliers to offer and amend invoice discounts electronically. The process is called dynamic because of the emphasis on two-way communication and discount adaptability.

One of the hallmarks of dynamic discounting is the ability for buyers to take advantage of sliding scale discounts. Unlike traditional 2/10 Net 30 discounts, which expire the tenth day, buyers can capture sliding scale discounts throughout an invoice term. Discount amounts are reduced each day as the original invoice due date approaches.

Dynamic discounting is a relatively new process, having been introduced in the early 2000s. The capability is typically found in procure-to-pay solutions with supplier networks such as Ariba or Xign. Increased use of these supplier network solutions has helped fuel the growth of dynamic discounting.

Automation as a Pre-Requisite

Unlocking the full benefits of dynamic discounting requires the buyer to have already automated many of their accounts payable processes. According to Henry Ijams, president of PayStream Advisors, dynamic discounting relies greatly on the speed in which a department can approve an invoice for payment. “It [dynamic discounting] works much better if the approval time on the invoice is fast,” he says. “It all hinges on speed.”

To facilitate this speed companies should implement electronic invoicing, automated workflow, and electronic payment.

Electronic Invoicing and Workflow

Electronic invoice processing is the best way to ensure that a buyer’s approval time is short enough to take full advantage of dynamic discounting. PayStream research states that it take the average AP department 15 days to receive a paper invoice. By the time the paper invocie arrives, the company has lost most of its time to capture a sliding scale discount and all its time to capture a standard 2/10 Net 30 discount. This is called “paper delay.”

Adopting electronic invoicing allows buyers to receive invoices immediately following a purchase, giving them plenty of time to capture discounts.

Automated workflow technology is alos vital in bringing down invoice approval time. Workflow technology can automatically route and approve most invoices instantly, as opposed to manual approval processes, which can last days or weeks.

Electronic Payment

In addition to electronic invoicing and workflow, companies that have implemented electronic payemtn methods find it easier to capture invoice discounts. Payments from companies that issue checks are subject to the same paper delay as paper invoices. An inefficient check payment system can undermine any discounting program, dynamic or otherwise.

“If a supplier agrees to take an early-payment discount and the payment goes through a check-writing process and is not received for a week so , the early payment they were anticipating will not materialize,” says Drew Hofler, senior manager of financial solutions for P2P solution Ariba. “They are not going to likely accept another discount offer.”

When paying invoices electronically, using either automated Clearing House, wire transfers, or purchasing cards, buyers have more control over payment timing. On the other hand, if companies receive paper invoices and pay vendors with paper checks, their ability to capture any invoice discount diminishes.

Offering the Discount

Dynamic discounting creates a fundamental shift in how invoice discounts are offered. Under the traditional 2/10 Net 30 discount model, buyers can take advantage of discounts only when offered by the supplier. When buyers can propose invoice discounts under this model through negotiations, the process requires terms to be set weeks or moths in advance.

According to TAPN’s Early Payment Discount Survey, 76 percent of respondents do not propose invoice discounts to their suppliers. Proposing discount terms to suppliers under traditional discount methods can be difficult and time-consuming.

With dynamic discounting, buyers have the ability to propose invoice discounts independently from preexisting terms. The discounts can be offered at any point in the transaction cycle. All that is required is that the buyer and seller have a way to communicate electronically.

Buyers often propose dynamic discounts using an interface in their P2P system. If the buyer wishes to pay a particular invoice early, they send a message to the vendor through the supplier network. The message typically states that the invoice has been approved and the buyer is willing to pay early in exchange for a suggested discount rate. The vendor may approve or decline the discount. If the vendor is not a member of the buyer’s supplier network, the message is sent via email.

The process works smoothest when the vendor is a member of the supplier network because efficient two-way communication is achieved. In addition, vendors who join a supplier network can take advantage of other services such as electronic invoicing, which greatly enhances a discount management system.

Supplier networks such as Ariba recognize the value that having vendors on a network brings to the buyer and, as a result, typically do not charge vendors to join. Ariba plans to use dynamic discounting as a means of signing up new suppli9ers as part of an initiative called Approved Invoice Quick Enablement. Under the program, when a supplier agrees to accept a buyer-propose discount, they are taken to a form where they create a vendor profile. Once created, they have access to discounting functions with the buyer, as well as other services such as electronic document exchange.

“The [suppliers] go into the network to their inbox where they see all their payment offers, all their invoices, and all their discount offers in one place,” Hofler says. “They can send POs and invoices over the network too if the buyer wants that.”

Determining the Discount

Having a system in place to facilitate dynamic discounting is only part of the process. Buyers must also determine the discount rate they will propose. If the rate is too low, the buyer sees no benefit from paying early. If the rate is too high, suppliers will not accept it. The goal is to find a balance.

P2P solutions that offer dynamic discounting often allow buyers to indicate a discount rate they want to offer a vendor. This rate can apply to a single invoice, all future invoices, or all invoices that meet a certain requirement, such as particular dollar limits. If the supplier agrees, the discounts are applied automatically.

Paystream data states that the average invoice discount achieved from buyer-proposed discounts is between 1.6 and 2 percent off the original price. In addition, buyers who report achieving these discounts tend to pay their suppliers about 10 to 15 days before the invoice is due. Because dynamic discounts are typically on a sliding scale, paying closer to the due date would result in buyers still receiving a discount, albeit reduced.

With the average buyer-proposed discount saving buyers 2 percent for paying 15 days early, the savings are not considerably different from the standard 2/10 Net 30 terms. However, the sliding scale discounts appeal to buyers because, even if they pay on the 29th day, they still receive a small discount. Suppliers enjoy the sliding scale system because it encourages buyers to pay invoices early beyond the standard ten-day discount.

