Early payment discounts are increasingly being leveraged by organisations to gain additional discounts from their suppliers.
However, making these savings requires a fast turnaround on any invoicing. It is not sufficient just to agree early payment discounts contractually: you have to be in a position to realise these discounts.
2: Benefits of Early Payment
So what benefits are associated with early payments and why would you focus on processes to realise these savings?
- Avoidance of late payment. Early payments can be a proactive way to ensure that payments are not made late. Late payments at worst incur penalties and at best strain the supply relationship.
- Impact on business profitability associated with the contracted early payment discounts.
- Better supplier relationships. Suppliers can recoup cash faster to secure their working capital. This is especially important with smaller business relationships where cash flow is critical.
- If your supplier reports payment data to a credit bureau such as Experian or Dun & Bradstreet, on-time or early payments will also strengthen your payment profile and credit report.
Dun & Bradstreet’s research in the UK revealed an average late payment amount of £63,881 for each SME, with 11 per cent owed between £100,000 and £250,000. This withholding of payments brings about cash flow difficulties for 35 per cent, delayed payments to other suppliers for 29 per cent and reduced profit performance for 24 per cent.
3: Financial Factors to Consider
There are of course many factors that need to be considered before implementing an early payment strategy. Some of these negatively impact an organisation and need to be allowed for in any financial calculation. Two of the most obvious being:
- Firstly, the suppliers will be impacted by the reduction in payment. For instance, as a supplier, if you give a 1% early payment discount, then you will be giving up 10% of that profit, if you are operating at around a 10% profit margin on that sale.
- Secondly your business will be impacted in terms of cash flow out of the business and this needs to be considered in context of the gains made. For example, if your customers pay late and you pay early there will be a need to have funds available to support this gap or you will need to use appropriate invoice financing to support the business.
So, considerations are cash and profit. Calculating the positive and negative financial impacts of these and weighing them up alongside other softer, yet quantifiable, benefits that are realised will provide the business case.
Cash flow and how to finance cash within a business is definitely on the agenda:
For the third year in a row, cash management services is the bank product area most likely to be under review
-- The Global Treasurer: Transaction Banking Survey 2018
Taking all of the above into consideration, if you decide to take advantage of early payment terms, how can you ensure that the right payment is made at the right time
4: Early Payment Automation
Manual processes for early payment will not suffice. These would not ensure that the correct payments were made at the correct time.
It is especially complex to do manually if these payments are subject to other volume discounts or were being made in multiple different currencies. Plus, when you factor in taxes, at country or regional/state level, it gets even more complicated to handle manually.
It also requires goods receipt processes to be integrated into the overall process, as invoices need to be reconciled against goods received and the orders originally placed. Delays in receipting goods could eat away the time to process invoices.
The following diagram outlines one possible flow, assuming there is already an ERP system in place. The ERP being used as the common repository for data required for the process.
This diagram highlights that automation needs to cover a number of domains:
- Order Processing
- Purchase Invoicing
- Sales Invoicing (two stage invoicing required if a Procurement Service Provider is involved)
And involves a number of Stakeholders including:
- User (consumer of goods or services)
- The supplier
- Goods receiving