How to Leverage Accounts Payable to Improve Working Capital

Tips on How to Leverage Accounts Payable to Improve Working Capital
Tips on How to Leverage Accounts Payable to Improve Working Capital

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Accounts payable (AP) management is the practice of formulating policies and processes to manage the trade credit purchases. Its focus centers on identifying trade credit lines, favorable terms of purchase and streamlining the flow and timing of purchases, all of which play a role in the business’ working capital. Accounts payable is counted among the three main components of working capital, the others being accounts receivable (AR) and inventory.

It is a proven strategy that any improvements in AP can lead to significant enhancement of working capital. Some ways to achieve this are described below.

Ways to Leverage Accounts Payable to Improve Working Capital

  1. Go Paperless:

    To avoid confusion and complexity, you could look at electronic imaging of all supplier invoices. All that needs to be done is to invest in a document imaging solution that you could integrate with your accounting or enterprise system. The created images should be linked to transaction records in your accounting system.

    This is the best way to ensure that invoices do not get lost or misplaced. Automating your accounts payable process can remove tedious tasks, such as filing invoices. Also, a clear picture of the state of affairs is available, in case management or external authorities raise any questions. By going digital, it would be easy to search for information and even perform comparisons. Consider this – in a paper system, the purchase order (PO) needs to be matched with the packing slip to understand what was ordered and what was delivered. Also, this needs to be matched with the invoice to ensure that the pricing is right. When volumes are high, this becomes a tedious task. In a paperless system, all this is done automatically by the system.

  2. Review Current Processes for Enhancement:

    Accounts payable includes several processes such as vendor selection, contract creation, procurement process and invoicing. Reviewing and improving each process would help in enhancing the working capital:

    • Vendor Selection:

      It is essential that you maintain a list of preferred suppliers. This would help to prevent unnecessary buying and enable your business to set up the most favorable buying terms.  When selecting a vendor, ensure that all key stakeholders, such as the procurement officer, are involved. Keep reviewing vendors by maintaining a supplier performance scorecard. You could use these scorecards for negotiating with vendors on various parameters, such as product quality, service standards and price. You could even negotiate longer payment terms from those who rank lower on your scorecard. Scorecards can also be used for showing vendors what competitors are offering and getting discounts on bulk purchases.  It would be best to monitor supplier performance on a range of metrics, such as delivery timelines, error rates and quality of service. You can push out those who fail to perform over time. Also, this can yield financial benefits by allowing you to demand discounts when suppliers fail to service terms.

    • Data Maintenance:

      Inaccurate data entry of supplier terms and from POs, can lead to erroneous payments, loss of discounts and disturbances in supply. To avoid any such troubles, it is imperative that all Service Level Agreements (SLAs) and POs are entered into the purchasing and AP systems. Data should include product information, quality standards, payment terms, delivery timelines and other parameters that are important for regulatory compliance. Data must be continually updated as and when changes occur in payment terms, discounts offered or any other contractual changes. Ensure that the actual contract document is stored in a safe place so that it is accessible when needed.

    • Review Contracts: Inaccuracy in payment data can lead to duplicate or erroneous payments. This is the reason why you must review contracts with suppliers frequently. Your team must be able to check for completeness and accuracy of the data. There is also a need to validate data for compliance. Review of contract terms would ensure that suppliers are meeting those terms time and again. Include penalties and fines in contract terms for under performance by vendors. It is also essential to review the contract as compared with industry standards and vendor authorization limits.
    • Manage the Procurement Process:

      When large businesses need to handle hundreds or even thousands of suppliers, there is a need to review and enhance the procurement process. It is indeed a challenge to keep track of all invoices received and reconcile them with the PO. Lack of proper procurement management can make it difficult to forecast and manage cash flows. It could also lead to overspending and dealing with unapproved suppliers.You must have procurement rules in place to ensure that internal stakeholders deal with only approved suppliers and spends are within reasonable limits. Review and accept only those early payment discounts that you can afford. It makes no sense to go for early payments discounts if you do not have cash in hand or if the capital outlay is high. Try to track accounts payable outstanding by vendor and payment terms. Set metrics, such as percentage of invoices paid as per term, so that it can be uniformly used across the organization. When purchasing new products, ask for longer payment schedules to reduce risks associated with such a purchase.

    • Improve the Invoicing Process:

      It is important that a centralized processing office is set up for standardizing the invoicing process. Inaccurate invoices, such as those having the wrong quantity or contact details, should be sent back to suppliers instead of investing time in corrections. Set up invoice process timelines, and to ensure that this is done, date stamp invoices as and when they are processed. For a healthy cash flow situation, ensure that you pay invoices only when they become due. Have a process in place for exception handling in case of invoices.You could save time by implementing an electronic system where suppliers can submit invoices in digital format. Another time-saving technique is to circulate the digitized invoices for electronic authorization. This would save precious time and costs involved in getting a physical sign off. One could even harness mobile technology, allowing managers to authorize invoices on the move using their smart phones, further quickening the invoice authorization process. Create electronic remittance system where remittances can be emailed as soon as the payments are made.

    • Leverage Analytics:

      From an accounts payable perspective, it is also important to track Days Payable Outstanding (DPO). This would decide how well you are managing your cash flow. Establishing analytics for DPO can be very effective. For instance, analytics can reveal instances where large payments may be going out too soon.

  3. Earn Interest: Negotiating with your bank regarding funds can garner handsome returns. For instance, the excess cash generated by increasing DPO can earn interest. Ask your bank to sweep those funds into an interest-bearing account for those days.

In conclusion, with the aid of improved processes, analytics and planning, accounts payable can be leveraged to optimize working capital. The increased cash flow will enable the business to optimize its current operations as well as work towards the objectives of projected growth.

Also Read Related Articles:

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1 Sources of Short-Term and Long-Term Financing for Working Capital
2 How to Optimize Working Capital for Your Business
3 6 Ways To Conquer Major Accounts Receivable Challenges

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