How to Analyze Working Capital, Suppliers, and Payment Terms

Acknowledgements: This series of articles has been written with the acknowledgement of Oliver Belin, the author of “Uncovering Supply Chain Finance”, a well-known book in working capital management and financing.

Introduction

A success factor that separates effective working capital initiatives programs from unsuccessful facilities is the detailed analysis of a company's suppliers, payment terms, trading volume, and its potential in improving working capital. 

This first brief and three-part series of articles look at the benefits of spend and working capital analysis, as well as provide an elaboration on the processes that can help successfully extract actionable information from spend data, which in turn helps organizations optimize their working capital and achieve savings and superior margins.

What is Working Capital, Spend, and Supplier Analysis

Working capital analysis is a business practice that is essential in today's data-driven market environment. From getting insight from spend figures to better identifying the risk of supply chain disruptions, working capital analytics, and if done right, can provide a wealth of important information for a company implementing a working capital finance program for a corporate client.

Spend and supplier analysis is the process of extracting, aggregating, classifying, and collating trading data, analyzing, identifying cash flow improvements or discount opportunities, as well as sharing the results within the organization and comparing it with the corporate's target. Spend analysis helps Chief Procurement Officers (CPOs), Treasurers, and Chief Financial Officers (CFOs) gain insight into actionable information to improve working capital, reduce costs and strategies to minimize risk in their supply chain. Usually, it is one of the first steps in working capital finance initiatives such as Supply Chain Finance, also known as Reverse Factoring.

It’s all about your Cash to Cash Cycle

Research shows that companies that are able to segment their suppliers for prioritization not only report an increasing number of suppliers selling their receivables in a Supplier Finance program, but they also achieve Days Payable Outstanding (DPO) and Cash to Cash Cycle (C2C) levels 25% greater than those without segmentation capabilities. In this context, segmentation on suppliers that are in favor of having their payment terms re-negotiated as well as those most likely to find value in such financing arrangements.

“It is surprising how few companies really know their supplier base with a myopic focus on costs when selecting suppliers”

Oliver Belin, Calculum

DPO, DSO, and C2C: Key working capital Metrics you should know:

• DSO - Days Sales Outstanding (DSO) represents the average number of days it takes your sales to be converted into cash or in other words how long it takes you to get paid by your customers. It is calculated by dividing your total average trade receivable for a given period by your total sales and multiplied by the number of days of the respective period.

• DPO - Days Payable Outstanding (DPO) is a working capital ratio that represents the average number of days a company takes to pay its trade creditors and suppliers. It is calculated by dividing your total average accounts payable for a given period by your total cost of goods sold (COGS) and multiplied by the number of days of the respective period.

• C2C  - The Cash to Cash Cycle (C2C) is a metric that represents the days it takes your company to convert your investments in inventory and other resources into cash flows from sales. In other words, it measures how long your money is tied up in the production and sales process before you get cash when selling your products. It is calculated by adding the Days Sales Outstanding (DPO) with the Days of Inventory Outstanding (DIO) and subtracting the Days Payable Outstanding (DPO).

Now corporates are starting to tap into the potential of Working Capital and Payment Terms Analytics. Currently, only approximately 20% of the largest and leading corporations possess the ability to view spend data by suppliers across the enterprise's total spend, which gives them an advantage when it comes to identifying additional opportunities. 

Precisely understanding a company’s DPO performance and analyzing supplier payment terms can be a daunting challenge. Typical reasons preventing companies from proactively addressing spend analytics include the difficulty of analyzing huge data sets to gain visibility across business units and regions and having no reference or comparison with other competitors and suppliers.

The 6 most important questions to ask when it comes to payment terms and working capital

Corporates and their wider trade ecosystem are looking for such analytic capabilities in order to give them answers to the following questions:

1. What factors are impacting a buyer’s DPO and on the other side of the equation, a supplier’s Days Sales Outstanding (DSO)? 
2. How does a company’s performance in terms of working capital stack up against other businesses or within an industry peer group? 
3. How and where should a company start improving payment terms with suppliers?
4. Which suppliers are most likely to accept new payment terms or make use of a working capital finance solution?
5. How much cash flow or cost reduction potential can be generated per supplier?
6. How to measure results and milestones, and then compare them with the targets?

It is surprising how so few companies really know their supplier base with a myopic focus on costs when selecting suppliers. Companies might know the costs of their products and services they purchase very well, but they do not know if payment terms with their suppliers are adequate and which suppliers they should select for a financing initiative.

Buying Smarter

Buying smarter, is not just buying at the lowest price. It is knowing everything about the company’s spending habits, supplier characteristics, including sustainability factors such as ESG (Environmental, Social and Corporate Governance), and using that knowledge to be a stronger negotiator. It is connected to a diverse network of high-quality suppliers, so the company can quickly discover collaborative partners who can lower costs for goods and services or improve working capital while minimizing risks. 

Our next article in this series will focus further on the why and how to implement such analytical solutions for working capital, suppliers, and payment terms. Stay tuned.