Payment Discount Analysis

Transcription

1 White Paper Paymet Discout Aalysis This white paper outlies a approach to aalyze the beefits of cash discouts offered by vedors for prompt paymet of a ivoice before the agreed due date. It provides some isights o the trade-off that takes place wheever discouts are availed of reductio i purchase cost versus icrease i borrowig cost. This documet also provides a approach to evaluate discouts offered o a tiered basis, which result i ehaced savigs for cliets. Paymet discouts ca reduce purchase cost sigificatly. Sice it is oe of the key aspects of the paymets process, it must be systematically aalyzed to esure optimal workig capital requiremet.

2 About the Authors G Ramesh Prabhu G Ramesh Prabhu is a Chartered ad Cost Accoutat with Tata Cosultacy Services (TCS) ad works with TCS Fiace ad Accoutig Services. His areas of expertise iclude fiacial ad cost aalysis, solutio desig ad drivig process excellece through process bechmarks ad maturity models. Gopalakrisha Sethurama Gopalakrisha Sethurama is a Chartered ad Cost Accoutat with Tata Cosultacy Services ad heads the Fiace & Accoutig (F&A) ceter of excellece. His areas of expertise iclude strategic guidace to add busiess value to customers ad drive cotrollership across all the F&A egagemets. 2

3 Table of Cotets 1. Why should we aalyze Discouts? 4 2. The Nuts ad Bolts of aalyzig Discouts 5 3. Reports & Dashboards 6 4. Other factors to keep i mid 7 5. Coclusio 7 3

4 Why should we aalyze Discouts? Vedors ofte offer early paymet discouts to their customers, based o the idustry, geography, product ad market coditios. The credit period is a key compoet of the cash coversio cycle (Receivable Days + Ivetory Days Payable Days) ad iflueces the workig capital requiremet of the busiess. Some vedors may also provide discouts for paymet made before the due date, which reduces the overall purchase cost to the compay. While most compaies opt to avail of ad track the early paymet discout as part of their paymet cycle process, the decisio to take advatage of these discouts should be recogized as a trade-off ad be made by comparig the iterest rate o short term borrowig with the discout that is gaied by makig the early paymet. A idicative model of the cash coversio cycle with ad without a early paymet discout is show below: Cash Coversio Cycle (Without Discout) Receivable +40 days Ivetory +20 days Purchase Payable -25 days Receivable +40 days = 35 days Cash Coversio Cycle (With Discout) Ivetory +20 days Purchase Payable -15 days Credit period availed by peer compaies How does this create opportuity to impact workig capital? = 45 days Fall i credit period whe discouts are availed Should Discout be availed? The diagram above delieates the importace of reviewig the decisio to take advatage of discouts. I additio, the decisio should be a ogoig process o accout of Chages i iterest rates due to macro-ecoomic ad liquidity coditios Chages i the compay s risk profile, thus ifluecig the borrowig rate Idustry treds ad their ifluece o the credit period availed of by competitio i the peer group Tiered discout models with multiple paymet due dates ad correspodig discouts Discout Borrowig Cost Credit Period Tier 1 Discout Due Date Tier 2 Discout Due Date Which Tier should be availed? 4

