Ask any supplier what the top five areas of contention are in any buyer-supplier relationship and terms of payment will appear on every supplier's list. Yet how we pay suppliers is routinely ignored as a tool for motivation and compliance.
In most companies, over 50 percent of incoming sales revenue is expended on external suppliers and providers of goods and services. Traditionally, how those suppliers are paid has been a financial function. Increasingly, companies are recognizing that the management of that function and the control of the largest use of working capital is a procurement responsibility, not just a financial one.
Regardless of where that function occurs within the company, the realities are that any issue for optimizing working capital for accounts payable or managing the relationship with external suppliers must involve the procurement department.
Dr. Joseph Cavinato, the distinguished professor of supply chain management at the Thunderbird School of Global Management, has developed a concept called the Cash Canyons. The concept recognizes two key issues:
Outlay of cash to acquire materials and services occurs often months, if not years, in advance of recognizing receipt of that cash from sales.
Accounts payable processes have changed little in the last 50 years.
In the late 1960s and early 1970s, most managers recognized that excess working inventory was a liability, despite recording it as an accounting asset. Similarly, most finance and procurement managers also know the negative impact of excess working capital but do not consider the costs significant. In the past, those costs could easily be passed on to customers. Today, however, global competition is changing that comfort level and is continuing to force change.
The lessons learned in managing the physical and information supply chains have not been applied to the financial supply chain. Those lessons are applicable and the level of rewards just as dramatic. Global enterprises carry excessive float because of the lack of visibility in the financial supply chain.
Payment to suppliers can take 30, 60, 90, or even more days to complete. Accounts payable management processes are outdated. They are labor and paper intensive and prone to error. The inefficiencies in the system that result in excessive administrative and financial cost are a burden to all suppliers. Rather than rewarding valuable supplier relationships with improved accounts payable processes, all suppliers are equally disadvantaged.
The focus should be on using accounts payable as a building block of supplier relationship management—not as a disincentive. The terms of payment should be a consideration in the negotiating and contracting phases and used as a positive motivation in the management of supplier relationships.
Payment terms should not be uniform for all suppliers. Key suppliers should be rewarded with advantageous payment terms, and poor, unresponsive suppliers should be penalized with disadvantageous payment terms. Procurement and supply managers are missing an opportunity to use accounts payable as a mutually advantageous aspect of supplier relationships.
What are the terms and conditions that govern how you pay your suppliers, and what do they think of your processes?