The Value of Cash and

Procurement
An Oracle White Paper
By David Hope-Ross and Folia Grace
July 2006

The Value of Cash and Procurement

EXECUTIVE OVERVIEW
Optimal payment timing balances the best
discounts with the best float.

Payment timing can make a significant effect on cash flow. Early payments can
yield the best discounts, but at the expense of drawing down funds early. Late
payments can yield the best float by delaying funds withdrawal, but at the expense
of lower discounts and possible penalties. Procurement can actively balance these
trade-offs to gain the best discounts and while preserving the best cash balances.
INTRODUCTION

Payment timing can make a significant effect on cash flow. This article discusses:

Why CFOs care about Procurements cash contributions

When to pay via strategic cash management and strategic sourcing

How to capture early payment discounts as well as maximize cash position

via tactical payment execution

Maximize cash on hand while balancing

WANT TO MAKE FRIENDS WITH YOUR CFO? GIVE HER SOME CASH!

discount availability.

Recently there has been lots of attention focused on benefits of negotiating

payment terms during strategic sourcing. There are good reasons. It is becoming
more and more apparent that payment terms can have a big impact on cash flow.
Therefore, purchasing executives should appreciate payment terms as a key
component of total cost. However, executives should not wait for sourcing cycles
to attack the opportunity. Indeed, there is substantial opportunity to cut cost by
addressing the timing of supplier payments with existing contracts and pending
transactions. With the right approach to payments, Purchasing can improve
margins and generate some cash for their CFO.

TIMING IS EVERYTHING

An ongoing industry debate centers on buying organization's ability to drive

benefits by delaying payment terms. On the one hand, the majority opinion argues
that buying organizations should delay payment so that their companies can accrue
the cash flow benefits of withholding payment for as long as possible. Often,

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proponents of this approach argue for maximizing Days Purchasing Outstanding

(DPO) and keeping discounts offered for early payment despite tardy remittance.
However, a growing minority opinion is questioning these practices with the
understanding that maximizing DPO will lead suppliers to treat their organizations
as serial late payers. Indeed, savvy suppliers are finding ways to recover the value
of cash withheld, often by raising unit costs or refusing to offer good terms to
habitual late payers. Thus, if an organization really hopes to reduce cost, it must
pay suppliers on time capturing every cent from early payment discounts. This
approach can increase margin because of lower unit costs, but the drawback is that
it can weaken the companys cash position.
One way of considering this is via the Strategic Cash Management Framework. This
framework helps you visualize the impact of varying terms on maximizing DPO to
maximize cash on hand, versus minimizing the cost of goods.

Striking the balance during sourcing cycles is the key. Increasingly, Purchasing
organizations are working with their finance organizations to determine what really
constitutes on time based on striking a balance between discounts, cash benefits,
and understanding how to leverage differences in suppliers relative cost of capital.
Though this might help to explain what constitutes an on time payment, it does
not serve to settle the age-old debate pay early versus pay late.

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HAVING YOUR CAKE AND EATING IT TOO

You can put this debate to rest. Organizations can apply both practices to generate
benefits, capturing early payment discounts as well as maximizing their cash
positions. The trick to getting both sets of benefits is taking a precision guided
approach to timing payments. The approach must be based on a clear
understanding of four key variables:

What are your current terms?

What are the sums of money (cash) involved?

What is the administrative overhead (e.g. paper invoices, supplier status

calls, etc.)?

What is the suppliers ability to enforce discounts?

With these questions answered, organizations can take a methodical approach to

identifying savings opportunities based on the ability to:

Generate cash by delaying payment for big ticket items with little or no
discount

Minimize administrative cost and maximize cash by paying on time for

relatively low value items.

Reduce A/P costs by paying on receipt for lower cost items with high
administrative overhead

Offer accelerated payment to suppliers in exchange for unit cost

reductions to improve margin and lower overhead, especially for big
ticket categories.

Considering these points visually, Tactical Payment Execution is the approach that
helps you evaluate the best focus and trade-offs for your situation. In many cases,
the optimal focus will vary by commodity category. For example, for spot buys of
low cost MRO items whose administrative cost is relatively high as a percentage of
the invoice, the optimal focus pay on-time or pay on-receipt will depend
on the rate of early payment discounts. Paying early or late will incur higher costs.

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Using these guidelines, procurement organizations can drive additional value from
the pay portion of Procure-to-Pay processes. However, they shouldnt do so
alone. The CFO and Finance organization should always be consulted in these
matters. They are uniquely qualified to understand the current cost of capital, the
cash position of the enterprise, and risk factors such as those associated with
fluctuation in currency exchange rates. The goals and objectives of the Finance
organization should be central to the ways in which payment re-engineering is
conducted. Furthermore, in considering returns (ROI) associated with these
projects, the incentives and compensation of the Procurement groups must be
considered. Often these will need to change in order to reflect broader business
goals, as opposed to the traditional incentives that typically are based on a
percentage of cost reduction.
GETTING THERE

While these practices seem simple in principle, they can be difficult to implement
under the weight of tens of thousands of paper invoices. Though most people
focus on the expense of physically processing paper, that cost can pale in
comparison to the opportunity costs of missed discounts and paying too early. By
their very nature, paper orders and invoices obscure visibility; create latency, and
introduce untold opportunities for human error. These will prohibit even efficient
organizations from taking a precision-guided approach to payment.

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World-class organizations share a common set of attributes that can be applied to

other organizations seeking to reduce paper and improve margin and cash position.
Primary among these are:

Adoption of a single set of operating principles and shared

incentives by Finance and Procurement

A single, aggressive, multi-year plan to leverage information

technology to reduce paper, promote visibility, and drive
compliance

Implementation of a seamless operating environment, often in

conjunction with Shared Services and Center-Led-Procurement
principles.

Negotiation of payment terms as a standard part of strategic

sourcing, often in conjunction with using Sourcing Optimization
tools to identify economic-breakpoints and impact of all types of
costs.

Use of transaction delivery networks and standards-based

documents (e.g. EDI and XML) across all categories

Use of self-service portals for suppliers for non-transactional

collaboration and where network-based transaction delivery is not
practical.

Replacement of the traditional order-invoice process with new

practices implemented in conjunction with suppliers and other
operating groups (e.g. Finance, Facilities Management, Plant
Maintenance, Production, Sales & Marketing, etc.). Examples of
these processes include Consigned Inventory, Vendor Managed
Inventory, VMI, consolidated billing, Pay on Receipt, Evaluated
Receipt Settlement, and Ghosted Procurement-Cards.

CONCLUSION

Payment timing can make a significant effect on cash flow. Early payments can
maximize discounts, but at the expense of drawing down funds early. Late
payments can maximize float by delaying funds withdrawal, but at the expense of
lower discounts and possible penalties. By working with Finance, Procurement can
actively balance these trade-offs to gain the best discounts and while preserving the
best cash balances. Procurement balances trade-offs by eliminating costly paper and
actively evaluating timing via strategic cash management, strategic sourcing, and
tactical payment execution.

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The Value of Cash and Procurement

July 2006
Authors: David Hope-Ross and Folia Grace
Contributing Authors: Charles Knapp
Oracle Corporation
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