Moderated by Srishti, Digital Transformation Consultant at Hyperbots
Srishti: Hello, everyone! My name is Srishti Rashvier, and I’m a digital transformation consultant at Hyperbots today. I’m delighted to have Shaun Walker as my guest. Thank you so much for taking the time, Shaun.
Shaun Walker: Absolutely, thanks for having me.
Srishti: Of course, here’s a little bit about Shaun. So he is the Sox compliance manager at Norfolk, Southern, and today we will be discussing exploring various types of payment terms. So whenever you’re ready, we can get started.
Shaun Walker: Alright! Let’s go.
Srishti: Begin with, how does net 60 compare to net 30 payment terms? And in what scenarios might one be more favorable than the other? To buy Ops.
Shaun Walker: Sure. So net 60 extends the payment period to 60 days, whereas net 30, the payment has to be done within 30 days. So a favorable scenario for net 60 is when a company needs more time to allocate funds effectively to enhance their liquidity without immediate cash outflow. So net 60 benefits buyers needing extended payment periods.
Srishti: Makes sense. Can you compare net 30 payment terms with cash on delivery terms and explain why each might be more advantageous for buyers?
Shaun Walker: Yeah. So net 30 allows the buyer to pay within 30 days, whereas cash on delivery requires immediate payment upon the receipt of goods. So in nearly all cases, net 30 benefits most buyers compared to COD, as it helps in cash conversion.
Srishti: I see. And how does net 30 compare to cash in advance terms, and under what circumstances might each term be preferable for buyers?
Shaun Walker: So, yeah, so net 30 is a 30-day payment period, whereas cash in advance requires the buyer to pay before the goods are shipped or services are rendered. Therefore, net 30 is ideal in most cases because it helps to conserve the cash.
Srishti: Understood, and what are early payment discounts such as 2/10, net 30? And can you provide examples of when they are beneficial or detrimental for buyers?
Shaun Walker: Yeah. So an early payment discount like 2/10 net 30 offers a 2% discount if an invoice is paid within 30 days; otherwise, the full amount is due. So essentially, the later you pay with a discount, the later you pay without a discount is more favorable, related to terms leading to early payments.
Srishti: Understood. And can you explain installment payment terms and provide examples of both favorable and unfavorable increments for buyers?
Shaun Walker: So installment payment terms allow the buyer to pay the total amount due in smaller scheduled payments over a set period. A favorable example is an agreement that offers flexible payment schedules without interest, enabling the buyer to manage the expenses more effectively. For instance, paying in 3 equal installments over 3 months can help maintain steady cash flow.
Srishti: That makes sense. How do different payment methods, such as electronic transfers versus checks, impact payment terms? And can you please provide favorable and not favorable examples for buyers?
Shaun Walker: Yeah, payment methods have a significant impact. So electronic transfers are generally faster and more secure, allowing companies to take advantage of early payment discounts more easily. A favorable example would be using ACH or wire transfers to promptly pay invoices, enabling the company to secure a discount, like the 2/10, net 30 that was mentioned before, which enhances savings. A non-favorable example would be relying on paper checks that can be slower and more prone to errors or delays, making it difficult to meet payment deadlines and miss out on available discounts.
Srishti: That’s really interesting. The right? That’s right.
Srishti: Yeah, sorry, go ahead.
Shaun Walker: I was just saying that choosing the right payment method aligns with the company’s operational efficiency and financial strategy.
Srishti: Absolutely, that makes sense. Can you explain the role of late payment penalties in payment terms and provide examples of both favorable and not favorable implementations for buyers?
Shaun Walker: Yeah. So a reasonable penalty, such as a one-and-a-half percent monthly late fee after the due date, encourages timely payments without over-stressing the buyer. A non-favorable implementation would be excessively high fees, such as a flat fee that’s disproportionate to the invoice amount or escalating penalties, which can create financial strain for the buyer, making it difficult to manage cash flow effectively and potentially leading to budgetary issues.
