Three Best Practices for Accounts Payable Departments That Will Bolster Working Capital
When interest rates rise, a strategically managed accounts payable function can help companies optimize their cash conversion cycles and free up working capital.
When corporate finance professionals advocate for automating their Accounts Payable (AP) process, they often cite how automation brings down the cost of paying bills and reduces the number of paper checks that are written.
But these conversations sometimes overlook another important way that the digitization of the AP function can be leveraged to help an organization’s bottom line. Namely, it can help improve a company’s access to working capital. This can be especially valuable in periods of rising interest rates.
Here are three AP best practices companies are following to achieve these results:
1. Expanding AP virtual credit card programs
An organization’s access to working capital is impacted by its cash conversion cycle (CCC), that is, the amount of time it takes to convert an asset into cash. A company’s CCC is based on how long it takes to sell its inventory, collect its accounts receivable and pay its bills.
Let’s take a closer look at how long it takes a company to pay its bills, known as Days Payable Outstanding (DPO) and how a virtual credit card program can help.
The longer an organization can wait to pay its bills and thereby extend its DPO, the more time it can use the cash that will eventually fund its payments. In other words, increasing DPO helps businesses maximize working capital and improve near-term liquidity.
When organizations pay supplier invoices using one-time use virtual credit cards, they can extend payment terms by as much as 30 days or more while also earning additional revenue on each payment.
Financial institutions like Commerce Bank are now offering some customers a 30/15 payment cycle, similar to that of their corporate purchasing cards. In those cases, the bank issues payment to suppliers according to the agreed-upon terms, but only requests funds from the company once every 30 days. The company then has 15 additional days to remit those funds to the bank.
That means a business holds onto its cash for an average of 30 days after the supplier is paid. During that time, it can temporarily repurpose that cash to pay down a line of credit, fund an outside investment or otherwise generate profit before it must be spent on supplier expenses.
Compare that to ACH or paper check payments, which typically have floats ranging from as little as two days (ACH) to as many as five (checks).
When positioned properly, virtual credit card programs can benefit a supplier’s CCC as well. For example, a supplier with an existing 30-day term for payment may agree to accept a virtual credit card if it is guaranteed payment in 25 days. In this case, the supplier reduces its Days Sales Outstanding (DSO) — the average number of days it takes a company to collect payment for a sale — by five days. The business making the payment sees an average term of 31.5 days. Both sides win.
2. Developing an integrated payment strategy that considers DPO
According to PYMNTS.com, 39% of U.S. and Canadian firms are currently using virtual credit cards as a form of business-to-business payment. But while their acceptance is growing, they don’t work for every supplier.
An effective payment strategy recognizes this and includes alternatives (i.e., ACH, checks and wire) that meet individual supplier needs. Such a strategy also considers how and when to make payments, assesses the value of early payment discounts on a case-by-case basis and outlines a streamlined process for delivering the greatest financial benefit to a company’s bottom line.
At the top of many companies’ wish lists is an integrated payables solution that optimizes the cost-saving and DPO-expanding potential of every invoice and payment method.
Companies that seek an integrated payables solution typically place the responsibility for determining supplier payment preferences and making payments in the hands of their bank or other payment providers. With this approach, they just send the provider a single file listing all the payments that need to be made during a given period.
While payments made by card garner the greatest DPO benefits, ACH and check payments can benefit to a lesser extent, depending on how they are funded. For example, when organizations fund payments through their account at Commerce Bank, they benefit from the two- to five-day float between the time when ACH and check payments are disbursed and when they clear. During that window, the organization is free to make overnight investments or other moves to gain a short-term working capital benefit.
DPO benefits fade when the payment provider requires an organization to prefund card, check and ACH payments to an account owned by the provider. While the prefunding requirement is virtually universal at fintechs, this option is also available at many banks, including Commerce Bank, for companies that do not wish to open an account at the bank or prefer a more hands-off approach to the payment process.
When companies take this approach at Commerce Bank, the bank conducts follow-up on any uncashed checks and takes responsibility for turning over any unclaimed funds to the state. Be aware, however, that every provider’s services are different. For example, some fintechs void uncashed checks after 60 days and return the funds to their clients, making them responsible for follow-ups and escheatment processing.
3. Implementing a payment hub
Working capital also benefits when a company’s Integrated Payable solution includes a payment hub. With a payment hub, the payment process — from the moment an invoice is ready to be paid through payment and reconciliation — is managed from this platform. It is the next logical step in the payment digitization process.
To appreciate the benefits of a payment hub, consider the fragmented payment processes they replace. Many companies still process checks, ACH, virtual cards and other electronic payment methods through separate payment runs. Their payment processes grow even more complicated and difficult to manage when new payment processes are added through acquisitions.
A payment hub not only streamlines these efforts, but also improves a company’s ability to control and optimize payment methods.
For example, working on the client’s behalf, the payment provider can proactively reach out to suppliers and encourage virtual credit card acceptance, when appropriate. When notified about the onboarding of new suppliers, the payment provider can assess the supplier’s needs and determine the appropriate method of payment, rather than treating check payments as the default option.
By maximizing card payments and reducing the number paper checks processed, payment hubs can help extend DPO while better managing cash on hand.
The bottom line
When interest rates rise, a strategically managed AP function can help companies optimize their cash conversion cycles and free up working capital. An organization that fails to take advantage of these opportunities is leaving money on the table that could be put to work in supporting its business goals.
At Commerce Bank we look at challenges as opportunities to innovate and at disruption as a chance to uncover new ways to add value. We value long-term relationships and are ready to take on challenges and opportunities together and strive to know your business and offer creative solutions to the challenges you face every day. Learn more at commercebank.com/BuiltForBusiness.