So far, in Inventory and Accounts Receivable, we’ve found $250,000 each in cash savings. Then we found another 250K in Sales and Marketing. And so, now, Accounts Payable is the final process within the Cash to Cash Cycle – and also the final $250,000.
The cash cycle is undoubtedly the single most important process to optimize for any business – from when you spend money to when you get money.
Circling the Cash to Cash Cycle
So let’s tie this back to accounts payable – the event that pays for the liability incurred by purchasing, which is for inventory required by manufacturing to meet demand. Sales generate this demand that creates the accounts receivables, which is turned into cash. And now we have come full circle and completed the discussion on the cash to cash cycle.
Increasing the Velocity of Accounts Payable Processes
Your accounts payable is a bit different than the other processes we have examined so far. The first three processes we looked at represented processes where the focus was on reducing the size of assets (inventory or accounts receivable) or expenses (marketing) and increasing the velocity or cycle time. But in accounts payable our focus is on increasing the size of the asset, while maintaining a solid credit rating – and increasing the velocity of the process.
Now let’s look at how to find $250,000 in accounts payable savings. If your organization has $500,000 in accounts payable each month, then STOP! We can find $250,000 in savings right here. Where, you ask? Increasing payables by 25% will produce $125,000 in cash plus $125,000 from automating tasks, taking more discounts, and managing the process better.
Service Business Procedures Case Study
An organization with $600,000 in monthly payables needed assistance. We examined their payables process to understand and quantify workflow, paper processing and credit issues. Then we designed and implemented a process to increase their use of payables and discounts, improve their payables cycle efficiency, and tie it to their purchasing and receivable cycles. We then reinvested $50,000 back into an Enterprise Resource Planning (ERP) program to automate some of the processes that weren’t automated already.
The metrics we developed reduced their purchasing & payables expenses by 25% and increased their efficiency from 50% to 75% within 2 months of implementing the new procedures. With these new processes and reports, the company now tracks payables cycle efficiency and average days payables, rather than just bills paid on time or outstanding balance, as the measure of their payables effectiveness. The result: an extra $300,000 in cash plus a 50% increase in process capability (capacity).
Methods to Design Your News Accounts Payable and Accounting Procedures
• Eliminate Paper. The single biggest cost for any purchasing and payables department is paper, including: purchase orders, purchase order follow-up, small-dollar purchases, delivery tracking & receipts, and vendor payments. Utilizing paperless invoices, Web-based supplier self-servicing, centralized vendor files, automated workflows for electronic or imaged invoices (see ERP below), and payment methods, such as business credit cards, Electronic Data Interchange (EDI) and Electronic Funds Transfer (EFT), can reduce paper handling costs by as much as 90%.
• Integrate ERP Systems. Enterprise Resource Planning (ERP) automates the purchasing and payables functions, which allows a company to get more work done with fewer personnel. Also, electronic invoice matching applications save time in retrieving paperwork. It is estimated that an ERP system can annually save an organization $300 per million in sales.
• Increase Payment Terms. Negotiate payment terms based on receipt of goods or the invoice. This can add one week or more to your terms, which can be 25% of 30 day terms. Use EFT for just-in-time payments to maximize your payables terms and minimizing the impact to your credit.
• Take Payment Discounts. If you are getting 2%/10 net 30 terms, then consider taking it. This means you are offered a 2% discount if you pay within 10 days, instead of the normal 30 day terms. This translates into an 18% return on your capital, and for many organizations this is a good return on your investment.
• Review Purchases. Purchasing is a continuous process that requires continuous review. Consider: transportation charges, expedited fees, odd lot penalties, new pricing, new products, consolidating vendors, new vendors or buying groups, payment terms, and more. Communicate with your suppliers to improve the process. And review and monitor everything to account for changes in your environment.
• Communicate with Suppliers. Communicate with your suppliers to improve the process. Ask suppliers to submit their invoices electronically. This will save you time, resources and losses due to waste.
• Eliminate Disputes. Disputes with your suppliers are typically the result of a problem with your purchasing/receiving process. When disputes occur, review your purchasing procedures to ensure that they are producing the correct metrics and that you are not forced to pay for your mistakes.
• Reduce Errors. Overpayments, payments made to the wrong vendors, fake invoices, or even late payments represent a common problem for payables. Increasing your focus on error control, along with written procedures and audits, can reduce these errors considerably.
• Train personnel. Provide your accounts payable staff with regular formal training. This will arm them with better knowledge of frauds, negotiating skills, and an understanding of the economics of payables – which will result in improved effectiveness.
Accounting Policies and Procedures for Cash in the Bank
In the past few weeks, we have showed you four parts of your financial statements that will each contribute $250,000 in cash savings. The last hurdle was Accounts Payable, and we sailed through it. And now we have crossed our final goal: $1,000,000!
Time was – and is – the key. All you have to do is own it. And, remember, next week we will put together each of the four elements of the cash to cash cycle, and look at how it affects the working capital of your business.