Payment Timing Optimization Analysis

Though little known, Goldstein Golub Kessler is a huge accounting and consulting firm with a myriad of practices. One of these practices focused on helping treasurers and chief financial officers manage their payables and receivables in such a way as to squeeze more cash out of the balance sheet. In this assignment, I worked with practice manager Robert Jaffe to create an article on payment timing strategies that was published in Cashflow magazine.

David R. Evanson

Cashflow, Winter, 1995

Results from the needs analysis were unequivocal.

There were several hundred thousand dollars in the company’s payables to be realized. This conclusion became apparent after the accounts payable supervisor answered a number of fundamental questions.

How many dollars do you pay per month or per year to your top vendors? . . . How do you decide on the timing of their payment? . . .How often do you get telephone calls from them? . . . What capability does your accounts payable system have to set the payment timing (your internal terms) differently for each vendor? . . . What percent of your payables are to discount vendors? . . . Factored vendors? . . . When invoices fall due after the check run date, do you pay them in the current check run? . . . How much do you pay your domestic vendors? . . . How much do you pay your foreign suppliers on open account or by letter of credit?

With the results in hand, I reported to the CFO. “At first cut, there appears to be about three quarters of a million dollars of new cash in your payables. With your loans hovering at prime, therezzs a real opportunity to make a positive impact on the bottom line.”

For chief financial officers, news such as this can be trifle unsettling. The nitty gritty of fine tuning vendor payments is not generally within their purview. Most prefer to keep their powder dry for establishing banking relationships, investor relations and lowering the overall cost of capital. Still, new cash on this order of magnitude is difficult to ignore.

In Theory . . .
The resulting work dealt with helping the company realize this cash, which turned out to be $600,000. More on this case later. Whatzzs of immediate importance is the underlying concept known as a payment timing optimization analysis. When this fundamental analysis is conducted, and applied, it can yield astonishing volumes of new cash.

Payment timing analyses rests on the following truth. That is, the true terms which exist between the customer and the vendor are rarely stated on the invoice. In reality, they are determined by a host of circumstantial factors, and relationships between accounts payable and accounts receivable staffs. At the most basic level, the analysis attempts to determine what the zzrealzz terms are, and where practical, to put them to work for the benefit of the company.

In Practice . . .
Consider the following typical scenario. A company consistently pays an important vendor at 39 days, or 9 days after the due date. Optimizing the payment timing suggests cutting the check for this vendor after 55 days or 25 days after the due date. Why? Because for the accounts receivable clerk on the other end of the transaction, the world is likely divided into three discrete time periods: current, 30 to 60 days old, and more than 60 days old. Since the payment has consistently fallen within the middle “bucket” without incident, it is reasonable to assume that no action by the vendor would be taken until payment moved into the next time frame. If this is true, the payer should then take advantage of all the time available to it within the 30 to 60 day time frame, hence the 55 day payment timing.

One other way to differentiate payment timing analysis from simple delaying of payment is that the latter is guided by the time value of money, while the former is guided by the value of the relationship between the vendor and the company. Our experience has been that any strain a test extension may cause dissipates after two months, if the company makes its new payments with consistency. In fact, after test extensions are implemented the number of additional calls received by accounts payable clerks are nil. Therefore, any additional time accounts payable clerks spend to handle the additional calls is inconsequential compared to the value of extra cash generated.

So, for profitable companies, the draw of payment timing is almost irresistible. After all, the analysis itself represents but a one time cost which is often returned six to 10 times over in the first year. In the second year and beyond, the benefits of the payment timing analysis cost nothing.

A Case in Point
Our client, ABC Inc. (a fictional name for a real company), was a profitable manufacturer of engineered products located in the Northeast. Revenues were approximately $100 million annually. After payroll and taxes, ABCzzs pool from which to draw new cash was approximately $52 million.

As a general rule, a majority of payables goes to a small fraction of the suppliers for most middle market corporations. In fact, my experience has been that regardless of the size of the company, 45 to 75 suppliers can cover from 30% to 70% of the payables. In this regard, ABC was right in with the averages. At ABC, we looked at a total of 67 vendors. (Initially, 75 were chosen for the analysis, but management removed 8 of them as sacred cows.) These 67 vendors accounted for $19.6 million, or 38% percent of ABCzzs total payables. Incidentally, of these 67 vendors, 63 were non-discount vendors, and four were discount payables.

In a nutshell, our objective was to look at each supplier separately, and with input from accounts payable staff and management, determine a timing strategy for each of them. We would then take what we learned from the sample, and apply it to the rest of the payables.

With ABC, for example, 47 of the 63 non-discount vendors which were analyzed, or 75%, were found to be extendible. We assumed that of the remaining balance of payables which were not being analyzed on a case by case basis, i.e. the other $32.2 million, 75% were also extendible in one way or another.

But for the moment, we were concentrating on ABCs largest vendors. The actual spreadsheet that was developed for ABC is attached. These spreadsheets are created for each payment timing analysis jobs to summarize the vendors, the assessments of accounts payable staff, management, the action taken, and the cash which the extension generated.

As a general rule, the input from accounts payable comes from the clerks who are actually fielding the calls on a day to day basis. Many times it’s more effective when a third party, such as a consultant, draws information from the accounts payable staff, since they can be intimidated by senior management, and therefore do not volunteer their thoughts freely.

As for management, itzzs usually the controller, treasurer or chief financial officer who approves or modified the test extensions. Often they increase some test extensions recommended by accounts payable. And once again, a consultant can add value by negotiating the needs of management with the recommendations from accounts payable. Sometimes certain functional managers, such as purchasing, can add value on specific vendor relationships.

