04 Aug 2010 Dynamic Discounting – Opportunity or Financial Fantasy?
Let’s indulge for a while in a purchasing and finance fantasy where a CFO and a CPO have a constructive conversation about how best to manage working capital. Suppose there’s a supplier – a strategic supplier with whom the company spends a lot of money – and they’re on 30 day terms. (That is, once they’ve invoiced for goods, they get paid thirty days later.) The CFO and the CPO compare ideas on how to make best strategic advantage of the relationship with this supplier.
The CFO view
“Thirty day terms is quite generous. Most of our suppliers are on 45 day terms and we actually pay on average in about 60 days. DPO (day payables outstanding) is a key measure for us and helps us to optimise our working capital. We take great pride in keeping one step ahead on this and we’d recommend that the contract is renegotiated to 45 days at least”
This is a typical CFO view of course. The only lever they have access to as far as suppliers is concerned, is payment terms and the retention of working capital.
The CPO view
“As a strategic supplier, we value the fact that they buy into our strategic commercial objectives and we are keen to nurture this important relationship. While we are always happy to extend payment terms when it is to our commercial advantage, our risk assessment points to a need for caution with some suppliers and we would be keen not to extend payment terms in some cases for fear of imposing undue financial pressure on them which, in turn, could increase risk to our business. The procurement function is as much about reducing supply risk as it is reducing costs.”
A very measured response and again, a typical CPO stance that takes a very different view from the CFO.
But what about this as an alternative view – the CEO
The CEO View
“As CEO – my primary concern is the bottom line. On the one hand, my CFO wants to optimize our working capital and report strong numbers to our shareholders. On the other my CPO want to maintain a stable and secure supply chain by ensuring that critical suppliers are not put under undue financial pressure.
But if our critical suppliers are feeling the pinch that much – wouldn’t we support them more if we paid early? How valuable would that be to them and how much would they pay for early payment?
If a supplier gave us a 2% discount for payment in 10 days instead of 30, what’s the return on capital? Gaining 2% in 20 days, that’s over 30% isn’t it?”
Snap out of it! Back to reality. The fact is, most organizations are so siloed that treasury management and procurement might as well live on separate planets and even if the benefits of dynamic discounting were recognized, most company’s procure to pay processes are barely able to support payment to terms in any case.
The fact is – discounts in return for prompt payment can give a huge return on working capital but until robust purchase to pay processes and systems are in place, they are just a fantasy.
Unless of course your company has robust P2P processes, in which case – what are you waiting for?