Moderated by Sherry, Financial Technology Consultant at Hyperbots
Sherry: Hello, and welcome to all our viewers on CFO Insights. I am Sherry, a financial technology consultant at Hyperbots, and I’m very excited to have Shaun Walker here with me, who is a seasoned internal audit leader with a wealth of experience in driving risk management, compliance, and governance initiatives across diverse industries. Thank you so much for joining us today, Shaun. Today we’ll be talking about strategic management of late payment penalties for optimal cash conservation. To get us started, can you explain what late payment penalties are and why they are important for businesses?
Shaun Walker: Certainly. Late payment penalties are fees imposed by vendors when invoices are not paid within the agreed-upon payment terms. These penalties serve as a deterrent against delayed payments, ensuring that vendors maintain their cash flow and financial stability.
Sherry: And how do companies compute the cash conserved by avoiding late payment penalties?
Shaun Walker: To compute the cash conserved by avoiding late penalties, companies need to calculate the potential penalties they would incur if payments are delayed and compare this to their cost of capital. The key formula used is the annualized penalty rate, which helps determine whether it’s financially beneficial to pay on time or conserve cash by delaying the payments.
Sherry: Can you provide an example where the annualized penalty rate is higher than the cost of capital?
Shaun Walker: Sure. One scenario would be a 1.5% penalty after 30 days every month, with an 8% cost of capital. If the penalty percentage is 1.5% per month and the penalty period is 30 days, the annualized penalty rate comes out to 18%, while the cost of capital is 8%. In this case, it’s financially detrimental to incur the penalty, so paying on time is preferable to avoid higher penalty costs.
Sherry: And can you also provide an example where the annualized penalty rate is lower than the cost of capital?
Shaun Walker: Yes. For example, let’s say the penalty rate is 0.3% after 25 days, with a 10% cost of capital. If the penalty rate is 0.3% per month, the annualized penalty rate is 3.6%, while the cost of capital is 10%. Since 3.6% is less than 10%, incurring the penalty is advantageous. By delaying the payments, the company conserves cash that can be invested elsewhere at a higher return than the penalty cost.
Sherry: How does the cost of capital influence the decision to incur late payment penalties?
Shaun Walker: The cost of capital represents the company’s required return on its investments or the cost of borrowing funds. If the annualized penalty rate is greater than the cost of capital, incurring the penalty is financially detrimental. If the annualized penalty rate is lower than the cost of capital, incurring the penalty can be financially advantageous. Understanding this relationship helps CFOs make informed decisions about whether to pay early or delay payments to optimize cash flow.
Sherry: What strategies can companies use to minimize the impact of late payment penalties?
Shaun Walker: Companies can implement several strategies, including:
Leveraging tools like Hyperbots’ Payment AI Copilot helps analyze payment data, identify potential delays early, and recommend corrective actions.
Sherry: How does Hyperbots’ Payment AI Copilot assist in optimizing late payment penalties and cash conservation?
Shaun Walker: It offers multiple features, including:
These features enhance efficiency and accuracy in payment management.
Sherry: In what scenarios might a company choose to incur late payment penalties, and why?
Shaun Walker: Companies may choose to incur late payment penalties in several situations, such as:
Sherry: What advice would you give to other CFOs regarding the management of late payment penalties and cash conservation?
Shaun Walker: My advice would be:
Sherry: Thank you so much for joining us today, Shaun, and for such an insightful conversation.
Shaun Walker: Absolutely, thanks for having me.
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.