Payables policies and practices to improve cash flow

In our recent article on Cash Management, we briefly discussed the importance of payments in the cash flow cycle. The focus of this article elaborates on the importance of managing accounts payable and a number of key issues.

In our recent article on Credit Granting Policies To Improve Cash Flow, we briefly discussed the cost of cash discounts in speeding up cash collections. In this article, we discuss the benefit to the purchaser of taking a cash discount when it is offered especially with the current low interest rates.

Let’s assume that you receive a $100,000 invoice that offers discount terms of 2% 10 days, net 90 days. To determine the effective yield of the discount, you can use the following formula to determine the benefit of paying on the 10th day:

Yield %=Discount/(Discounted Payment) x 365 days/(Net Period-Discount Period) x 100
9.31%=($100,000×2%)/($100,000-$2,000) x 365 days/(90 days-10 days) x 100

The 9.31% yield should be compared to the opportunity cost of either investing surplus funds or the short-term borrowing rate depending on your financing situation. From a financial presentation point of view, the discount is generally used to reduce the cost of purchase which improves product margins and EBITDA while the related interest cost is included in interest expense. There should be a payables policy on taking discounts which should be reviewed when interest rates and/or the company’s financial position change significantly.

Many companies are implementing the use of purchasing cards which are sometimes known as procurement cards.  They differ from corporate travel and entertainment cards which often do not restrict the card to business purposes. Purchasing cards can be issued with restrictions on the types and amounts of purchases that can be made. They can even be restricted to use at specific vendors. The advantages of a “P-card” include:

• Eliminating the cost of processing of high volume, low dollar purchases through the regular payables system, which involves the typical three way match in which the invoice is matched to a purchase order and receiving document.
• Allows front end controls over spending before purchases are made rather than at the invoice/expense approval stage.
• Improves supplier relations by making payment when the product or service is supplied which improves the suppliers cash flow.
• Allows reporting by small dollar vendor, which improves negotiations over pricing with vendors as they know that you can restrict purchases made at competitors.

P-cards can be issued to employees so that they can make time critical purchases outside of normal office hours to minimize production delays.

Many purchasing card providers will offer rebates in exchange for accelerated payments but these will have to be evaluated similar to the cash discount example above, to determine if the rebate is beneficial.

Payments can be made by cheque, or electronically by wire or electronic funds transfer. Paper cheque payments have the advantage of the mail float delay (the elapse of time between mailing of cheque and deposit by the supplier) and the disadvantage of potentially paying bills late and losing discounts or incurring late fees. Cheques also have a higher risk of fraud than electronic payments which results in higher costs for control and fraud prevention. Electronic payments allow you to ensure that payments reach suppliers on time so that discounts can be claimed and late fees avoided. As timing of electronic payments is known, idle balances in disbursement bank accounts should be minimized.

The US Treasury determined that it only costs 10.5 cents to issue an electronic payment compared to $1.03 for a paper cheque for federal benefit payments. Issue costs however, are only part of the picture of making payments. Control and fraud prevention measures, due to the ease of creating fraudulent cheques, can significantly increase costs. The 2012 AFP Payments Fraud and Control survey found that two-thirds of companies were hit by attempted or actual fraud during 2011, but few incurred financial loss because they took measures to mitigate exposures. Cheques remain the payment type most vulnerable to fraud attacks with 62% of respondents incurring an incidence of fraud and 26% indicating that they have been hit by frequent cheque fraud attacks. Attacks typically spread out over the course of the year, but many (38 percent) cluster together. More information about the survey can be found at www.afponline.org/fraud.

The Canadian Financial Executives Research Foundation issued a research study “Electronic payments in Canada: Whats the hold up” examines the barriers to adoption for electronic payments.  Take some time to review it.

There is a delicate balance between maintaining your reputation and credit rating by paying promptly and maximizing the free credit available, by deferring payment of suppliers. This aspect of cash management is much more of an art than a science, as finding the right balance is different for each supplier and customer relationship.  If you are in need of cash, “play the game.”  Do unto others what is done by your customers to you.  This is often expected and accepted by your suppliers.  Test them and see who complains – find out which suppliers have effective accounts receivables procedures and take advantage of those that do not.

One of the most effective and common strategies is to simply wait for them to call.  When they do, just say that you will release the cheque the same day/next day (the best that you can do) and then do it.  Ensure that you track how long it took, so you can plan for the next payment.

One strategy that is often overlooked is to ensure that your purchasing staff negotiate for extended terms. So many buyers just accept the supplier’s standard terms without even putting the possibility of extended payment terms on the table.

In difficult times, not extending payment terms and deferring significant payments is poor management that can have a very large effect on your business.

I find that clients who print cheques and then do not release them on a regular basis, become inefficient at administering their cash flow and easily lose track of their commitments.  I encourage all my clients to allow the accounting system to do what it is designed for and that is to track what you owe your suppliers until you are ready to pay them and release the cheque.  Of course there are situations which create exceptions to this but you should ensure that they are infrequent.

If you found this article valuable, you may want to refer to previous articles in this series:

• Cash management
• Credit granting policies to improve cash flow
• Collection practices to maximize your cash flow
• Inventory management to improve cash flow

This is the final article in this series on Cash Management.

David Balmer is a Chartered Accountant with over twenty years of Treasury experience with companies such as RJR Nabisco, Cott Corporation and Maple Leaf Foods Inc. He has presented at treasury conferences in Canada and the United States. He has also earned treasury designations from treasury organizations in both the United States and United Kingdom. Contact David at dbalmer@sympatico.ca .

James Phillipson is a Chartered Accountant and a Principal of Mastermind Solutions Inc. https://www.mastermindsolutions.ca/index.php/services/financial-services/, with over twenty years experience in large and small businesses.  He has provided financial counseling to his clients since 1996, often in the role of or as a coach to a Controller or Chief Financial Officer.  James has experience in financial roles in a wide variety of businesses and industries.