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Calculum Inc
Calculum Inc
Our media pack is available for download and contains the Calculum logos and company information. If you’d like to receive our press releases, organise an interview, and collaborate on a content piece, please contact us.
In today's corporate landscape, working capital represents a significant portion of balance sheets, often tying up substantial amounts of cash that could be deployed more effectively elsewhere.
Studies have shown that shareholders value released capital three times more when converted to cash, and companies with efficient cash conversion cycles exhibit higher EPS growth rates. Despite this, many companies overlook the importance of managing working capital efficiently, particularly when it comes to optimizing supplier payment terms.
Part one of the series outlines the first two steps of the comprehensive framework, emphasizing the importance of integrating such practices into standard procurement procedures to ensure sustained success and consistent cash generation.
The Opportunity Analysis is an important first step that, by design, requires minimal resources. The goal here is to quickly determine if there are any high level signals that indicate your payment terms are sub-optimized and whether a deeper investigation is justified.
Specifically, we want to see if there is evidence that justifies creating a team to develop a business case for payment term optimization. You want to assign a couple of people to create the business case and you don’t want to use those resources without support and authorization.
Furthermore, you want to make sure the business case gets the appropriate level of attention. The opportunity analysis step determines if there is any “smoke”. The business case will determine if there is “fire”.
There are both quantitative and qualitative indicators to examine in the opportunity analysis stage.
They include:
Is your cash conversion cycle > 0?
(that is, is your DSO + DIO – DPO >0?* ). If so, it means you are paying your suppliers before you receive payment from your customers. This indicates that your working capital efficiency is sub-optimal and since your supplier payment terms are a component of working capital efficiency, it is likely that your payment terms are sub-optimal.
Note that you need to be careful how you calculate DPO, you want to make sure COGS and Accounts Payable are properly aligned.
Is your DPO less than competitors?
While DPO is not a perfect proxy for average payment terms, especially in industries where COGS is not a high percentage of vendor expense, it is a good indicator of where your payment terms stand relative to your competitors.
Do you have mature payment term policies and processes?
Some of the questions (not an exhaustive list) that you can ask to find out include :
It is highly unlikely that supplier payment terms are optimized unless Procurement and Finance have established clear policies, processes and tools to help Procurement manage supplier payment terms and understand the ramifications of their payment term decisions throughout the entire sourcing and negotiation processes.
Changing payment terms is, effectively, a capital investment decision which can impact profitability, capital efficiency and Return on Invested Capital (ROIC). For example, payment terms 30 days below the optimized level is a capital investment, so Procurement needs to understand the return on that investment.
We can use an analysis of competitor metrics such as DPO or working capital / sales ratio to help provide a high level quantification of the opportunity, such as that seen in Exhibit 1 below.
However, if that is not available, you can use your position within the payment terms business process maturity model to support a more detailed examination of the opportunity to optimize supplier payment terms.
Once you have completed your preliminary analysis you have reached the first decision point - do we believe our supplier payment terms might be sub-optimized? If so, you will want to make a request to senior management to use some resources to develop a more detailed business case around payment terms optimization.
Your request should specify items such as:
It is tempting to skip the Opportunity Analysis step given its seemingly meager results. However, everyone in your company is busy and has a lot on their plate. Without senior management in the loop, it will be difficult for you to get the resources and organizational buy-in you need to properly develop a terms optimization business case and get the attention of decision makers within your company .
Aside from providing the basis for the ‘go’ or ‘no go’ decision for a payment term optimization program, the business case should provide strategic direction for the program if it is approved.
It should answer questions such as:
A less obvious but equally important goal of the business case is to achieve senior management support for the resources and business process changes required to achieve the goals laid out in the business case. Supplier payment term extensions are large-scale, strategic initiatives and should be communicated as such. They should be introduced internally by senior management (e.g., CEO, CFO, CPO) and driven by their mandate. The mandate should clearly communicate what the organization is trying to accomplish and how the program supports organizational goals.
The business case team usually comprises 2 – 3 people. Ideally there is one representative with a finance background (e.g. from Procurement Finance, Treasury or FP&A) and a representative from Procurement.
In addition, specific data should also be gathered. . At a minimum, you will need a spend file for a 12 month period showing supplier name, supplier location, spend volume, spend currency and payment terms. Additional information such as type of commodity is helpful.
You will then need to analyze your supplier payment terms vs benchmarks by individual supplier, commodity, region, etc. Often this requires the use of consultants or third party applications such as Calculum.
The resulting working capital analysis should show you:
You will then need to look at where you fall in the payments process maturity model to identify business process changes which can support the term optimization opportunity and, perhaps more importantly, sustain the gains you achieve.
Finally, the program management process and timelines will need to be outlined. For example, who will be on the program steering committee to review progress and make decisions? What is the meeting cadence? What plan changes require steering committee approval? How will best practices be circulated throughout the company based on your experiences?
If the term optimization program is approved, you will have your strategy, resource requirements, program management process and business process changes documented, together with a mandate from senior management to achieve specific payment terms and cash flow objectives down to the individual Procurement manager level.
If you don’t follow the business case process described above it will be difficult to achieve your objectives. While optimizing payment terms will seem like a good idea, and many in your company will voice support, you will struggle with organizational focus, resource allocation and scalability.
*DSO = Days Sales Outstanding / DPO = Days Payables Outstanding / DIO = Days Inventory Outstanding
Robert is currently the Chief Product Officer of Calculum and the Managing Partner at Capgenta, a consulting firm specializing in payables optimization and Supply Chain Finance.
Previously, Bob co-founded Supply Chain Finance provider PrimeRevenue and Intelisys, an e-Procurement technology company.
A recognized expert and thought leader in payables optimization and Supply Chain Finance, he was recognized by Supply & Demand Chain Executive Magazine as a “Pro To Know” and has been quoted in multiple publications including The Financial Times, CFO Magazine, Supply Chain Brain and Global Trade Review.