Srishti: I see. And can you explain what are payment upon receipt terms? And when are they considered favorable or unfavorable for buyers?
Shaun Walker: Yeah. So payment upon receipt, also known as PUR, requires the buyer to pay for goods and services immediately upon delivery. PUR is favorable when the buyer has strong liquidity, and it’s non-favorable if a buyer has limited cash flow or they need time to verify the quality and quantity of goods before making the payment.
Srishti: That’s fair. And how do milestone-based payment terms work? And can you provide examples of their favorable and not favorable use for buyers?
Shaun Walker: Yeah. So milestone-based payment terms tie payments to the completion of specific project stages or deliverables. In a software development contract, payments are made upon reaching key milestones, such as completing the initial design, development, and testing phases. A non-favorable example will be when milestones are poorly defined or subject to subjective interpretation; it can lead to disputes and delays in payments.
Srishti: Understood. Can you describe letters of credit as a payment term and provide examples of when they are advantageous or disadvantageous for buyers?
Shaun Walker: So letters of credit, also known as LC, are financial instruments issued by a bank guaranteeing that a buyer’s payment to a seller will be received on time and for the correct amount. A favorable example in international trade, an LC reduces the risk for a buyer by ensuring that the payment is only made once the seller fulfills the contract terms, therefore providing security and facilitating trust between trading partners. A non-favorable example would be for smaller transactions or domestic deals. The complexity and associated costs, such as bank fees and stringent documentation requirements, can make LCs disadvantageous, potentially outweighing their benefits.
Srishti: That makes sense? What are open account payment terms, and when might they be favorable or unfavorable for buyers?
Shaun Walker: So an open account term involves goods being shipped and delivered before payment is due, typically within 30, 60, or 90 days. A favorable example for buyers is that open account terms improve cash flow and reduce the need for upfront capital, whereas a non-favorable example would be if the buyer faces unforeseen financial difficulties. Open account terms can lead to cash flow strain due to the extended payment period, making it challenging to meet financial obligations on time.
Srishti: Understood. And that brings me to my last question: how does Hyperbot’s payment AI co-pilot play a role in identifying and optimizing various payment terms across your vendor base?
Shaun Walker: Sure. So Hyperbot’s payment AI co-pilot is instrumental in managing and optimizing our payment terms. It leverages advanced machine learning algorithms to analyze payment data in real time, identifying patterns and opportunities for more favorable terms. The AI co-pilot also compares our current payment terms against industry benchmarks and similar vendors. It highlights areas where we can negotiate improvements; it provides actionable insights and recommendations, such as suggesting optimal payment schedules or identifying opportunities for early payment discounts. Also, the AI co-pilot generates comprehensive analytics reports. It enables our finance and procurement teams to make data-driven decisions that enhance cash flow and maximize cost efficiencies. So in conclusion, by automating the analysis and negotiation process, Hyperbots ensures that we consistently secure the best possible payment terms, supporting our overall financial strategy.
Srishti: Understood. This is really helpful, and with that, we have come to an end for today’s discussion. Thank you so much for joining us and sharing your insights; also, big thanks to our viewers. So I’ll see you around. Have a good one. Goodbye.
Moderated by Srishti, Digital Transformation Consultant at Hyperbots
Srishti: Hello, everyone! My name is Srishti Rajveer, and I’m a digital transformation consultant here at Hyperbots. Today, I’m super delighted to have Shaun Walker as my guest. Thank you so much for your time, Shaun. It’s really lovely to have you here.
Shaun Walker: Absolutely, thanks for having me.
Srishti: Of course, and here is a little bit about Shaun for the viewers. He is the Sox compliance manager at Norfolk Southern, and today we will be discussing maximizing cash savings through early payment discounts and strategic financial management. So whenever you’re ready, Shaun, we can start with the first question.
Shaun Walker: Alright! Let’s dive right in.
Srishti: Can you explain what early payment discounts are and why they are important for businesses?