Benefits of Dynamic Discount

Dynamic Discounting is generally considered a single component of a wider discount management program. Buyers propose dynamic discounts to the suppliers that are onboard with the program and negotiate standard terms with the rest. Discount management programs provide several benefits to buyers. These benefits include:

1) Reduced Spend. According to TAPN benchmarking data, a majority of companies taht implement discount management plans typically get between 1 percent and 20 percent of their vendors on board. While the percentages will likely increase, expecting to enroll 100 percent of vendors is unreasonable because there are many types of spend, such as utilities, that cannot be discounted.

Hofler says companies whose discounting provider actively enrolls vendors can expect to achieve discounts on 80 percent of their discountable spend within two years of implementing a discount management plan, which adds up to 0.3 percent of total spend. “That is a reasonable expectation to achieve in discounts,” he says. “That’s about $3 million out of $3 billion of total spend.”

2) High Rate of Return One of the main reasons companies typically delay paying vendors is a desire to keep as much cash on hand as possible. Paying early means buyers give up their cash cushion. However, P2P providers contend that the savings earned form a discount management program surpass the interest a buyer could earn by placing that money into a short-term investment.

With buyers typically receiving a 2 percent discount on their purchases, the money saved by paying a vendor’s invoices early adds up to a 36 percent annual return on cash. Other short-term investments in which buyers can hold money before paying invoices, such as mutual funds and money market accounts, usually pay between 5 percent and 10 percent annually.

Explaining the high return of discounts compared to other investment is essential to convincing finance departments to make funds available to pay vendors (See eProcurement and Early Payment Discounts: Are Finance and Purchasing Finally Seeing Eye to Eye? and JPMorgan Chase launches fully integrated ePayment solution - â€œAP Tracâ€ which discusses Dynamic Discounting and Supply Chain Finance.)

3) Expand Discount Opportunities. Dynamic discounting allows buyers to increase the number of vendors from which they receive discounts. Standard discount terms are negotiated ahead of time by procurement. Because procurement does not have the capacity to negotiate discounts with all vendors, they tend to focus on the largest-volume suppliers.

Dynamic discounts can be offered at any time; they do not require terms to be negotiated beforehand. Offering a small company an invoice discount simply requires sending them a message explaining the terms. If they accept, the discount is applied.

“A procurement organization would never deal with these [smaller companies] because they don’t have the bandwidth,” says Chris Rauen, Corporate Marketing Manager for P2P solution JPMorgan Xign. “When you have a network in place, suppliers can sign up over the web. With no extra cost, a whole new category of suppliers can be populated into the network and allow their buyers to increase their return on cash by paying these suppliers early.”

Rauen says these smaller businesses, which usually represent about 80 percent of vendors and 20 percent of spend, are more likely than larger companies to accept discounts higher than standard terms. In some instances, smaller companies are willing to accept discounts as high as 5 percent because they are “hungry for cash.”

Implementing Dynamic Discounting

Implementing a successful dynamic discounting program requires buyers to understand their invoice payment procedures and be able to improve them if necessary. The goal behind most improvements should be to reduce overall payment time, which is the primary hurdle preventing companies from taking advantage of vendor discounts.

Buyers considering dynamic discounting - or simply curious about the effectiveness of their existing discount management system - should examine the following metrics:

Average days to receive an invoice
Average days to pay an invoice
Percentage of offered discounts captured
Percentage of offered discounts missed

A thorough understanding of these metrics can help companies determine where the holes in their invoice approval process are. Bringing invoice approval times down makes companies more capable of capturing discounts and offering them to their suppliers.

“Businesses need to have a very fast internal approval time or adopt e-invoicing,” Ijams says. “Today, many companies do not have the visibility (into their payment process) to know when payments are due because average receipt-to-approval times are so long. They are constantly just paying what’s coming in.” Reducing approval times - ideally through automation - is the key to adopting dynamic discounting.

Technology Requirements

According to Hofler, dynamic discounting functionality is included in most P2P solutions and requires little to no additinoal technology to implement beyond joining a network. In addition to the solutions, which are typically installed in a buyer’s system as opposed to a web-based on-demand solution, are capable of integrating into most standard Enterprise Resource Planning solutions (ERP). Once integrated, the two solutions can feed data into one another, meaning the discounting system automatically knows when an early payment was made.

Hofler says, “Dynamic discounting really benefits from full EIPP, and nojust the ability to send documents and invoices through the network. While that does speed up the mail process, buyers also need to approve those invoices and automate workflow so you can get an average approval rate of three days instead of 20.”

Why Pay Early?

Invoice discounting is not a new phenomenon. However, Advances in technology have replaced the former supplier-controlled discounting process and made it much more dynamic. Suppliers interested in getting paid early to maximize cash-on-hand and buyers interested in paying early to save money both have the opportunity to propose sliding scale invoice discounts.

Although some buyers may have reservations about paying suppliers early, Ijams believes the cost savings make it worth their while.

“if you think about it, the whole process seems counter-intuitive to AP,” Ijams says. “Why would I want to pay my suppliers early? We’re taught in finance to collect early and pay late. But what if someone said, ‘if you pay early, I’m going to give you a big, fat carrot for doing that’?”

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All Posts Tagged supply chain financing

What is Dynamic Discounting?

Automation as a Pre-Requisite

Offering the Discount

Determining the Discount

Benefits of Dynamic Discount

Implementing Dynamic Discounting

Why Pay Early?

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