EPI: The Neglected Metric in Corporate Finance
In a recent Shared Services Link webinar, Deliver Savings and Increase Profits: Top Working Capital Management Strategies, attendees identified their top KPIs relating to working capital management. At the top of the list was days payable outstanding, followed by cash flow gain, return on invested capital, and early payment discounts earned.
One metric that did not get a mention was EPI: earnings per invoice.
That’s no surprise, as few organizations consider invoice processing as a profit center. For most companies, invoice management continues to rely on armies of people shuffling piles of paper. There’s too much time resolving invoice errors and exceptions, and few opportunities to capture early payment discounts.
As trading partners turn to business networks for real-time processing of electronic invoices, however, straight-through processing rates can exceed 90 percent. More importantly, an invoice becomes a valuable corporate asset, making positive contributions to the income statement and working capital. When coupled with a new form of electronic payment such as AribaPay, where detailed remittance information is tightly coupled with the payment, the value proposition grows.
Let’s look at the potential income statement impact from electronic invoicing and payments, starting with the process improvements, using conservative estimates of the savings potential.
Invoice volume: 400,000 invoices a year
Invoices process electronically: 70%
Cost savings per invoice: $4
Savings: $1.12 million
Next, let’s consider savings from electronic payments.
Payment volume: 200,000
Electronic payments: 70%
Cost savings per payment: $2
In this example, process savings come in at $1.4 million. But there’s more opportunity for business impact. As a business network helps you achieve high, straight-through processing rates, you can now capture virtually all early payment discounts, and extend discounts to new groups of suppliers that you would never consider when transacting off line, with paper.
Let’s run the numbers for an annual spend volume of $3 billion.
Spend volume: $3 billion
Discount adoption at 10% of spend: $300 million
Average discount: 1.5%
Gross discounts: $4.5 million
At $4.5 million, that’s more than 3X the savings than what you get from a more efficient invoice and payment process. Often, when building a business case for automating invoice and payment processes, these savings are not considered.
Finally, as part of this exercise, there’s an opportunity to improve working capital that many organizations also overlook. This involves payment terms. If your organization has a days payable outstanding (DPO) metric below the standards of your industry, or if you have no clearly defined payment term policy, you have an opportunity to standardize and rationalize your payment terms, and free up working capital.
Let’s look at some more numbers.
Spend volume: $3 billion
DPO extension: 15 days
Savings per billion dollars per day of DPO extension: ~$2.7 million
Free cash flow: $120 million
Finally, if you earn 3% on that cash flow, that contributes another $3.6 million in earnings to your bottom line.
To recap, that’s $1.4 million in cost savings, $8.1 million in earnings generated, and $120 million in freed up working capital. Not a bad day’s work from fixing a broken payables process.
(This article was originally published in The Digitalist.)