Shaun Walker: Sure, early payment discounts are financial incentives offered by vendors to encourage buyers to settle their invoices before the standard payment. Typically, they’re expressed as X/Y net Z, where X is the discounted percentage, Y is the number of days during which the discount is available, and Z is the net payment period. For example, 2/10, net 30 means there’s a 2% discount if the invoice is paid within 10 days; otherwise, the full amount is due in 30 days. These discounts are important because they can lead to cash savings for businesses. Businesses can reduce their overall cost of goods and services, improve cash flow management, and optimize working capital. By consistently taking early payment discounts, businesses can strengthen relationships with vendors and potentially secure more favorable terms in the future.
Srishti: That sounds really advantageous. Can you also explain how companies can compute the cash saved by taking these early payment discounts?
Shaun Walker: Certainly! To compute the cash saved by taking early payment discounts, companies need to calculate the annualized discount rate and compare it to their cost of capital. If the company’s cost of capital is, for example, 8%, taking the discount would be highly advantageous.
Srishti: That absolutely makes sense. Can you also provide an example where the annualized discount rate is higher than the cost of capital?
Shaun Walker: Absolutely. For example, take the 2/10, net 30 payment term scenario. The discount is 2% if paid within 10 days, and the full payment is due in 30 days. If the cost of capital is 8%, the annualized discount rate in this case is 37.04%. Since 37.04% is significantly higher than the 8% cost of capital, it’s highly advantageous for the company to take the early payment discount, resulting in substantial cash savings and reduced overall purchase costs.
Srishti: That is really helpful. Can you also provide an example where the annualized discount rate is lower than the cost of capital?
Shaun Walker: Sure. For example, consider payment terms like 0.5/10, net 40. The discount is 0.5% if paid within 10 days, and the full payment is due in 40 days. If the cost of capital is 12%, the annualized discount rate is 6.12%. Since 6.12% is lower than the cost of capital of 12%, it’s not financially beneficial for the company to take the early payment discount. In this case, the savings from the discount don’t compensate for the opportunity cost of using the capital to pay early.
Srishti: This is certainly very helpful. How does the cost of capital influence the decision to take these early payment discounts?
Shaun Walker: The cost of capital represents the company’s required return on its investments or the cost of borrowing funds. When evaluating early payment discounts, the key is to compare the annualized discount rate to the cost of capital. If the annualized discount rate is greater than the cost of capital, taking the discount is beneficial. If the annualized discount rate is less than the cost of capital, it’s not advantageous to take the discount. Understanding the cost of capital is crucial in determining whether early payment discounts are a good financial decision.
Srishti: That absolutely makes sense. Can you help our viewers understand how technology, such as Hyperbots’ Payment AI Copilot, assists in optimizing these early payment discounts?
Shaun Walker: Hyperbots leverage advanced machine learning algorithms to analyze payment data in real-time. It offers automated tracking, data-driven insights, and a recommendation engine that suggests optimal payment schedules. It performs scenario analysis, integrates with financial systems, and sends alerts and reminders to ensure payments are made within discount periods. By automating and enhancing the analysis of payment terms, Hyperbots’ Payment AI Copilot enables companies to systematically capture savings from early payment discounts while maintaining optimal cash flow management.
Srishti: Thank you so much for sharing these insights. What strategies can companies use to ensure they take advantage of favorable early payment discounts?
Shaun Walker: Companies can maintain a strong cash flow, automate payment processes, prioritize invoices with discounts, negotiate favorable terms, and regularly review payment practices. They can integrate financial systems to provide real-time visibility into invoice statuses and discount opportunities, educate finance teams, and use analytical tools like Hyperbots to optimize payment decisions.
Srishti: That’s super helpful. In what scenarios might a company choose not to take an early payment discount, even if it appears beneficial?
Shaun Walker: A company might not take a discount if there’s a high cost of capital, liquidity constraints, or strategic investment opportunities with higher returns. Additionally, if there are concerns about a vendor’s reliability, companies might delay payments until satisfaction is confirmed.
Srishti: That’s insightful. Any final remarks for our viewers today?
