Troels Erland Jensen
Head of Working Capital Advisory, Nordea
Dynamic discounting may not exactly be the new kid on the working capital block, but recently there has been a significant uptick in the adoption of this simple but effective payment method. And considering that dynamic discounting can improve a buyer’s relationship with their suppliers, increase overall supply chain strength, and deliver benefits to a cash-rich buyer’s bottom line in a low interest rate environment, it is not hard to see why Nordea is recommending this solution to customers.
Get that working capital to work
Nordea recently conducted a research report on Working Capital Management in the Nordics, released in December 2016, based on data from 184 public companies across the region. The report showed that the median Nordic business has a third more net working capital (NWC) locked up than their European equivalent. By improving to best in class, the businesses we assessed could release value equivalent to 11% of their market cap — a total of €65 billion.
Managing working capital should be a clear priority for all organisations. Many businesses have a strong cash position – and effective cash management can help support these businesses to achieving better profitability and working capital position. Regardless of their objectives, with dynamic discounting, businesses can take advantage of their excess cash and gain a better return on invested capital. Dynamic discounting also supports the cash flow of the suppliers.
With dynamic discounting, buyers benefit from increased flexibility to choose how and when to pay their medium – and small-sized suppliers, with earlier-than-due-date payments resulting in a discount on the original invoice. So, in effect, the earlier the buyer pays the supplier, the greater the discount, as the discount is determined "dynamically" in relation to the amount of days remaining until the initial due date. Suppliers, for their part, get paid earlier, which can improve their short-term liquidity position and even allow them in-turn to pay their suppliers early or invest more in their business.
Dynamic discounting in practice
Dynamic discount is an online service that is set up by the buyer, who then invites their chosen suppliers to the platform by private request. The platform facilitates the commercial negotiation between the supplier and the buyer and the establishment of payment terms, ultimately decided by the buyer. In this way, discounts do not need to be negotiated by both parties in advance – instead, the buyer sets a liquidity limit and interest rates (based on industry, supplier size, etc.) and then allows the supplier to “dynamically” take discounts as their working capital needs dictate.
The supplier sends in the invoices as usual (preferably as electronic invoices) and, once approved, they are uploaded to the system for payment, including payables and credit/debit memos. The setting up of payment terms is both clear and flexible and suppliers can see just how much they will get paid depending on when an invoice is paid.
It is then up to the supplier to choose the date they would like to receive the payment for each approved invoice that they see in the system. So, if they need the extra liquidity to pay an upcoming VAT bill or make an investment, for instance, they can request certain invoices – corresponding the amount they need – are paid early. The supplier can choose to receive payment as soon as it becomes available, or wait to receive the full payment on the original maturity date.
Efficient for buyers in a low interest rate environment
For a cash-rich buyer operating in a low interest environment, the benefit is obvious. Rather than leaving liquidity sitting in a low-interest account for 90 days, they can pay large invoices early to receive additional purchasing discounts of several percent – an obvious improvement on the bottom line.
For instance, if a buyer receives a 2% discount for paying a 90-day-net invoice after 30 days, they basically invest the payment sum for 60 days and receive a return on that investment. This is the equivalent of just over 10% annual return on capital. And while the early payment of the invoice would lead to a reduction in interest on the cash, a 10% return far outweighs the loss of interest.
But apart from saving money by paying invoices earlier, dynamic discounting also reduces supply chain risks (financially sound suppliers mean reduced supplier risk), cuts down on the number and frequency of supplier inquiries, builds stronger supplier relationships and accelerates e-invoice adoption. If targeted to the correct segments, dynamic discounting can be combined with traditional supply chain financing to cover both large and smaller suppliers.
On the supplier side, it improves cash flow and provides early payment assurance, both of which save time, puts cash in their accounts sooner and increases their liquidity visibility.
What’s so different about dynamic discounting?
As a discounting method, dynamic discounts are more flexible than more traditional methods as they are calculated in relation to the payment due date. This means there is no need for static terms such as discounts expiring after a certain number of days. It also provides a solid alternative to factoring or asset-based lending for improving working capital and cash flow.
Dynamic discounting differs from supply chain finance too. In supply chain finance, the buyer uses third-party funding – e.g. from one of their banks – to finance early payment terms, while with dynamic discounting the buyer finances the early payment to the supplier using their own cash.
Early payment programs can be especially interesting for companies with small- and medium-sized suppliers, as combined with supply chain financing it allows them to cover all segments with working capital solutions. Buyers with the ability to receive invoices electronically, and approve them quickly with an optimised purchase-to-pay process can make considerable savings.
How to get going with dynamic discounting
Nordea is able to offer a dynamic discounting solution to our customers, together with Basware, one of the global leaders in providing financing technology solutions. Basware onboards Nordea customers and integrates the solution into the customers’ purchase-to-pay (P2P) or Enterprise Resource Planning (ERP) solutions. Learn more
about Basware’s Financing Services solutions.