Corporate Cash Balances and the Bottom Line: A Paradigm Shift to Dynamic Discounting

According to the Federal Reserve, as of June 2011 corporate cash balances of US non-financial corporations were close to US$2 trillion dollars, an increase of 36% since 2009. The ratio of liquid assets to short-term liabilities is now the highest it’s been since 1956. Concerns at Fortune 500 companies about the future economic outlook are a key driving force behind this trend, and given the current low-growth economic environment it is likely to continue.

CFOs Are Feeling the Pressure

The trend of cash outgrowing strategic liquidity requirements has also sparked investor interest and chief financial officers (CFOs) are increasingly feeling the pressure to deploy or distribute this excess liquidity. However, as consumer demand declines and there are no external demand drivers on the horizon, good investment opportunities are difficult to come by. At the same time, in the current environment of high uncertainty, high volatility and potential merger and acquisition (M&A) opportunities it is perfectly understandable that CFOs prefer holding more cash to distributing it via dividends or share buy-back programmes.

The good news is new solutions leveraging real-time data exchange and increasing internet-savviness of suppliers now enable CFOs and treasurers to turn the simple concept of early payment discounts into a high-return investment opportunity, while preserving the financial flexibility vital to the organisation.

How can dynamic discounting help?

Dynamic discounting solutions allow large corporates to pay approved invoices earlier than due, against a discount that typically corresponds to APRs between 10% and 36%. As only approved invoices get paid out earlier, this process is risk-free; and since approvals take 10 to 15 days on average, with large companies generally paying after 56 days, there is a large enough window for earlier payments.

Why are treasurers interested?

Corporate treasurers struggle to find investment opportunities that meet their three key requirements:

  1. Short-term: so corporate treasurers can swiftly respond to changing cash-flow needs in their organisation.
  2. Low risk: so they don’t lose the money.
  3. High yield: generating returns that minimise the gap to returns generated from the company’s core business or even exceed the latter.

Requirements one and two traditionally have driven corporate treasurers to invest significant portions of their company’s cash into treasury bonds (T-bonds) and money market accounts (MMAs). Today, assessment of default risk has become much more difficult, with US disputes on the debt ceiling and non-negligible default probabilities for some European governments and banks.

The third requirement has already been a challenge for many years, and neither T-bonds nor MMAs seem likely to deliver a respectable yield anytime in the near future.

The answer to the problem already exists within each large company, as part of its very own supply chain. Many of their suppliers face unprecedented challenges to stay afloat and to maintain sufficient cash-flow, especially during the period when goods and services are delivered until the moment payment is received. The lengths of such periods are dictated by the payment terms and can be as long as 90 days, but even payment terms of 45 days or less can be a challenge to suppliers. As a result, suppliers have to obtain financing to cover these gaps. Unfortunately it has become increasingly difficult for suppliers to qualify for financing, especially small suppliers, and it typically comes at a high cost. Often suppliers resort to factoring or credit card borrowing at APRs of 20%, or they get invited to a purchasing card (p-card) program charging a 2.5% fee, which translates into 30% APR for 30 days.

According to data from Factors Chain International the factoring market alone grew to US$2.3 trillion in 2010.

Because each supplier is eventually being paid from the very cash that the corporate treasurer seeks to invest, the supplier’s challenge presents a tremendous opportunity to the corporate treasurer. By paying suppliers early in exchange for an early payment discount, this can translate into an APR 50x times higher than what T-bonds or MMAs can offer.

Benefits for the CFO and Treasurer

Unlike interest generated from T-bonds and MMAs, which is non-operating income, returns generated from a dynamic discounting program come in the form of additional discounts that lower the total costs of goods sold. These returns directly impact the bottom line and significantly improve earnings before interest and taxes (EBIT).

For example, a company with an annual spend of US$20bn could potentially improve its EBIT by US$60m, simply by leveraging US$400m of its cash to accelerate US$2.4bn of its annual spend by 60 days and at an interest rate of 15% to its suppliers.

The following figures illustrate the corresponding balance sheet to the example above.

Figure 1: Without a Dynamic Discounting Programme.

Source: Taulia

Figure 2: With a Dynamic Discounting Programme.

Source: Taulia


CFOs and corporate treasurers who move away from focusing solely on working capital reductions can realise immediate and substantial improvements to their bottom line. Equally important, CFOs and corporate treasurers are able to maintain full visibility and control over the company’s liquidity and preserve financial flexibility. All of these benefits can be achieved risk-free, at a 50x multiple over what T-bonds and MMAs can provide. As such, making dynamic discounting a strategic initiative is the logical consequence to prioritising EBIT over a pure working capital focus.


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