Electronic invoicing (e-invoicing) is estimated to comprise up to 15% of the total invoice volume processed in the US today. Paystream Advisors even predicted in a recent study that e-invoicing would overtake paper invoicing within the US by 2011. The growth in e-invoicing is widely forecasted to gain further momentum, despite the persistent need to overcome challenges. One such challenge is the lack of interoperability between the various e-invoicing solutions. Another is the recent trend started by two of the larger players to levy new or higher charges on participating suppliers.
Interestingly, the financial justification of most buyer-side e-invoicing projects is strongly based on efficiency gains: receiving more accurate data and doing so electronically substantially reduces the data entry and invoice processing costs for the recipient. In many cases, the buyer’s ability to increase capture of lucrative early payment discounts is also part of the business case; however, the importance of optimising the time value of money is arguably still largely underestimated. Below, we will take a closer look at this financial aspect.
First, let us briefly recap the current financial environment. Large companies have emerged from the financial crisis with record levels of cash: the S&P 500 industrial companies increased their holdings of cash and marketable securities to US$820bn, up 27% from a year earlier. What is more, an analysis of the 500 largest non-financial US companies by the Wall Street Journal reveals that the cash to assets ratio has reached 9.8%, up from values between 4% and 6% in the 1990s (a similar study by Goldman Sachs reports a jump from 6% in 2002 to more than 10% today).
When speaking to treasurers of large companies, we consistently find that current liquidity levels exceed strategic liquidity by a wide margin. At the same time, short-term risk-free interest rates have reached a historic low, with four-week Treasury bills trading around 0.1% on the secondary market, compared to 4-5% in 2007. Consequently, treasuries struggle to find attractive short-term investment opportunities. However, for small to medium-sized enterprises (SMEs) things look markedly different: US small businesses are having to pay more to borrow relative to the Federal Reserve’s benchmark rate than at any time in at least a quarter of a century, according to official data from the central bank. Moreover, often credit is still not readily available, forcing many SMEs to factor their receivables, often at interest rates of 10-20% annually. The worldwide factoring market in 2009 was a stunning US$1.8 trillion.
Taken together, these opposing problems faced by large corporates and SMEs scream for arbitrage. Given that the supplier base of most large corporations largely consists of SMEs, there is a significant opportunity associated with optimising payment terms and A/P.
Taulia estimates that the cumulative amount of business-to-business (B2B) invoices approved but awaiting payment has never been higher. The increasing adoption of e-invoicing and A/P automation solutions continues to reduce the length of the approval cycle (defined as time from invoice receipt to approval) from approximately 25 days to 10-15 days or even less. At the same time, the strong focus on preserving liquidity during the financial crisis has motivated many large buying organisations to extend their payment terms, which now average 56 days (up from 53, according to REL Consultancy). Remarkably, the shorter approval cycle has not led to an overall acceleration of payments, as the majority of invoices are subject to payment terms such as Net 45, Net 60 or Net 90, which do not offer early payment discounts.
Why does the number of invoices awaiting payment matter? The simple answer is that these invoices can be used to improve working capital or profits. Upon approval, the buyer can either guarantee payment of an invoice (reverse factoring/supply chain finance (SCF)), or pay the invoice early against attractive additional discounts (dynamic discounting).
SCF versus Dynamic Discounting
SCF is typically implemented to enable an extension of payment terms by a large buying organisation, which results in a one-time reduction of working capital. The role of SCF is to reduce resistance and insolvency risk of the affected suppliers by providing them with access to financing at attractive rates. As the buyer confirms future payment to the bank, such supplier financing rates result from adding the respective margins of the bank and the solution provider to the buyer’s cost of capital. From an accounting standpoint, not much changes for the buying organisation, as the bank advances the funds for earlier payment to the suppliers, and payments for A/P continue to be made at the due date.
There are two disadvantages to such a solution, however – namely that it fails to provide treasury with an attractive investment opportunity and the financing provider typically claims a significant part of the difference between the financing interest rate offered to the supplier and the buyer’s cost of capital. Tellingly, in most cases SCF increases the overall injection of bank financing into the supply chain. Banks, therefore, market it heavily.
Dynamic discounting, the alternative to SCF, converts earlier approvals into earlier payments. The arbitrage opportunity between large buying organisations and their suppliers is therefore directly addressed – without using a bank as middleman. Dynamic discounts differ from traditional discounts in two key aspects: first, the discount is calculated dynamically as a function of the time of payment, e.g. it is based on a sliding scale. This eliminates one problem of terms such as 2% 10, Net 30, where you are no longer entitled to a discount if the invoice approval takes longer than 10 days.
Second, and more importantly, dynamic discounting can address the entire invoiced spend – not just the fraction that is currently subject to traditional payment terms. To do so, earlier payment against a time-variable discount is proactively offered to the suppliers for all approved invoices with non-discount payment terms, e.g. via a vendor portal or an e-invoicing network like OB10. For these invoices, payment takes place at a discount attractive to both the buyer and the supplier, often calculated from an interest rate around 10% times the days the payment is advanced. Earlier payment is lucrative for a large buying organisation, as typical interest rates underlying such discounts are much higher than the buyer’s cost of capital for risk-free investments. In particular companies holding liquidity in excess of strategic liquidity will find dynamic discounting attractive as it presents an opportunity to make short-term risk-free investments into their own supply chain at rates vastly superior to any alternative investment.
As treasurer you also gain additional flexibility: since offering an earlier payment is optional instead of mandatory and since the ‘maturity’ of earlier payments is typically around 20-40 days, turning off the early payment option immediately starts freeing cash that may be needed for an acquisition. In short, large buying organisations can spend less and generate higher profits. From an accounting perspective, a dynamic discounting solution – when turned on – will result in a reduction of A/P in the short term, but with a lower spend because of discounts earned. Typical savings range from US$1-5m per US$1bn in annual spend.
E-invoicing and A/P automation now allow corporate finance to manage a substantial amount of approved payables, which in turn allows for the generation of significant financial gains. The source of these gains is the synergy between the high demand for cash and the high cost of borrowing for SME suppliers in conjunction with the low opportunity cost for cash-rich buying organisations. Depending on a large corporation’s liquidity requirements, SCF can be used to free up working capital, while dynamic discounting reduces spend and provides treasury with a high-yield low-risk investment opportunity.
Tim de Knegt, treasurer for the Port of Rotterdam, discusses how he is looking to bring more value to the Port's clients using blockchain.
Regulation technology is fast gaining currency by transforming how financial institutions can tackle compliance in a swift, comprehensive and less expensive manner.
Many banks around the world, large and small, continue to experience major security failures. Biometric systems such as pay-by-selfie, iris scanners and vein pattern authentication can help.
The implementation date of Europe's revised Markets in Financial Instruments Directive, aka MiFID II, is fast approaching. Yet evidence suggests that awareness about the impact of Brexit on MiFID II is, at best, only patchy and there are some alarming misconceptions.