I was volunteering with a group in a church kitchen when someone opened the oven door. It made a loud creaking sound. Someone cracked, “That’s the same sound that Rob’s wallet makes when he has to open it.” When you’re a CPA and a banker, you’re a prime target for that joke, which was both very funny and true. Companies should also be reluctant to open the corporate wallet for payments until the payments are due.
Goals for Accounts Payable Management
The goals for accounts payable management include:
- Delaying payments as long as appropriate: You want to make payments as far into the future as possible without angering vendors and employees. You also don’t want to incur late fees or damage the company’s credit profile.
- Identifying liabilities: This is especially true for accrued liabilities for which the company owes money but has not received an invoice.
- Identifying the invoices and vendors for which to take discounts
- Providing projections of cash outflows for cash flow planning
- Coordinating with treasury, finance, or accounting staff to make sure that cash is available for payments when needed. They may need time to get the cash from operations or other working capital accounts. In the worst-case scenario, they may say that the cash won’t be available when the payment group would like to make the payment, so the payment will need to be delayed.
- Efficiently processing payments: Much of this is done via automation and integration of different parts of the payment process.
- Reducing fraud and errors
The first five goals are most applicable to working capital management. I also briefly touch on the latter two.
Types of Payables
There are many types of payments that give rise to accounts payable. Here are some of the more common ones:
Trade Payables
For companies that sell goods, trade payables comprise the largest share of payables by far. Many of the concepts in this course are most applicable to trade payables. Negotiating and managing trade payables is crucial for these companies’ working capital. Two key aspects of this negotiation are the amount of credit extended by the vendor and the payment terms. The best time for a company to get good terms is when adding a new vendor. The vendor is more likely to make concessions to get your business. Also, make sure to clarify payment terms with a vendor if it’s not part of the negotiation when setting up the relationship. This will give you a glimpse of whether the vendor takes payment terms seriously or is less likely to be bothered by slow payments.
Payroll Payables
For service companies, payroll payables may be much larger than trade payables. Payroll payables are important for both providers of goods and for providers of services. There is little room to stretch payroll payments. You definitely don’t want to anger employees. It’s hard to rebuild trust after an employer is perceived as unfair.
Debt Payments
A company can negotiate payment terms when establishing debt. You want to demonstrate the company’s financial strength to maximize the credit available and reduce debt costs. Both lenders and the company want debt payments to come due when the company is best able to make the payment. Thus, schedule payments during the times of the year or month when the company has high cash balances.
Dividends Payable
Dividends are paid at the discretion of the company, subject to the pressures of capital markets. A company wants to maintain consistency with past dividend actions, if possible. Shareholders and the market take a very dim view of less favorable dividends.
Taxes Payable
My policy has always been to never get cute with tax payments. Don’t mess with the IRS. Penalties and interest on late tax payments are brutal. Communication with tax authorities can also be maddening. I don’t recommend it unless you like to play on-hold music as background music for a long time while trying to get work done on your computer. Ironically, once reached, tax staff have been some of the most pleasant people I’ve worked with. Please be kind to them. They have a massive job to do, are given few resources, and often have little authority to make exceptions to policies.
Accrued Payables
This often includes tax liabilities that are submitted periodically with a tax form. It’s shocking how many small businesses don’t have cash available when taxes are due. This is especially egregious when sales taxes are collected by the company and then used for operations. A company that struggles with this may need to set aside funds each period in a separate bank account so the cash is ready to be paid when due.
Deferring and Scheduling Payments
One of the main goals of payables management is to make payments when due and not earlier than that. An exception to this is when there is a favorable discount for early payment.
When I was a bookkeeper of a small non-profit while I was in college, this meant filing invoices in an accordion folder where each pocket of the folder was a date in the future for when the invoice was to be paid. Today, scheduling due dates can be easily done with all accounting software systems. A fully automated system receives the invoice in a file easily imported into the accounting software or by scanning PDF files and mapping the key data on the invoice into the appropriate fields in the accounting software. One of those key fields is the due date, which is used to schedule the payment. The payables group then authorizes and releases those payments on their due dates, hopefully electronically, with electronic remittance for the highest efficiency.
There is almost no benefit from check float with remote deposit capture. The only float left is the time that the check is in the mail. The benefit of that float is more than offset by the inefficiency and costs of mailing checks and remittance documents.
Maintaining Relationships with Vendors
The inventory process and payments process are tightly connected, yet they may be in two different departments in large companies. Those two departments must work together to identify the best vendors and maintain a good relationship with those vendors. Late payments and poor communication by the accounts payable staff can poison a relationship with a critical vendor. Good relationships can lead to more flexibility in payment terms and occasional exceptions to those terms when needed.
Another reason for good relationships with vendors is efficiency. A company wants to create the most efficient ordering and payment process with its major vendors. This can be accomplished when the company’s systems and its vendor’s systems are highly coordinated or integrated. Automation is maximized by minimizing staff manual intervention during processing. This automation will likely also reduce errors.
On the other hand, the relationship with vendors can cause a company to bend too far, to the detriment of working capital. Vendors may leverage their relationship, or at least their power, to negotiate payment terms that are exceedingly beneficial to them. Some vendors may request faster payment on some invoices or special processing. These negate the benefits I listed earlier.
When to Take Discounts
A 2/10 net 30 discount equals a 37% effective annualized interest rate. It would be madness for a company not to take this if their vendor offered it. Only a company with extremely tight cash flow or a very high yield on funds would pass it up.
The discount is so valuable that it may be good for a company to borrow funds to take the discount. They may tap their line of credit if the interest rate on the line is less than the effective annual rate of the discount.
Centralization vs Decentralization
A big decision for larger companies is finding the most effective point on the spectrum from centralization to decentralization of payables. Here are some thoughts on the two ends of the spectrum:
Centralized Processing
Centralized processing is often more efficient from both cost and cash flow perspectives. Central processing allows a small set of highly trained staff to quickly process payments. Central processing from one or a small number of bank accounts makes cash management much easier, with less excess cash going unutilized. Reporting of cash balances and projections of future balances may be easier to produce and more accurate. Centralized processing usually leads to tighter internal controls, potentially leading to less fraud and mistakes.
Decentralized Processing
Decentralized processing may better fit companies where purchasing decisions and vendor relationships are managed locally. It may allow faster payments when needed for those vendors. Culturally, it reduces the “us vs them” mentality that develops between remote locations and the headquarters. A poorly run centralized payables department can be exasperating to the rest of the company. In other words, it has become a single point of failure for a critical company process.
Communicating When Cash is Tight
The worst thing you can do when you are seriously delinquent on a loan payment or invoice is not to talk with your bank or vendor. When I worked at banks that had a past due borrower who wasn’t communicating, we had no other option than to begin foreclosure or other harsh collection procedures.
Your bank or vendor usually understands that cash crunches occasionally happen. Often, they will provide an alternative payment plan or some other modification to help you with temporary cash shortages. Being honest with your vendors allows both of you to work together toward the best solution for everyone. Their long-term success is tied to your long-term success.
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