Shaun Walker: Early payment discounts are a powerful tool for optimizing cash flow and reducing costs. By understanding how to compute and compare the annualized discount rate to the cost of capital, companies can make informed decisions. Tools like Hyperbots’ Payment AI Copilot are crucial for automating processes and providing strategic recommendations.
Srishti: Perfect. With that, we’ve come to the end of today’s discussion. Thank you so much for joining us, Shaun, and sharing your insights. A big thanks to our viewers as well. Have a great day!
Shaun Walker: Thank you!
Managing vendor payments is a critical task for any company. With numerous invoices to process and a variety of payment terms to consider, businesses must make decisions carefully to maintain healthy cash flows and foster strong vendor relationships. This blog outlines the strategic consideration of early payment discounts and late payment charges and introduces a decision-making framework to optimize payment timings. We also explore the emerging role of artificial intelligence (AI) in streamlining this process.
Payment terms define the agreement between buyers and vendors regarding the payment schedule for goods or services. Common terms include Net-15, Net-30, Net-45, Net-60, and Net-90, where Net refers to the total number of days within which payment is due. While Net-30 is a standard in many B2B businesses, the specific terms can vary widely across industries and individual vendor relationships.
To incentivize timely or early payments, many vendors offer discounts. For example, a term like 2/10 Net-30 means a 2% discount is available if payment is made within 10 days; otherwise, the full amount is due in 30 days. Another term, 5/10, 2/30, Net 60, offers a 5% discount for payments within 10 days, a 2% discount within 30 days, and no discount if payment is made between 31 and 60 days. These discounts can lead to significant savings and optimize cash out flow.
Conversely, some vendors impose interest charges on late payments to discourage delinquency. The conditions for these charges, their rates, and the strictness of enforcement vary widely. Some vendors may overlook occasional delays, while others may enforce strict penalties or even halt supply for repeated late payments, impacting business operations.
To strategically manage the timing of vendor payments, businesses must evaluate the cost of capital against the potential savings from early payment discounts or the costs associated with late payment penalties. Below are different scenarios with calculations and a summary table to guide these decisions.
Scenario: An invoice of $10,000 with terms of 2/10, Net-30
Criteria: Choose early payment if the annualized discount rate is higher than the companys cost of capital.
Calculation:
- Discount Offered: 2% for payment within 10 days.
- Savings: $10,000 * 2% = $200.
- Annualized Discount Rate:
- =(0.02/(10/365))?100
=(0.02/(10/365))?100 ? 73%.
Given a cost of capital at 7% annually, the substantial annualized return of 73% from taking the discount clearly justifies paying early.
Scenario: An invoice of $10,000 with Net-30 terms, without any early payment discount.
Decision: Since there’s no discount, paying on the due date makes sense to better manage cash flow.
Scenario: An invoice of $10,000 with terms of 0.5/30, Net-60.
Criteria: The early payment discount is less than the company’s cost of capital.
Calculation:
- Discount: 0.5% for payment within 30 days.
- Savings: $10,000 * 0.5% = $50.
- Annualized Discount Rate:
=(0005/(30/365))?100
=(0005/(30/365))?100 ? 6.08%.
Decision: The discount rate is lower than the 7% cost of capital suggesting it’s financially smarter to pay on time.
Scenario: An invoice of $10,000 with Net-30 terms and a 0.5% monthly late payment fee.
Criteria: Evaluate the opportunity cost of capital versus the late payment fee.
Calculation:
Late Payment Fee: 0.5% per month, or a 6% annualized rate
Cost of Capital: 7%
Decision: The late payment interest rate is lower than the 7% cost of capital suggesting it’s financially smarter to pay late.
