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Calculum Inc
Oliver Belin
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Calculum Inc
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The emphasis of this article is to elaborate on the collaboration across the various business functions within a buyer organization, which is crucial when it comes to optimizing payment terms. To implement a Payment Terms Optimization Initiative successfully, it is essential that cross-functional teams involving top management, treasury, and procurement work closely together.
Now that supply chains are global, lead times elongated, and supply chain risks increasing, these functions can no longer exist independently. Implementing and managing a program to optimize payment terms and realize working capital benefits requires that the different departments start working more closely together, are engaged, and speak each other’s language to ensure the realization of benefits.
The first recommendation is to bridge the information gap in analyzing and optimizing payment terms by aligning and coordinating the business functions under a common language supported by relevant common Key Performance Indicators (KPIs) and incentives. Today, many organizations are siloed from a function and management perspective and fail to fully account for the benefits and the cash flow implications of decisions that cut across those silos. By contrast, high-performance supply chains are characterized by internal cross-functional teams. Looking at the most successful term optimization programs, in all cases, the initiative has been led by a multi-skilled cross-functional team and enterprise-wide collaboration involving all critical stakeholders in the implementation process.
Job titles of the people responsible for optimizing payment terms will vary from company to company. When implementing and managing such payment terms optimization solutions, the parties typically involved include the top management, with the two essential parties being treasury and procurement. Given the predominantly buy-side perspective on the subject, it is understandable, reflected by both the impact on the cash flow and the suppliers we need to negotiate the payment terms.
For any Payment Terms Optimization Initiative to succeed, every department involved must be able to recognize the benefits the solution will provide them. For instance, because managing cash flows is one of the treasury's core responsibilities, adopting such a solution makes sense and is aligned with the departmental objectives. However, for procurement, these benefits are less applicable. Instead, procurement is more concerned about how changes in payment terms may affect their relationship with suppliers. As such, the positive impact that a Payment Terms Optimization Program will provide in these areas must be communicated. Otherwise, procurement may be skeptical or even outright against the implementation.
Top management is vital in aligning all functions internally and among all shareholders. Therefore, an executive board member should sponsor a Payment Terms Optimization Program, with the CEO, CFO, or Managing Director providing top-level corporate support for the financing initiative.
The top management typically identifies the need for change and a clear road map towards a Payment Terms Optimization Initiative, defining objectives and governance across all functions to support the implementation phase and continued alignment after the program setup. Several critical success factors have emerged in practice.
In the past, the treasurer has long been viewed as a tactical member of the corporate finance team. As guardians of the organizations’ assets, the treasurer’s role in some cases is predominantly reactive, stewarding liquidity and optimizing capital structures. Although the treasurer performs a critical role within the organization, until recently, the part was that of a watchman, keeping a cautious eye on corporate cash and minimizing the risk of the company’s financial assets. Particularly in an unstable market, the treasury function operates in a much more complex environment to generate value.
Companies have been pressured to use their working capital as efficiently as possible. As a result, the role of treasury has changed and broadened, with strategic working capital management becoming even more central. A recent survey confirms that 83% of treasurers foresee their roles expanding further over the next five years.
Given new market dynamics and new technologies and processes, treasury has evolved into a strategic, internal business partner to its organization - an increasingly relied-upon role responsible for delivering corporate value. The core functionality described above remains the same. However, the tools available to support the treasurer are now much more sophisticated such as new AI-based Payment Terms Analytics Platforms, which have become part of the treasury toolkit.
As supply chains extend into new markets, procurement has become increasingly professionalized, with highly qualified executives joining procurement departments. The way procurement fits into the organizational structure can differ as much as business models vary, with Chief Procurement Officers reporting to the CEO, the head of the relevant region, the COO, CTO, CFO, or even the CMO.
Most procurement people describe their role as getting the best prices for purchased goods and services and managing supplier risk to ensure certainty of supply. It is a concise albeit simplistic definition of procurement. It’s not just the cost of supplies. There is a cost that most purchasing people overlook - the cost of working capital. Watching how procurement can impact the cost of operating capital allows high costs to leak from the supply chain - a leakage that, if identified and stemmed, can have a significant financial benefit on both sides of the buyer and supplier equation. It may be seen as being within the domain of financial professionals, yet procurement professionals, even if they are unaware of it, play a key role in managing working capital.
Payment terms negotiated as part of any supplier contract can generate additional revenue streams through discounts and define the target Day Payable Outstanding (DPO). Consequently, from a treasury perspective, there is a strong incentive to work closely with procurement, which should be involved in any Payment Terms Optimization discussion as they constantly interact with suppliers. However, there are potential friction points, and payment terms can be a double-edged sword. These primarily result from different objectives and metrics for measuring success. For example, supplier payment incentives such as early payment discounts may reduce the cost of goods and services and meet procurement objectives. On the other hand, reducing DPO may be detrimental to working capital and liquidity management. It could compromise the treasury’s goal to maintain adequate levels of liquidity and avoid short-term borrowing to cover working capital shortages.
While it is good to contribute to the working capital by extending payment terms, this only sometimes supports healthy supplier relationships. But there is another, more compelling reason why the traditional approach to working capital management needs to make more sense from a procurement point of view. It could cost a fortune, as suppliers might increase the pricing of goods and services the buyer purchases. It can also have a personal impact on the bonus paid out to procurement, which is traditionally based on lowering the costs of purchased goods and services. It can be a tricky balancing act. Therefore, it is also essential to adjust the bonus scheme of procurement when starting a Payment Terms Optimization Initiative, primarily if it is implemented to optimize working capital. The bonus scheme of procurement should also be linked to achieving specific payment terms or cash flow results.
There are different objectives and views when it comes to optimizing payment terms. When viewed through the procurement lens, the only visible costs are expenses for goods and services purchased and, depending on the organization's structure, purchase-to-pay process costs. The cost of working capital is not on the radar.
And it is the same through the finance lens. Treasury managers only see the cost of working capital and the return on cash. The benefits of discounts are far from evident to them, and often early payment is anathema to the treasury. The only way to see the benefits of improving payment terms is to rise above the silo boundaries and take a holistic view – not just for one organization but the entire supply chain.
The rate of return on cash should not be considered in isolation. It should be viewed alongside the cost of working capital to the suppliers, and if that is very high, the differential between those two numbers can generate a win-win for both parties. Achieving buy-in from multiple stakeholders also requires a common language. The rollout must involve the procurement and purchasing managers, who will communicate with suppliers.
