The Bottom Line on Dynamic Discounts and Reverse Factoring

Ask any chief financial officer (CFO) if they would like a 30% or more annual return on capital, while making their financial processes more efficient, and you’d probably get your hand bitten off. Particularly in the current climate, which tempts businesses to hold onto their cash for as long as possible.

At the end of 2009, UK companies had significantly improved the time it takes them to settle their bills, according to the Late Payments Index by Experian, the global information services company. Firms were paying their late bills an average of just under 21 days after agreed terms – an improvement of over 2.5 days compared with the previous year.

But while everyone’s doing it, it isn’t good for supplier or partner relationships. Nor does it make the best financial sense. So why do organisations persist in holding on to cash?

CFO Versus CPO

Looking at the issue from the traditional CFO viewpoint, the only leverage they have on suppliers is payment terms and the retention of working capital. On the other hand, the traditional view of the head of purchasing is not to squeeze suppliers by extending payment terms, because of the risk this might incur to the company’s supply chain.

So the arm-wrestling contest between purchasing and payment continues. What’s more, the contest is usually over very small percentages. A typical business reserve account gives around 3% interest, or just 0.25% per month. It’s better than nothing, but does it compensate for the squeeze on suppliers and the risk it causes?

Doing the Maths

The alternative is dynamic discounting. While paying suppliers early to improve your own cash flow seems counter-intuitive – and is likely to cause some internal controversy – the figures certainly add up.

Let’s assume that by offering to pay invoices in 10 days instead of 30, a company negotiates an average additional discount across its suppliers of 2%. That’s nearly six times what it would earn in interest by delaying payments. Furthermore, the return on capital would be 2% in 20 days, or over 36% annually – a figure that would soothe the most ruffled feathers.

Even if the negotiated early-settlement discount was half of the above – just 1% – that’s an 18% annual return on capital. While there is some discrepancy between achievable returns in practice and theory, there is no argument that the payoff achievable through returns on capital employed by better management of supply chain finance is vastly superior to those achieved by e-invoicing, scanning and the resultant head count reduction.

Capturing the Discounts

Although the figures are compelling, there’s still the issue of ensuring that payment systems are capable of tracking and hitting early settlement deadlines. So how can you be sure of achieving this?

The secret is gaining control of the purchase-to-pay (P2P) process, which then gives financial managers a choice of how and when to pay, in order to best suit their working capital strategies.

Having an automated invoice processing solution is a key first step, to ensure that an invoice is received electronically or data is taken off paper documents through scan and optical character recognition (OCR) thus enabling electronic processing. However, it’s vital to look beyond simply scanning and capturing of invoice data, and uploading it onto the accounting system.

The most vital stage is what happens after the invoice is digitised – the matching of the invoice to its corresponding purchase order (PO) or contract and other supporting documents, so that all evidence for prompt approval and payment is available to accounts payable (A/P) and other staff involved in the approval process.

The second issue is ensuring that the staff that approve invoices can do so quickly and easily. Manual tasks like finding supporting documentation, checking and consolidating can cause delays that could mean early settlement deadlines are missed. Not forgetting the costs associated with downstream journal corrections, and other corrective measures that arise in a manual – or less than fully automated – process.

Automation is critical, as is the ability for A/P staff to access their invoice workflow wherever they are. A cloud-based solution is ideal for these circumstances, so the workflow can be processed on handheld devices, laptops, or when working from home.

Integration with core business systems is also critical, so that any exceptions (such as invoices without orders or incorrect coding) can be highlighted, and escalated where needed. This way, automation can be applied, allowing management by exception. This also means that targets such as settlement deadlines can be built into workflow, so they can be hit every time and ensure savings are captured.

Benefiting From Your Banking

Many organisations already have the building blocks in place for integrated P2P solutions, which in turn would give them the capability of deploying dynamic discounting to suppliers and partners, boosting capital and reducing the cost of doing business.

Another option, in collaboration with your bank, is to look at reverse factoring. Where traditional factoring uses an invoice as the underlying asset for financing, reverse factoring brings the qualified invoice into play. In essence, traditional factoring deals with the supplier’s receivables from many ‘unknown’ buyers, whereas reverse factoring deals with the payables of one well-known buyer.

The weakness with traditional factoring is that the factor company does not know whether the supplier really delivered the promised goods or services, or whether the delivered goods or sent invoice will be contested by the buyer. As a result, only about 70% of the invoice value would normally be financed.

However, with reverse factoring, the buyer approves the invoice prior to the financing organisation settling with the supplier, thus enabling financing of 100% of the invoice value.


The keys to A/P automation or P2P are control and choice. If you have the control over your process, which gives you insight into the real financial data as a finance manager, you have the choice of how and when to pay your supplier. This in turn allows you to maximise the return on your capital.

The fundamental point is to ensure that systems are integrated, so that staff can track the status of invoices throughout the payment cycle. If you can’t approve an invoice within five days, you will not have the choice of reverse factoring or dynamic discounting.

But for companies that have that integration and control over their cycle, P2P automation offers a real payback.


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