Dynamic Discounting is becoming a very popular means for companies to invest some of their short term cash in their supply chain for significant annual returns on that cash. But paying early can do damage to DPO metrics, and that is anathema to many treasurers and finance focused folks. Having been in this Dynamic Discounting business for the better part of a decade (almost since it's inception as a technology), I have encountered this issue many times. And while it is a valid concern, Dynamic Discounting returns and DPO metrics need not be mutually exclusive and can, in fact, BOTH be achieved...and even reinforce one another.
Over the years, as part of the analysis process with customers and prospects, I have reviewed literally hundreds of vendor master spend files and have learned that there are 2 immutable truths regarding most companies and their payment terms:
- Their payment terms proliferate like rabbits (and rare is the company with less than 40-50 different ones)
- Most companies have little idea prior to analysis how much earlier they are paying suppliers than they ought to be, due to immediate terms or too short terms. Many are simply shocked to realize how many suppliers they are paying on "immediate" terms for no better reason than because someone, at some point entered that term into the system for those vendors, when they should be on standard 45 day terms, for example.
While I have found the above to be true, I have also seen how best practice companies take the opportunity to combine a payment terms rationalization and optimization project with a Dynamic Discounting program to achieve increased DPO, Increased discount savings, and reduced supply chain risk...all without sacrificing any of these goals. In my experience, best practice companies maximize their discount savings AND extend their DPO by first defining a payment terms strategy in which they 1) Rationalize payment terms down to just a few standard, consistent terms from the 50+ they currently have and 2) Optimize their payment terms by bringing them in line with industry standards where they lag. Quite often companies find that they are paying suppliers on earlier terms than their competition is, and can extend their payment terms to fit industry averages.
The result of this is two-fold:
- Increased DPO due to payment terms being moved to industry standards and consistently applied in as few standard terms as reasonable.
- Increased appetite for Dynamic Discounting from many of the vendors now being paid later than they were used to previously.
When combined like this, a terms rationalization and optimization project increases DPO and the desire for accelerated payment, while the Dynamic Discounting program meets the liquidity needs of suppliers who need accelerated cash flow and yields significant discounts and annualized returns to the buying organization. And since the best practice uptake of early pay discounts is around 20-25% of suppliers, the net result, as illustrated in the figure below, is an increased DPO to go along with the increased dynamic discount savings and reduced liquidity risk in the supply chain.
So not only can Dynamic Discounting and DPO improvement co-exist, I have found it to be a best practice for them to do so!
I'll be sharing more about this, and how companies are finding good yields on short term cash through Dynamic Discounting in a webinar with Vishal Patel of Ardent Partners on June 21st at 11:00 EST. You can Register here.