Note that overall these initial test extensions were fairly conservative. That is, ABCzzs largest vendor, Epsilon Plastics, was consistently paid at 37 days. An aggressive posture suggests that our payment would escape notice until it was older than 60 days. And thus, rather than taking 8 days, ABC might reasonably extend Epsilon another 20 days to take full advantage of the 30 to 60 day aging bucket. But remember, payment timing analysis values the relationship of the vendor above the time value of the cash. Epsilon was vital, and if push came to shove, could idle ABCzzs production.

Another factor to keep in mind is that payment timing analysis is not a game that is won by the swift. In the case of Epsilon, payment was eventually extended to 50 days through subsequent testing. However, an immediate and one time extension of 13 days might have proved too much too fast, and a swift rebuke could have scuttled any extension altogether.

Also noteworthy is the variance of opinion between accounts payable staff and management. The focused relationships that accounts payable personnel have with their counterparts in collections at ABCzzs vendors sometimes preclude them from seeing what the real dynamics ought to be between the two companies.

For example, Tau Products which sold ABC blades for their machine tools was extremely aggressive in their collection practices. The accounts payable supervisor was intimidated, and suggested no extensions. The treasurer, identified as SC in the spreadsheet and who had a larger view of the industry, saw things differently, and recommended a 15-day extension. She knew that Tau was highly profitable and that competition in blades and other similar products was heating up on the heels of inexpensive imports. She knew that in light of this, Tau was looking for ways to protect its franchise. And while Tau did not advertise more advantageous terms, treasurer SC speculated they might be accepted without much protest. She turned out to be right.

When all was said and done, the 67 vendors which were analyzed yielded $427,000 in new cash. This new cash can be applied to loan balances, to new equipment purchases or simply added to the company’s pool of working capital.

For All the Rest
The next major task was to apply the extensions to the rest of ABC’s payables. When this was done, another $179,000 of new cash was found.

There is a human side to payment timing, and for the remaining vendors this comes heavily into play. ABC provides a good example of the various ways this human dimension has an influence.

First, ABC decided that it would not make extensions on any payments for vendors in its home town. An unnecessary gesture from a payment timing perspective, but perhaps a vital one from a community relations standpoint.

Second, for ABCzzs smallest vendors — small machine shops and sole proprietors — ABC instituted an across the board extension of just seven days. It’s not just that ABC had a heart. Often times these vendors were used in a clutch, and ABC wanted to make sure that when it said to jump, they continued to respond with “How high?”

Third, ABC decided that the vendors outside of the sample set who were paid on 30 days would get extended the same number of days as the 30 day suppliers inside the test sample.

The final leg of ABCzzs payment timing analysis was to take a look at the companyzzs discount vendors. Here there were two objectives. First, to ensure that the company was aware of and taking advantage of all discounts which were available to it. Second, to make sure that the discounts taken were more valuable than the cash which might be realized by extending payment. As it turned out, there were no extensions of sufficient length to obviate the benefits of a discount.

As for the discounts, ABC missed only one. The vendor in question, Gamma Plating, offered a 1/2% discount when paid 10 net. The annual invoices from this vendor amounted to $716,257. Therefore, taking the discount reduced the purchase cost by $3,581. However, when adjusted to allow for the 20 days currently taken before the payment [($716,257/365 days) x 20 days x 5% = $1,962], the net value of taking the discount was $1,619.

A Final Detail
Before the program could be launched, ABC had just one more exercise. This is, the company had to decide what kind of “pull back” rule it would use. A possible problem with extensions is that given the date which the company cuts checks in relationship to the weekend means many extensions unwittingly move into a later payment period than was intended.

For example, if payment timing analysis suggests cutting a check at 56 days (i.e. 26 days after the 30 day terms) but the day the company actually cuts checks, say Thursday, stretches the 56 days to 57, then payment will likely not arrive at the vendor until the 61st day. This can provoke notice because the vendor’s accounts receivable collector can be significantly more alert to payments arriving in the 31 to 60 day past due aging bucket on the age trial balance.

To circumvent this problem, ABC instituted a decision rule which said that all checks which were stretched beyond the agreed upon date by virtue of the company’s check cutting date were “pulled back” to the prior week. In some cases this cost ABC as much as six days of cash. But better lost cash than lost vendors.

And of course, just before the trigger was pulled on the whole program, staff in purchasing, accounts payable and management were put on the alert. In payment timing analysis, one of the key ingredients of success is a “buy in” all around.

In The End
Over the next several weeks, ABC fielded several calls from its vendors. Some adjustments had to be made, but overall, ABC realized 95% of the cash that it found in the test extensions. Subsequently, ABC initiated a second test where it found even more cash.

In this second test, ABC took a look at the “sacred cows” or discount vendors left untouched in the first test extensions. Not surprisingly, ABC found a little breathing room there too. In fact, the company also tested grace periods on discounts, and found there were some ripe for the taking.

The analysis paid a second dividend for ABC. Realizing their creditors might be testing them as well, ABC asked us to look at the collection function to see if productivity could be boosted there as well. It turned out that through automation, the company could dramatically free-up collector time, reduce days’ sales outstanding, and, in the process, send an unequivocal message as to precisely what the terms were between ABC and those vendors which it offered credit.


Bob Jaffe is director of the treasury consulting group for Goldstein Golub Kessler & Co. PC, New York City where he consults to audit as well as non-audit clients. For more information, call 212-523-1324.

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