Emerging Payment and Discount Paradigms in the Supply Chain

Working capital optimization, cash flow visibility and discounts, discounts, discounts! Get ready to reap the benefits of AP automation

Who would have imagined that creating a seamless purchase-to-pay process would be more challenging than putting men on the moon? While great strides have been made in supply chain management processes, accounts payable and supplier payments are still mired in labor and paper-intensive processes.

Not anymore. The good news is that several new payment management tools are starting to change the status quo. Today, many innovative financial managers now recognize AP automation as an area offering significant potential for not only generating bottom-line improvements, like cost containment and productivity enhancement, but also delivering numerous strategic benefits around spend and discount management.

Take the Discount, Dummy

Here's a classic issue. You receive an invoice from a supplier, but because of a quantity or price exception against the purchase order, your accounts payables department is unable to process the invoice fast enough to capture the early payment discount your procurement department negotiated with that supplier.

"For most organizations, lost discounts can add up to hundreds of thousands of dollars in profit leakage each year," claims Sush Koka, research director at PayStream Advisors, a Charlotte, N.C.-based research firm. "We are very excited to see many companies starting to move towards paperless environments, which allow them to review and approve invoices faster."

These companies have learned that accelerating the invoice receipt-to-pay cycle from weeks to just days delivers a rapid return on investment (see Figure 1).

Figure 1: Slow Processing of Invoices Causes Missed Discounts

Source: PayStream Advisors, Inc.

Drive to Capture Early Payment Discounts

One of the major drivers for AP automation has been senior management's emphasis on improving visibility to payment liabilities. This has come to bear along with a strong push toward increasing discount capture from suppliers for prompt payments, such as 2 percent 10 net 30 terms.

Table 1: Early Payment/Supply Chain Finance Benefits

However, the reality is far from this. According to PayStream Advisors' Financial Automation Survey, at least half of the organizations participating in the survey are unable to capture anywhere between 50 to 70 percent of discounts offered because their AP departments are unable to approve and pay the invoices within the 10 day discount window.

The enemy of efficient AP processing and working capital visibility is paper. Payables departments relying on paper invoices and decentralized receipt of transaction-related documents suffer from lengthy approval and payment cycles, which can range from 15 to 40 days, or even more in some cases. According to statistics from PayStream Advisors, the average invoice cycle time is 23 days from receipt to approval, with best-in-class companies completing this cycle in five days.

Drive for Straight-through Processing

In order to overcome these challenges associated with paper, organizations are moving automation to the front-end of the invoice receipt-to-pay cycle. They are also looking to leverage straight-through-processing or "touchless" processes to the extent possible (see Figure 2).

The rationale for this is simple. Touchless processing facilitates the automatic payment of "clean" invoices — those with no errors or ones that meet predefined criteria. This allows organizations to enhance discount capture as well as to free up buyers and AP staff to spend more time managing exceptions and accelerating dispute resolution with suppliers.

Figure 2: Stages of AP Automation Impact Discount Capture and Working Capital Benefits

Whether the functionality is provided by your ERP system, a workflow system or an e-invoicing application, here are some options that enable touchless processing:

  • Validation of invoices, at the time of submission, based on preconfigured business rules and tolerance levels to correct any errors or exceptions before the invoice even reaches AP and the clock starts ticking.
  • Automated three-way matching of POs, invoices and good receipts documents, so that invoices can immediately be scheduled for payment. Some organizations even allow a two-way matching success (PO and invoice) to trigger the payment instruction for a small set of trusted suppliers.
  • Automatic approval of, or fewer levels of approval for, certain non-PO invoices, especially when it comes to small dollar invoices or suppliers with whom you have a long and strategic relationship.

Finally, it is important to configure reminders, escalation procedures and out-of-office rules to ensure that invoices that do need approval do not fall through the cracks.

Dynamic Payables Discounting

However, despite your best efforts, sometimes the invoice does not get approved and paid within the standard 10 day discount period. Why should you lose the discount completely just because you approved the invoice on day 15? Why should the discount rate drop from 10 percent to zero percent on day 11? This same logic has led to the evolution of an innovative concept called dynamic payables discounting.

The concept of dynamic discounting has long been a hot topic within electronic invoicing circles. By providing an incentive to suppliers for early settlement, dynamic discounting serves the cash management needs of buyers and suppliers alike. While discounts have been traditionally driven by suppliers as an incentive for securing early payment, the enhanced visibility into invoice status outlined above is turning the tables and enabling buyer organizations to proactively propose early settlement discounts to suppliers.

Dynamic discounting enables buyers to capture a discount rate prorated based on the number of days between the actual payment and the maturity date, on all or any of their invoices — hence the term dynamic. Web-based solutions are now available that allow buyers to configure various discount schemes based on their cost of capital and let suppliers discount any or all of their receivables on an as-needed basis. The solutions are flexible enough to enable configuration of discount schemes on a global basis (for all suppliers), for specific groups of suppliers or even at the individual supplier level.

Figure 3: Comparing Standard Discounting Terms with Dynamic Discounting

With the availability of dynamic discounting, you can still pay the invoice on day 20 and receive a 1 percent discount on the invoice amount. Or even better, you might be able to take a 2.5 percent discount if you can pay on day five (see Figure 3). You get your discount; the supplier gets paid early — a win-win situation all around.

Two forms of dynamic discounting have gained popularity — automated recurring discounts and one-off discounts. Under the recurring discount scenario, buyers contractually agree to pay an invoice as soon as it is approved and take the discount based on a previously agreed sliding scale. This does not require manual intervention from either party and applies to every invoice from that particular supplier. One-off discounting, on the other hand, involves suppliers picking and choosing only the specific invoices they want to discount.

While technology has become the great enabler of accelerated invoice processing and discount capture, solution providers also play a critical role in this process by educating internal staff and suppliers and bringing everyone aboard the solution.

In Conclusion...

In a seemingly short period of time, AP automation efforts have gone from backburner IT initiatives to the front-burner of finance department priorities as the broader, strategic value of accelerating invoice approval has come into full view. But while the path to optimized working capital and supply chain finance is comprised of a series of stepping stones, little progress can be made without accounting for how to best accommodate paper invoices. To achieve the broader promise of working capital optimization, organizations must look to more pragmatic technology solutions capable of combining paper to electronic conversion with aggressive supplier on-boarding capabilities.