While it might be tempting to delay payments to use capital elsewhere, this approach should be carefully weighed against potential relationship and financial costs.
| SCENARIO | TERMS | DECISION CRITERIA | CALCULATION | DECISION |
| Early Payment | 2/10, Net-30 | 2/10, Net-30 | 2/10, Net-30 | Pay early |
| On-Time Payment | Net-30, no discount | No financial incentive to pay early | N/A | Pay on time |
| On-Time Payment (Discount Lower Than Cost of Capital) | 0.5/30, Net-60 | Discount rate < cost of capital | Annualized discount rate = 6.0% Cost of capital =7.0% | Pay on time |
| Delayed Payment | Net-30, 0.5% monthly late fee | Late fee < opportunity cost of capital | Late fee annualized = 6% Cost of capital = 7% | Evaluate carefully; generally pay on time |
AI technologies can automate the analysis of payment terms, discounts, and penalties across thousands of invoices and vendors. By integrating historical payment data, AI can also forecast the impact of payment decisions on cash flow and vendor relations, offering recommendations for each invoice based on maximizing financial efficiency and strategic value.
Deciding when to pay vendor invoices is more than a matter of following terms; it’s about strategically managing financial resources to benefit the company’s bottom line while maintaining strong vendor relationships. By considering early payment discounts, late payment charges, and utilizing AI, businesses can optimize their payment strategies for improved financial health and operational efficiency.
In today’s rapidly evolving business landscape, efficiency and cost optimization are not just goals but necessities. AI-driven Accounts Payable (AP) automation stands out as a transformative solution, driving significant improvements in financial operations, but how do you build a compelling business case for AI-driven automation? Let’s dive into the data and insights that underscore its value.
Traditionally, AP processes have been manual, time-consuming, and error-prone. According to a report by the American Productivity & Quality Center (APQC), companies that operate with manual AP processes can see processing costs as high as $10 per invoice. Furthermore, the Institute of Finance and Management (IOFM) states that manual invoice processing can take up to 8.6 days. This inefficiency not only drains resources but also hampers business scalability.
AI revolutionizes this scenario by digitizing invoices and streamlining approvals. A pivotal study by Ardent Partners found that automated AP solutions can slash invoice processing costs by up to 80%, reducing the expense to as little as $2 per invoice. Additionally, automation can cut processing times to just 3.3 days on average, enhancing operational efficiency.
Processing cost savings:
Consider the direct cost reductions from AI-driven automated invoice processing. For a business processing 1,000 invoices monthly, transitioning from a manual process costing $10 to an automated process at $2 per invoice saves $8,000 monthlytranslating to annual savings of $96,000.
Early payment discount opportunity :
AI aggregates and recommends to CFOs/Finance controllers the vendor invoices where it makes economic sense to avail early payment discounts. It is usually done by comparing the annualized discount rate with the cost of capital. In the above example considering the average invoice value to be $500, there would be a total accounts payable to be $400,000 per month. Let us take a typical case of 25% of vendor payments having an early discount payment term of 2/10 net 30. It means 2% of 25% of $400,000 = $2,000 per month can be saved translating to annual savings of $24,000.
AI frees staff from manual data entry, allowing them to focus on higher-value tasks. As highlighted above, the AP clerks have been seen processing 300-400 invoices a day as against the 30-40 invoices per day, pre-automation. This efficiency not only accelerates the payment cycle but also improves staff satisfaction and retention.
Manual processes are susceptible to human error. AP automation significantly reduces these errors, ensuring data accuracy. Compliance is another critical consideration. Automated systems maintain detailed audit trails, simplifying compliance with regulations and standards, which is a non-negotiable aspect of modern business practices.
When building your business case for AI-led AP automation, consider the following steps:
The data is clear: AI-led AP automation offers a path to significant cost savings, efficiency improvements, and enhanced financial controls. By carefully constructing a business case that highlights these benefits, supported by solid statistics and data, you can make a compelling argument for adopting AP automation in your organization.
Embracing AI-led AP automation is not just about keeping pace with technology it’s about seizing an opportunity to transform your financial operations fundamentally. The time to act is now.
Are you ready to explore how AI-led AP automation can benefit your business? Contact us for a personalized assessment and take the first step towards transforming your accounts payable process today.
