How well a company manages its cash conversion cycle is a key indicator of financial health. But, for many companies, it’s an area of weakness. This is especially true when it comes to DPO, or days payable outstanding, which measures the average number of days a company takes to pay its suppliers.
The challenge? Few companies have visibility into how their DPO compares to their peers. And that’s dangerous territory.
DPO performance is at its highest levels in nearly a decade. According to this study released in July 2018, the 1,000 largest U.S. public companies extended payment to 56.7 days in 2017, a 6% increase from 53.3 in 2016. These longer payment terms have helped companies unlock hundreds of millions of dollars in working capital that’s been redirected to fund strategic business and transformation initiatives. Those companies that optimize payment terms can realize a direct and positive impact on the cash conversion cycle.
Suboptimal payment terms tell a different story. If you’re paying suppliers too early, you’re depleting working capital that could be used to fund strategic business initiatives, while indirectly funding your competition. Here’s an example:
Let’s say Mermaid Coffee pays its supplier, CafeBean, every 30 days. Meanwhile, competitor, K-Street Coffee, pays CafeBean every 55 days. By paying CafeBean early, Mermaid Coffee is funding CafeBean’s ability to meet K-Street’s longer payment term requirements. As a result, K-Street can hold onto more cash longer and invest those funds into strategic business initiatives whereas Mermaid Coffee can’t.
On the flipside, a buyer that pays its suppliers too late is also doing itself a disservice. Companies need suppliers that are financially stable, innovative and competitive. If a payment term is too long, you could be inflicting undue hardship on the supplier and its ability to meet your business requirements.
To put this into context, let me share a quick success story with you. A major beverage company was facing billions of dollars in leveraged buyout debt on its balance sheet and turned to PrimeRevenue to run a working capital analysis. In that analysis, we uncovered they were behind their peers in DPO by a matter of 30 days and had an opportunity to improve their cash conversion cycle.
A year later, the beverage company had improved their DPO by nearly 300% and generated almost $1 billion in free cash flow. The company has substantially reduced its cash conversion cycle, and Standard & Poor has upgraded the company’s credit rating several times, taking the company from BB- to A- . Today, the company has a major competitive advantage with a stronger balance sheet and supplier relationships, along with the ability to acquire.
This is why it’s critical for companies to understand whether their DPO is within a healthy range. A quick and easy way to do this is through PrimeRevenue’s Working Capital Grader. This free tool allows companies to compare their DPO performance to their publicly traded peers and competitors. Simply enter your company’s name and the names of four competitors (must be publicly traded) and you’ll see how your DPO stacks up.
Another way is through PrimeRevenue’s detailed Working Capital Analysis. Based on a knowledgebase that includes more than $3 trillion of analyzed spend, PrimeRevenue will conduct a free, cursory review of how your supplier payment terms compare to peer and industry benchmarks, and how much working capital can be unlocked through payment term optimization.
Contact us if you’d like to learn more.
Published February 14, 2019