5 To make this decisio, the compay should fid aswers to the followig questios: O what occasios should the discout be availed of? Whe should the discout ot be availed of? Ca What-if scearios be geerated, to simulate how chages i iterest rates, credit periods ad discout rates may impact the workig capital? If discouts are offered o a tiered basis, how ca the most optimal tier be idetified? How ca iformatio o the credit period availed of by peer groups be leveraged to better maage the workig capital? The Nuts ad Bolts of aalyzig Discouts The key compoet i aalyzig discouts is the evaluatio of the opportuity cost the trade-off betwee the discout rate ad the cost of borrowig. The opportuity cost may be calculated as follows: Opportuity Cost = (Normal Credit Period - Discout Period) * Borrowig Rate/365 Oly if the discout rate exceeds the opportuity cost, should the compay avail of the discout. I case of tiered discouts, the same logic ca be exteded to cover both tier 1 ad tier 2 discouts. Discout Rate Opportuity Cost > = Avail Discout The opportuity cost ca also be adjusted to calculate the impact of the idustry credit period (average credit period ejoyed by peer compaies). This may be compared with the curret discout rate, ad if foud to be better, may be used to egotiate a loger credit period durig cotract reewal. Opportuity Cost = (Idustry Credit Period - Normal Credit Period) * Borrowig Rate/365 A simple spreadsheet model may be developed to calculate this across all vedors as show below. Here, tier 1 discout % represets the discout that ca be availed of if paymet is made withi the Tier 1 stipulated period; similarly, tier 2 discout represets the discout (usually lower tha tier 1) that ca be availed of if paymet is made withi the tier 2 stipulated period. Per aum Borrowig Credit Period(days) Discout - Tier 1 Discout - Tier 2 Vedor Name Purchases Cost % Curret Idustry % Days % Days A 60, B C D E F 90,000 0, ,000 50, ,

6 The spreadsheet below evaluates ad lists the recommeded course of actio for each vedor, based o the cocept of opportuity cost. Decisio DPO Impact (Days) Icremetal Float Save Discout? Decisio Opportuity Decisio % Opportuity % Tier 1 Tier , Tier 2 No No Tier ,236 12, ,342 1, The DPO (Days Payable Outstadig) Impact above shows the impact of the suggested course of actio (Decisio) o the credit period ad o the cost of borrowig (iterest cost). The Opportuity colum idetifies vedors where higher savigs may be realized if the credit period is exteded to idustry levels. The savigs are also quatified ad show as a percetage of total purchases from the vedor. The icremetal opportuity savigs to be gaied, both i percetage ad value, by reegotiatig the credit period durig cotract reewal is show o the right side of the spread sheet. Reports & Dashboards 1 A idicative dashboard, showig the potetial float cost savigs across all vedors may be icorporated i the spreadsheet model (as show below). This shows the float savigs gaied from the curret decisio to avail of a discout, ad the potetial opportuity savigs to be gaied by reegotiatig the credit period to idustry levels durig cotract reewal. The orage bar o the left shows the curret float savigs ad the blue bar to its right represets the higher float savigs opportuity that may be availed of by movig to the idustry credit period (o a select subset of vedors). 30,000 25,000 20,000 15,000 10,000 5,000 18,204 6,382 24,586 Float save from availig Discout Potetial Float save opportuity by egotiatig credit period to idustry stadard Icremetal Float Save Opportuity Total Float Save Potetial Float Save Potetial Refereces [1] I a credit trasactio, float refers to the amout of time, or buffer, betwee the date a purchase is charged ad the date the paymet is due. If the compay delays settlemet with vedors it ca maximize its retur o float. However this cost must be compared with the savigs gaied from early paymets, to optimize the total cost to the compay. 6

7 Other factors to keep i mid The approach listed i this documet ca provide isights ito the discout aalysis process ad ca help idetify the factors which ifluece the availig of discouts. Oce the decisio is take to avail of discouts, it is importat to track ad moitor upstream processes, especially paymets, to esure that paymets have bee made o time ad to the correct beeficiary. A idicative set of metrics that should be tracked ad moitored are give below: % of duplicate vedors % of ivoices paid before the due date % of discout availed % of delayed paymets % of ivoices pedig three way match % of POs with goods received ad pedig ivoices etc Coclusio I today s volatile eviromet it is extremely importat to aalyze the best possible outcome for each vedor, by takig ito cosideratio the market treds, their expected movemet ad their impact o iterest rates ad credit periods, to egotiate vedor cotracts. At TCS, we have bee advisig our cliets to explore alterate scearios, based o their busiess situatio. For example, we aalyzed the paymet patters, discout etitlemets ad idustry discout treds etc. of oe of our maufacturig cliets. Our suggested approach resulted i a savigs of $0.4 millio per aum through icreased paymet discouts. Paymets discouts ca add a sigificat boost to savigs ad should therefore be systematically aalyzed to esure the optimizatio of workig capital requiremets. 7

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