Smart working capital management
April 13, 2011 - SCMR Editorial
As we have discussed in the past, certain working capital improvements should be spearheaded by procurement professionals. Other working capital enhancements deserve the participation by procurement professionals. In the process, you can add real value to your company while demonstrating that you are able to drive strategic value across both cost-related and non-cost dimensions.
Payment terms are a great area for leadership by procurement. But there are some pitfalls to avoid. What I’d like to do today is comment on the temptation to be preoccupied with DPO (days payable outstanding).
Partly driven by their financial office, many procurement departments are pursuing objectives of extending DPO year after year. The objective is typically to better match DPO with DSO. In other words, you’re trying to balance the cash cycle time tied up in accounts receivable (waiting for your customers to pay you), with the cash cycle time contributed by supplier payment terms.
A single-minded focus on DPO extension can, however, be counterproductive. In particular, it can leave untested the willingness of suppliers to entertain aggressive discount payment terms in exchange for early payment by the customer.
In this credit-constrained environment, we have seen numerous examples of suppliers offering aggressive discount terms in order to better manage their own cash flow cycle. If your procurement department is focused solely on extending net payment terms, you’ll never uncover the potential for better discounts. It is better, and more valuable, to obtain the option of paying either discount or NET terms, at your company’s discretion. Then, based on your company’s finances and liquidity objectives, your Treasury department will have the flexibility to pay earlier and earn the discount (which flows directly to your bottom line), or pay on a net basis and hold on to your cash.
If you’re being measured against a simple DPO objective, suggest to the scorekeeper that you report DPO adjusted for discounts taken, and separately report the value added by your negotiation of better discount terms.
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