Collaborative Finance and the Working Capital Bonanza at American Electric Power
Money, money, everywhere,
Nor any rate to take.
For organizations with healthy cash balances, the million dollar question, literally, is where to invest that cash over the short term. In its role as cash stewards, most treasurers focus more on risk than return. But in a networked economy, a collaborative finance approach presents new opportunities to manage cash that can mitigate risk while boosting returns.
The enabler is the business network, where trading partners can come together to manage their cash as effectively as their transactions. Consider the case of American Electric Power (AEP), which not long ago launched an initiative to streamline its procure-to-pay process.
Rather than focus exclusively on the operational aspect, AEP recognized the impact of a business network on cash and working capital management. As a result, AEP made early payment discounts the driver of the initiative and, in the first year of its deployment, realized a substantial increase in early payment discount savings.
Now, while early payment discounts can deliver cost savings and double-digit cash returns, this can occur at the expense of Days Payable Outstanding (DPO). Accelerate payments to suppliers, and you can turn over your AP balances quicker. That’s where attention to payment terms can make this a “no-brainer” decision.
For AEP, the lack of a payment terms strategy led to more than 150 payment terms. Even worse, upon further analysis, AEP learned that it was paying its suppliers faster than its peers. This presented an opportunity for AEP to standardize terms, ultimately extending them in many cases to conform to the industry average. Now, AEP has the best of both worlds: more early payment discounts and extension of DPO to free up valuable working capital.
In addition, AEP is helping its suppliers meet cash flow needs, in a self-service manner. As Rick Gray, senior treasury specialist explained, it’s a more streamlined process that requires no effort from AEP staff. “The tool allows suppliers an easy way of getting their money sooner without reaching out to our accounts payable or procurement departments,” he said.
What’s also interesting about AEP’s approach is that the solution was deployed independently of a PO and invoice automation solution. In fact, the cost savings from the discounts will fund the larger procure-to-pay project.
For organizations with large cash balances, the opportunity to consolidate a payment terms standardization program with a dynamic discounting program is something to consider. When you can increase earnings on cash, extend DPO, and help suppliers reduce DSO or increase their cash flow, that’s win-win-win.
Collaborating over cash is one of many ways you can benefit from a business network. For other ideas, head over to Conversations on the Networked Economy.