Accounts Payable is not usually the first thing that business owners think of when they review working capital needs. They usually focus on inventory and accounts receivable, because these are assets they will need to fund either with cash flow from operations, cash from borrowing, or cash from alternative forms of funding such as invoice factoring.
Business owners view accounts payable as a use of cash, which can be reduced when cash flow is constrained. It should, however, be viewed as an integral component of working capital, which when managed properly can minimize the use of cash at all times – not just in a cash crunch – and maximize the amount of working capital available to fund business growth.
Working capital optimization is more than just stretching accounts payable by delaying payments to minimize cash outflow. In some cases this can erode supplier goodwill, resulting in slower delivery times and delays in responses to problems. Actually, paying early can sometimes be the right strategy when suppliers offer generous discounts for early payment.
To maintain strong financial health, businesses need to take a strategic approach to efficiently manage their accounts payable. Businesses should adopt a management focus that emphasizes the importance of optimizing accounts payable to free up working capital to fund growth.
Failure to adopt effective accounts payable practices can expose businesses to a number of risks. They may not process invoices on a timely basis, take advantage of discounts, or negotiate favorable payment terms with suppliers.
Strategies for Accounts Payable Management
Businesses should adopt a customized approach to optimize accounts payable that incorporates best practices to maximize benefits.
- Adopt Effective Best Practices: Refine your accounts payable processes to enhance the accuracy of cash flow forecasts. Improved processes position you to improve liquidity, mitigate funding gaps, and realize higher profits. Business owners can also strengthen their negotiating power by leveraging insights gained from process improvements.
- Utilize management workflows: Create management workflows to identify information bottlenecks and streamline invoice processing.
- Strengthen purchasing approval processes: Define the level of authority required to make purchases at various levels. The best way to reduce cash outflows is to not make unnecessary purchases in the first place.
- Foster a Working Capital Culture: Increase collaboration between with the Purchasing Dept. and Accounts Payable Dept. Everyone throughout the company should be in the same mindset of optimizing the A/P process. It’s more than timely invoice processing; it’s about fueling growth by freeing up working capital.
- Negotiate Payment Terms: Incorporating payment terms into the vendor selection process is essential. Negotiating longer payment terms and early payment discounts with suppliers will improve your cash flows.
- Automate Accounts Payable: Automating accounts payable provides the ability to electronically interface with accounting and purchasing systems, eliminating paper shuffling, data entry, and errors, to increase efficiency and reduce costs throughout your business. Automation also makes it possible to interface with vendor systems to facilitate timely invoice processing, and capture of available discounts or rebates.
- Set Clear Metrics: Establish metrics to measure the efficiency of accounts payable processes. Some typical metrics for accounts payable include:
- Average days payable: Monitor average days payable to ensure they are in line with assumptions used in forecasting cash and working capital requirements. Measure the percentage of invoices paid within terms.
- Number of late payments: Track the number of late payments because they can result in late fees and interest costs and strain supplier relationships.
- Number of supplier disputes: Supplier disputes can be costly and time-consuming. They should be tracked by type to determine where improvements need to be made.
- Number of payment errors: Payment errors, such as overpayments and duplicate payments, can be costly and affect relationships with suppliers.
- Savings from discounts captured: The amount of discounts captured provides insight into the benefits of early payments and the cost of accounts payable processing.
Increasing Accounts Payable
Reducing cash outflow and increasing working capital by increasing accounts payable makes more cash available to fuel growth, reduces the need to borrow, and decreases financing costs.
Increasing accounts payable should be an ongoing management practice, not just a knee-jerk reaction when cash is tight. It should be a comprehensive approach involving suppliers and your management, purchasing, and accounts payable personnel.
The objective is to increase accounts payable while maintaining good vendor relationships to ensure on-time delivery of quality materials and inventory at the best price possible.
Some ways to increase accounts payable include:
- Vendor Selection: Payment terms need to be one of the criteria used in vendor selection, along with price, quality, ability to deliver on time, and other considerations. If your standard payment terms are Net 30 Days, or 2.00% 10 Days, Net 30 Days, then set them as the minimum acceptable payment terms for new vendors.
- Contract Review: Have vendor contracts reviewed for terms, operational and legal requirements, and accuracy. A carefully vetted contract will help to avoid errors and disputes that can have a negative impact on cash flow.
- Vendor Onboarding: Set up new vendors with accurate and complete master data files. Provide vendors with the information needed to interact with your business, such as contact information for purchasing, accounts payable, and operations, and how they can interface with your information systems and vendor portal if you have one. This will ensure a smooth flow of transactions and help strengthen supplier relationships.
- Purchasing: Establish purchasing policies and procedures that include buyer authority levels, and legal and operational requirements including payment terms. Review purchasing practices regularly to ensure that they are in sync with your policies and procedures.
- Invoice Processing: Ideally, your business processes are automated and able to receive and process invoices electronically. Review vendor invoices for accurate quantities and prices. Process invoices in a timely manner so they are paid when due, or early-payment discounts can be taken.
Improved Liquidity and Working Capital
Using these strategies will help optimize your business’s accounts payable and working capital to fuel growth, reduces the need to borrow, and decreases financing costs. It will also help your entire business run more smoothly and strengthen supplier relationships. A comprehensive approach should encompass collaboration with suppliers, as well as coordination among your management, purchasing, and accounts payable teams.
There are times when even the best-run businesses experience cash flow and working capital problems, and they may not able to obtain the funding they need due to economic conditions beyond their control. High-interest rates and difficulty obtaining loans from banks and other lenders can jeopardize growth or worse, put you in a defensive position where you feel pressured to turn to high-interest rate lenders and become entangled in an endless cycle of debt.
The best way to avoid these problems is to have a strategy to improve liquidity with injections of working capital from an alternative source of funding such as invoice factoring. With invoice factoring you can obtain funding faster and easier than applying for a loan from a bank or other traditional lender. You can “spot” factor one large invoice when you need immediate funds, or use a factoring program for all your invoices to ensure continuous reliable funding.
Capstone is an expert in helping small businesses obtain the funding they need. Please contact a Capstone representative to learn more about how we can help you improve your business’s liquidity to keep your operations running smoothly and fuel growth.
