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Contracts & Procurement Experts Beware!

August 3, 2010

An article in GT News offers valuable insights into the world of accounts payable – and should alert those enaged in contracts to several issues that need our input.

The article discusses the latest trends in e-invoicing and highlights its rapid growth. In the US, there are forecasts that the number of e-invoices will overtake paper invoices in 2011. Many will welcome this development since it clearly represents a source of increased efficiency – for example, it leads to fewer errors and shortens approval times (industry estimates suggest these fall from an average of around 25 days in the paper-based system to just 10 – 15 days).

So suppliers may be excited by the prospect of earlier payments – but they would be wrong. As most know, large corporations have used the recession as a further excuse to prolong the payment term – now running at an average of 56 days, versus 53 days a year ago. So approvals are getting faster while payment is getting slower. And the large corporates are simply piling up the cash.

This is where the story becomes really interesting. The article tells us: “Large companies have emerged from the financial crisis with record levels of cash: the S&P 500 industrial companies increased their holdings of cash and marketable securities to US$820bn, up 27% from a year earlier. What is more, an analysis of the 500 largest non-financial US companies by the Wall Street Journal reveals that the cash to assets ratio has reached 9.8%, up from values between 4% and 6% in the 1990s (a similar study by Goldman Sachs reports a jump from 6% in 2002 to more than 10% today).”

But this windfall for the largest companies is at the expense of many of their suppliers. The SME market has seen a reverse trend. Their cash reserves have fallen and “small businesses are having to pay more to borrow relative to the Federal Reserve’s benchmark rate than at any time in at least a quarter of a century, according to official data from the central bank. Moreover, often credit is not readily available, forcing many SMEs to factor their receivables, frequently at interest rates of 10-20% annually. The worldwide factoring market in 2009 was a stunning US$1.8 trillion.”

So we have a picture in which the largest companies have used the recession to build their war-chests, in part at the expense of their suppliers. And now, armed with this data and all the insights that they are gaining from their new e-invoicing systems, Finance managers see a new opportunity to turn the screw. Rather than thinking about supplier liquidity as a problem, they see it as an opportunity. They are preparing either to offer factoring services, or to increase their use of early payment discounts.

Their new electronic systems offer a far more efficient way to manage such programs, including the ability for selective application or to turn the system on or off depending on cash needs. “The cumulative amount of business-to-business (B2B) invoices approved but awaiting payment has never been higher. These invoices can be used to improve working capital or profits. Upon approval, the buyer can either guarantee payment of an invoice (reverse factoring/supply chain finance (SCF)), or pay the invoice early against attractive additional discounts (dynamic discounting).”

Should those of us in the world of contracting and procurement care about this? Well, as suppliers, many of us will obviously not be happy about this trend and its impact on our business. But those in Procurement should also be asking questions, rather than allowing this financially driven shift to take place by default. In my response to the article, I made the following observation:

“This analysis is typical of that used within the finance community, but ignores the broader economic cost of such policies. First, companies pay a premium when they delay. Suppliers are not stupid – they mark up their price to take account of the delay or to cover the early payment discount. Second, such behavior by large corporates jeopardises the performance (and sometimes survival) of their suppliers. This can have significant downstream consequences as suppliers struggle to cut corners and cut costs. Smart finance experts also examine the broader business consequences of their behavior.”

Just because we can do something does not necessarily make it right or make it wise. If you work in a large corporation, be sure that you are involved in this debate. And if you work in an SME, be prepared; decide now what policies you will put in place to protect yourself from the impacts of this financial engineering.

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