Manufacturing leaders understand that they must manage their physical supply chains: sourcing and tracking the raw materials and parts that come into inventory and shipping their finished goods out to customers.
But what about the supply chain of cash that’s flowing out of and into your business’s bank accounts?
By stratifying your suppliers and looking at how they are performing, you can learn a lot. For instance, are you paying someone early while they are accepting longer terms from other buyers?
Here are some of the more sophisticated strategies that manufacturers can implement that will lower their cost of goods sold, boost their balance sheets and improve operational efficiency. By leveraging these financial tools, manufacturers can meet their company’s operating strategy while improving the health of their supply chain.
Cloud-based Dynamic Discounting
Think of this tool as part stock market/part eBay for accounts payable. The buyers who participate typically have excess cash and a large number of approved invoices payable at standard terms.
Here’s how dynamic discounting works. Suppliers are invited — but not required — to participate in a fully automated online marketplace. The buyer decides how much cash to put into the marketplace each day, a function that is largely automated based on the company’s cash flow, reserves and other factors. When suppliers have approved invoices and need the cash earlier than the net-30 timeframe, for instance, they log into the marketplace and bid on getting paid immediately — but at a discount. The buyer sets a discount goal and suppliers bid against each other during the day until the available cash is exhausted. At the end of the day, the buyer accepts the discounted invoices the company wants to pay; the winning suppliers are notified and they get payment within two days. Suppliers get their payments early, boosting their cash flow at a lower cost to funds, and the buyer pays less than the agreed upon price for the goods or services the supplier provided.
Supply Chain Finance
This tool is similar to dynamic discounting, but instead of using the business’s liquidity, a bank lends its liquidity to certain discounted transactions. In this case, it’s the bank that pays invoices early, acting as a “factor” or middle man in the payment transaction.
For example, a bank will pay the supplier on Day 5 of a net-30 invoice, minus 1 percent. When the buyer pays their invoice on Day 30, they’re paying the normal amount through a lockbox in the bank. This tool is typically used on very large, high-value payments that a company’s best suppliers need to get early payment on. This allows companies to extend days payable outstanding (DPO) and hold onto money longer to fund their business.
Commercial Card Programs
Another way to drive up your company’s liquidity while ensuring that your supply chain stays healthy is to extend DPO through the use of commercial card payments to suppliers. Buyers may choose to pay earlier for their approved invoices via credit card transactions to balance the liquidity benefit. These automated programs are also win-wins.
For example, a supplier accepts a discounted credit card payment on day 20 of a net-30 transaction, getting cash earlier than expected. The business’s credit card account is charged on day 20 and the supplier gets paid right away, but the cash does not immediately leave the business’s account until days later because its credit card bill does not come due immediately. This can lead to improvements in the suppliers’ cash flow while allowing the buyer to hold onto their cash longer improving liquidity. When you’ve got corporations spending millions a month, an extra 15 days makes a big difference.
For large manufacturing businesses with a lot of small suppliers, it may not be financially feasible for them to participate in dynamic discounting or other financial supply chain management programs. What they can do is have their bank push their approved invoices into a specialized supplier payment network.
For instance, some small suppliers participate in networks that allow them to get access to cash early and that deal in electronic remittances, so they can post the payments directly to their books and recognize the revenue immediately, rather than waiting days to receive and deposit paper checks. Some specialized suppliers — such as health care providers or middle-market companies — participate in networks that cater specifically to their industry or market segment. Banks that are familiar with several independent payment networks can handle these transactions for clients, substantially reducing their overhead and time spent on hands-on management of large numbers of payments to smaller suppliers.
Kala Gibson is the senior vice president and head of business banking for Fifth Third Bank. Stay connected at @FifthThird. Fifth Third does not provide legal or tax advice. This information is provided for educational purposes only and is subject to change. Fifth Third Bank. Member FDIC.