What do early payment discounts and the ‘Time Value of Money’ have to do with one another? In a word, everything. If you’re in Accounts Payable (“AP”) or P2P, you may have never associated one with the other. But they are very much intertwined in the entire ePayables process. In my experience, core finance concepts are not typically part of standard AP training, (although it would make sense for many reasons if they were) the ‘Time Value of Money’ is an important one that many AP and P2P professionals know has practical implications in their daily work.
Let’s take a closer look into at early payment discounts and how the ‘Time Value of Money’ plays a role in the everyday life of AP. Reducing the amount paid for a supplier’s goods and services by simply paying sooner than agreed upon and receiving a discount in exchange (frequently called a “supplier discount” or an “early payment discount”) has been an accepted and common practice since the dawn of currency and formal commerce. In fact, the “Time Value of Money” which is the concept that one dollar today is worth more than one dollar in the future serves as both the foundation of modern finance theory and the rationale behind why these types of transactions make sense to trading partners. This core principle of finance holds that money available at the present time is worth more than the identical sum in the future due to its potential to earn interest or be reinvested to aid growth or expansion. In short, any amount of money is worth more the sooner it is received.
While ‘supplier discounts’ were once a common occurrence, they began to diminish significantly during the industrial revolution when enterprises and trading partner relationships grew larger and less personal. That was then, and this is now. Much has changed over the years and early payment discounts now are much more the rule than the exception. The majority of suppliers offer discounts for early payment as part of their standard customer invoicing process. Similarly, AP and finance organizations have programs in place to optimize their cash and yet, only a small percentage of supplier payments actually capture a discount. The sad reality is that despite demand for early payment discounts on both sides of the invoicing process, few partners actually achieve them. According to Ardent Partners’ 2018 State of ePayables research findings, only 19% of early payment offers are captured.
The primary culprit in this financial misalignment has been the heavy reliance upon paper invoices, paper checks and manual processing, with slow and often lengthy approval times, and poor visibility into outstanding liabilities (aka – invoices due), making it difficult for AP departments to react and respond to these opportunities. Lengthy invoice processing times have adverse consequences for buyers and suppliers alike, including late payments, missed early payment discounts, increased supplier inquiries and inaccurate accruals/receivables resulting in inaccurate financial information and potentially poor decisions.
All of this brings us back to the importance of the ‘Time Value of Money’. If ePayables processes are askew and the receipt, approval, and/or payment of invoices are not automated, organizations will not be in a position to reap the benefits of early payment discounts and the significant impact and role they can play in optimizing cash flow in an organization. Taking advantage of early payment discounts is a win-win scenario for buyers and suppliers alike. Suppliers get access to their money sooner and can put it back to work for their organization. Buyers, on the other hand, help their suppliers by putting capital back into the supply chain faster while achieving a positive rate of return on their own working capital. Time is money and cash is king. Mastering the concept of the ‘Time Value of Money’ and understanding how it applies to ePayables, is yet another way for AP to move on from traditional stereotypes of being a back-office, tactical department to a value-adding, strategic function to the enterprise.
