In an era where capital is scarce, it’s good to know you can decrease your working capital by paying more attention to your payables terms.

Lots of Payment Terms, Little Rationale

Every company has payment-terms agreements with their vendors.  They typically represent the intention between the buyer and seller at the beginning of a relationship.  These terms get loaded into the system and memorialized as part of every invoice.  Over time, as market conditions fluctuate, pricing, deals and allowances will be regularly renegotiated, but the important element of the payment terms is largely forgotten.

For example, a large retail client of ours had negotiated over 90 different sets of payment terms across 3,500 vendors.  Though a handful of terms were used more than the rest, there was no rhyme or reason as to why any vendor was assigned a specific payment term.  In this situation, to try to capitalize on the opportunity, some finance departments will try to get a few more days out of everybody.

We call that the machete approach; PRGX prefers the scalpel approach.

Our approach adheres to principles tested with numerous client initiatives.  With this approach, we figure out how we can help clients move groups of vendors to longer terms in an incremental fashion by segmenting them and building individual action plans for each:

• Some vendors you leave alone because they would push back hard, and they have the power to significantly disrupt your business
• The majority you can get to extend payment terms, but you have to negotiate with them, just as you would any other aspect of your relationship
• And some you can simply “inform” that these are the new terms

The trick is to know how far you can push the terms relative to your power with the vendor and the standards in that category.  This insight can only come from rigorous analysis and market experience.  Our surgical analysis only moves vendors that can safely be moved based on the retailer’s relative market share and category benchmarks.

In the example above, we already had the client’s data by virtue of our recovery audit relationship.  With the client’s permission, we were able to quickly analyze payment terms for them and demonstrate a realistic business case for the DPO extension.  We also organized the agreements by vendor, looked at how each stacked up in its category relative to what an industry acceptable set of payments terms would be, and used that information to determine which vendors to target for renegotiations.

We then created four options ranging from conservative to aggressive.  The aggressive approach would yield big dollar one-time cash savings as well as ongoing benefits, but could not be used for every vendor.  The other options produced relatively smaller savings, but all reduced the amount of working capital necessary to run day-to-day operations.

Knowing what to do and how to do it leaves one final question: who will do it?  One way retailers often fail is by trying to execute a terms renegotiation through the finance or payables departments, without having merchandising on board.  We advise clients to pull in all stakeholders: merchandising, treasury, A/P, indirect procurement and store operations.  And, we make sure merchandising leads this initiative because they have the most important relationship and leverage points with the vendors.

This work is not easy, but with the data, the right analytics and insights, and a proven approach, a DPO extension is a powerful and underutilized tool to reduce working capital and increase free cash.

Want to learn more about how to extend vendor terms and DPO?  Contact us at .(JavaScript must be enabled to view this email address).