Where credit is due

Management of payments is a key tool in effective cash management. Creditor management is about maximising the period from purchasing goods and services to paying for them, thereby reducing the working capital requirement in the business. This objective of maximising the credit period must be carefully managed to ensure relationships with suppliers are not damaged and stock levels are optimised.

All businesses should set a clear policy on creditor management that will underline their approach to sourcing and negotiating terms and conditions. That policy should take account of optimal stock holding levels (including the importance of holding buffer stocks to avoid stock outs) and timing of other cash flows within the business. The purchasing strategy should be aligned to business goals and priorities should be set. Is price the most important issue, or is certainty of supply or quality of product paramount? Determining the key drivers for the business will guide in your approach to managing creditors.

Your ability to optimise the credit period will be driven by a range of factors, including the relative importance and dependence of the business on particular suppliers and their dependence on the business as a customer. If a supplier is heavily dependent on your business you will be in a strong position to negotiate extended terms. Where goods required in the business can be sourced from a number of suppliers there may also be opportunities to negotiate favourable terms with existing or new suppliers, who will be keen to retain or win your custom.

Building strong relationships with suppliers is critical, especially given the current economic climate. A good starting point is to review the number and frequency of use of suppliers. Consider concentrating supplies to a smaller number of suppliers and developing strategic supplier relationships. Such an approach can deliver financial savings, in terms of better prices and payment terms, and greater reliability in terms of product quality and supply. However, care must be taken to ensure that over-dependence on too few suppliers does not carry too high a risk for the business.

Agreeing to pay suppliers on set dates can also assist in negotiating extended credit terms as certainty of payment will allow them to plan their payments to match.

Stock holding considerations will be important in negotiating with suppliers, in terms of the holding costs to both your business and the supplier. Better terms can often be agreed by negotiating purchasing agreements where commitments to take set (or minimum) quantities at set dates are made, thereby enabling the supplier to better plan production.

Many factors influence negotiations with suppliers. Generally, your negotiating position will be stronger if you are a key customer and if you have complied with terms on previous business undertaken with them. While there are good opportunities to negotiate better terms in the current economic climate, care should be taken when negotiating to ensure that the terms do not place the supplier under undue cash pressures, especially if alternative supply is difficult to source.

Effective creditor management addresses the whole of the purchase-to-pay cycle of the business, from order placement to receipt of goods or services through to payment. Each of the steps in the process is examined below, along with some ideas on how to deliver cash benefit to the business.

It’s essential to have a formal purchasing policy and procedure in place, which should be distributed to all relevant functions within the business. The policy should be reviewed regularly and amendments made where necessary. Consider tightening up the process  to ensure only business-critical purchases are made. By doing so, significant savings can be delivered without any adverse impact to the business. A key to achieving these savings is to communicate their necessity to all staff and obtain their commitment.

Further practical ways of achieving better cash flow for the business in the order process include:

• Buying on sale or return. This provides the business with the flexibility to have goods on hand while not committing funds for payment 
• Changing order dates. One-off benefits to the cash cycle can be achieved by changing order dates and frequencies
• Centralising procurement. While many businesses cannot afford to commit a resource specifically to procurement, most businesses can still generate savings by reviewing their current approach to buying and streamlining the process. Simple measures such as requiring final sign off for all purchases by the finance function can help identify inefficiencies
• Linking order placement to order quantity optimisation. Better prices and terms can often be negotiated by placing larger orders less frequently or at agreed schedules.

A procedure to ensure confirmation of goods and services received should be in place. This can involve issuing goods received notes or signing delivery dockets or invoices supplied at the time of delivery or thereafter. Most disputes are likely to result from issues surrounding delivery – for example, incorrect quantities or items – and it is essential therefore to match proof of delivery to

invoices received and to identify discrepancies immediately.

A prompt and proactive approach to resolving disputes will help build stronger relationships with your suppliers. It will also save time for your business as the information relating to the dispute will be readily available and the circumstances surrounding the dispute will be fresh in people’s minds.

Where damaged goods have been received they should be returned immediately and replacement goods or a credit note should be received.

Once confirmation of receipt of goods is given, the focus of creditor management becomes one of payment.

Management of payments provides the greatest opportunities for a business to manage its cash better. While good debtor management is essential for bringing in cash, a business has greater control over its own cash and if managed properly can control payments to keep cash within pre-determined limits.

The starting point for effective cash management is to have clear visibility over liabilities and new purchase requirements, and to schedule upcoming payments to match forecast receipts and cash availability within the business. Cash-flow forecasting is a key business tool in this process and can be done on a simple spreadsheet or with more sophisticated forecasting tools.

In order to achieve visibility and control over all payments (including direct debits), managers must have a clear process for recording and tracking liabilities and payment dates. This will normally be controlled through the accounting system but additional processes, such as critical payment control schedules, may be employed.

Better management of payments can be achieved by:

• Reviewing payment methods. While payment by automated methods such as direct debit and the UK’s Bank Automated Clearing System (electronic funds transfer) provide benefits in reduced processing costs, they provide less flexibility than cheque payments in terms of the ability to hold payment for a short period
• Restricting payment authorities. To give greater control over the management of cash, previously held authorities (eg cheque-signing authority) should be reviewed and withdrawn if appropriate
• Changing payment dates. These should be matched to receipts where possible to ensure funds are in place ahead of payment out of monies. Where a mismatch currently exists, talk to suppliers and agree a change in payment dates
• Reduced number of payment runs. A significant benefit can be delivered by reducing the number of payment runs within the month. Letting your suppliers know that you intend to do this is essential to ensure they are fully aware of your plans and can plan their cash flows accordingly
• Reviewing discounts available and only using them where it makes sense to do so. While they often seem attractive, the cost of making payment early may be greater than the discount received. It is essential to calculate the cost of capital to the business and compare that to the discount offered. If discounts are not taken, ensure the maximum credit period available is taken
• Considering netting of amounts due to suppliers against amounts receivable from the supplier
• Proactively claiming rebates
• Reconciling statements to invoices and only paying for confirmed deliveries. As noted earlier, disputes should be identified and followed up on immediately to ensure prompt resolution.

These points demonstrate a number of ways to better manage your creditors to deliver significant cash benefits to the business. Payment procedures should be reviewed regularly to identify further opportunities for savings given changing circumstances.

Many businesses find that they have difficulties in making payments to their suppliers at some time or other. Irrespective of the cause of such problems, it is essential to open discussions with suppliers as soon as possible to advise them of the issues and negotiate a payment plan. Open and honest dialogue with suppliers will build trust and enable them to provide support during difficult times.

Effective management of creditors is one of the easiest ways for a business to improve cash flow. And regular review of policies and procedures can help to identify opportunities to deliver savings as business conditions change. Opportunities to negotiate better terms from suppliers exist in the current climate and should be seized upon.

Alan Morris is head of KPMG’s Cash Management team in Ireland.