Approved payables finance (APF) is producing win-win working capital solutions for corporate buyers and their suppliers. Through APF, a form of supply chain finance, buyers are generating significant increased cash and driving working capital metrics to new levels. And here’s the best part: Instead of accomplishing these gains on the backs of their suppliers, buyers are doing it while helping reduce suppliers’ financing costs and days sales outstanding (DSO). In this way, APF is strengthening buyer-supplier relationships — rather than creating friction, as can happen when buyers simply dictate extended terms without providing any sort of value exchange.
Sound too good to be true? Let’s look at how the APF process works, how buyers and suppliers are both able to come out on top, and some examples of companies achieving impressive results.
How APF works
Sometimes referred to as “reverse factoring,” APF allows the buyer to extend payment terms with its suppliers while providing them with an optional on-demand financing alternative often at a lower rate than they could obtain on their own, because it’s based on the buyer’s credit profile.
After the buyer reconciles the supplier’s invoices to POs and releases the approved invoices to suppliers’ to discount, the buyer’s bank purchases the supplier’s receivables. The supplier can tap into funds earlier in its receivables cycle without using its own credit lines or paying high discount charges to a factor. While suppliers may access cash any time after approval, the buyer reimburses the bank on the invoice due date.
Although final determination is made by the buyer, APF is widely considered an off-balance sheet funding solution where the bank takes on the payment risk of the buyer. Suppliers bear the ongoing program expense as the cost of funds is aligned with the buyer’s cost, which is set at a per annum rate based on a fixed spread over the relevant LIBOR or cost of funds for the period of the discount. The program discount rate charged to suppliers incorporates the credit spread, as well as the administrative costs of running the program.
An APF program can be integrated with a bank’s broader suite of supply chain management services to create an automated, end-to-end payment solution. Both buyer and seller get greater visibility to payment events and certainty of cash flow.
Benefits for everyone
From the buyer’s perspective, APF provides a more relationship-friendly approach to extending terms with suppliers that can produce large cash flow gains and help improve working capital ratios. By providing suppliers with less expensive financing, buyers may be able to negotiate product discounts.
By providing access to lower-cost financing, these programs also enable buyers to reduce financial pressures on their suppliers and help ensure they maintain strong financial health.
When viewed from the supplier’s point of view, the cost of an APF program is often lower than the cost of funds at their local banks and usually well below their weighted average cost of capital. In addition, getting paid faster through APF increases their cash flow, allowing them to reinvest in inventory and fulfill more purchase orders.
$100 million in free cash flow and stronger supplier relationships
A major U.S. carpet and flooring manufacturer — back in growth mode following the housing crisis — is using APF to generate cash to pay down debt and invest in capital expansion all while strengthening their supplier relationships.
With significant capital being funneled into inventory, the company was experiencing a mismatch between its collection of receivables from retailers (about 40 days on average) and supplier payments (about 32 days), adversely impacting working capital. Its cash conversion cycle metric had risen above 120 days.
With its CEO providing strong sponsorship, the company initiated an APF program and set out to raise $100 million in free cash flow. The APF solution not only supported the company’s working capital objectives, but also offered an attractive financing alternative to their very long term strategic supplier base that had their own working capital concerns. Within 18 months, the company was able to exceed this goal through extending payment terms with suppliers, while suppliers were able to finance their receivables at an attractive rate.
Payables and receivables
A growing technology company, a provider of integrated printing solutions, has shown that companies can engage in supply chain finance as a comprehensive working capital solution — using it to both extend payables and accelerate receivables.
A supplier to many large and creditworthy buyers, the company began using a receivables purchase program in 2012 to attain faster on-demand payment and reduce days sales outstanding (DSO), while leveraging the credit rating of its buyers to lower its cost of financing. Two years later, following the success of the receivables program, the company wanted to address the payables side of their working capital metrics. The company decided to deploy an APF program to provide the same financing opportunity to its supplier base, while receiving extended payment terms from its suppliers and thereby improving its own days payable outstanding (DPO).
A global, holistic solution
APF can enable an international company to obtain working capital benefits from its eligible global supplier base, as evidenced by the 3-year-old and expanding program of a large U.S.-based retailer of consumables. The company initiated an APF program with its Asia-Pacific suppliers in 2012, and due to its success, rolled out the program to U.S. domestic suppliers in 2014.
The company has been able to stand out in its space by forging a holistic view of total supplier spend that uses APF with some suppliers and ePayables, or virtual card payments, with others. Most of its competitors were only offering one or the other.
APF tends to work best with suppliers with large invoice values. Conversely, ePayables is a good fit for suppliers receiving high volumes or smaller value payments – a perfect complement to positively impact working capital over the entire supplier base. Moreover, ePayables offers suppliers the short-term financing typical of a card payment while generating cash rewards for buyers.
By expanding the program to include both international and domestic suppliers, this company has achieved its goal of generating over $500 million in cash flow from internal working capital.
A big but worthwhile effort
There are several “best practices” that will help ensure a successful APF implementation, the first of which is choosing an experienced, and proven provider. Buyers need to lead their internal team to collaborate in order to accelerate implementation and supplier adoption, including:
- Educating C-Suite level executives such as CFOs and CEOs on the strategic value of APF and how it can generate large volumes of cash and improve working capital metrics — and earning their vocal and active sponsorship.
- Selling the concept internally to key groups such as Finance, Accounts Payable, Procurement and Information Technology (IT) - keeping in mind that each will benefit from the program.
- Identifying the best supplier candidates for the program and successfully selling the program to their financial decision makers.
- Making sure both internal and external auditors confirm accounting treatment of the program.
- Finding a bank that can help with all of the above.
Instituting approved payables finance doesn’t happen overnight, but as the examples above illustrate, it can certainly be worth the effort. APF can be a working capital initiative that drives growth and expansion — literally transforming some companies —while solidifying strategic trading relationships.
Case study information is for illustrative purposes only. Results may vary.
- Approved payables finance (APF) is a form of supply chain finance that lets buyers extend terms and suppliers get paid faster and access lower-cost financing.
- Because there is an exchange of value, APF strengthens buyer-supplier relationships.
- Banks play a key role in APF by purchasing the supplier’s receivables and assuming the payment risk of the buyer.