How to Effectively Measure and Reduce Processing Costs in Accounts Payable?

Introduction

Reducing the costs of processing accounts payable has become a key focus area — spurred by improved staff deployment and automation of transactions and workflows. In today’s competitive market, enhancing the speed and precision of these processes is crucial for noticeable growth.

More companies are adopting accounts payable automation to accurately gather all transaction details, facilitating their use in various integrated systems that maintain integrity between contractual and transactional data. Advances in technology are highlighting the priorities of Finance and Accounting professionals, making it clear that the advantages of lowering your company’s accounts payable costs are significant and undeniable.

Switching from manual to automated systems boosts productivity in transactions and enhances visibility of cash flows. According to research from The Institute of Financial Operations, the main reasons for investing in automated accounts payable systems are cost savings and enhanced accuracy.

Findings from their peers indicate that 90% of organisations still handle paper invoices and related transaction documents to some extent, which results in higher costs, reduced efficiency, and increased risk of errors in their systems.

This widespread reliance on outdated methods not only hampers the agility of these organisations but also significantly impacts their bottom lines. Recognising the inefficiencies of such processes is the first step towards transformation. Now, let’s explore effective methods for measuring key KPIs associated with accounts payable and discuss strategies to reduce processing costs.

Understanding Processing Costs in Accounts Payable

What are Processing Costs in AP?

Processing costs in accounts payable (AP) refer to the total expenses involved in managing the payment of invoices and other financial obligations of a company. These costs encompass all activities required to review, approve, and process payments to vendors and suppliers.
Processing costs are crucial for financial management as they directly affect a company’s cash flow and operational efficiency.

Common Components of Processing Costs

The main components of processing costs in AP include:

• Labor: This is often the most significant part of AP costs, encompassing salaries and benefits for the staff involved in invoice processing, data entry, and payment authorisation.
• Technology: Investments in AP software and other technologies that automate invoice matching, payment scheduling, and record keeping are also included under processing costs. While technology may represent an upfront cost, it can lead to longer-term savings through increased efficiency and reduced errors.
• Errors: Mistakes in invoice processing can be costly. Errors might lead to duplicate payments, overpayments, or underpayments, all of which require additional resources to rectify, thus increasing the overall processing costs.
• Delays: Late payments can result in late fees and strained vendor relationships. Conversely, inefficiencies in the AP process can also tie up capital that might otherwise be used more productively elsewhere in the business.

The Impact of High Processing Costs on the Business

High processing costs can have a detrimental impact on a business in several ways:

• Reduced Profitability: High costs reduce the overall profitability of a company. Every dollar spent on inefficient processes is a missed opportunity to invest in other areas of the business that could yield higher returns.
• Cash Flow Issues: Inefficient processing can lead to slower payment cycles and strained liquidity. This can affect the company’s ability to meet its financial obligations on time, potentially leading to higher borrowing costs.
• Operational Inefficiencies: Excessive costs can be symptomatic of broader operational inefficiencies within the AP department. This can divert attention and resources from strategic activities, impacting overall business growth and adaptability.
• Vendor Relationships: High processing costs often result from delays and errors that can also affect vendor relationships. Suppliers may become less willing to offer favorable terms or prioritise service for companies that do not manage their payables effectively.

RELATED CASE STUDY: Accounts Payable Optimisation for a Global Beverage Producer and Distributor

Key Metrics for Measuring AP Processing Costs

AP Metric #1 – Average Cost per Invoice Type

Calculating the average cost per invoice type is a key, yet challenging metric in automated invoice processing due to the complexity of the steps involved. Not every invoice costs the same to process; for example, invoices with exceptions and those without purchase orders (non-PO) often cost more than straightforward ones.

Reviewing a benchmarking study that shows average and best-in-class costs can help you understand how your AP performance stacks up against others. The cost savings from automating invoice processing are substantial, potentially reducing costs by 60% to 90% per document, depending on the sophistication of your existing processes.

AP Metric #2 – Discounts Captured vs. Offered

Optimised AP processes enable quicker invoice processing, which allows your company to capitalise on early payment discounts. It’s important to monitor both the amount and the number of discounts missed and use reason codes to pinpoint why discounts are not being captured. To enhance this KPI, consider an invoice processing system that alerts you as discount deadlines approach to ensure timely payments.

AP Metric #3 – Late Payments and Penalties

Focusing on the late payment metric is crucial, despite it being an unpleasant aspect to consider. A high rate of late payments leads to unnecessary costs through penalties and interest and can damage your company’s reputation. Aim high with goals, like achieving 100% on-time payments, as this can enhance your standing with suppliers and improve negotiation terms.

AP Metric #4 – ROI on Invoice Automation

AP is often a step behind other departments like payroll in adopting automation. However, digitising and optimising AP processes provide the transparency needed for strategic decision making and growth. Investing in invoice automation can significantly improve your AP metrics. If you need to justify the investment, use an ROI Calculator to articulate the financial benefits to your executives.

AP Metric #5 – Average Invoice Processing Time

The average time it takes to process an invoice indicates how much of your AP team’s effort is consumed by manual, repetitive tasks. In efficient departments, the typical processing time is around 3 to 4 days, whereas less efficient units might take up to 17 days. To reduce delays, especially when key staff are unavailable, ensure that your AP system can be accessed on mobile devices, enabling approvals to be made anytime, anywhere.

Best Practices for Sustainable Processing Cost Reduction

Implement a Paperless Automation Solution

Every practice listed here is valuable, whether you choose to automate with AP software or not. However, adopting paperless automation significantly enhances the likelihood of optimising these practices. Eliminating paper invoices and manual entries, which are expensive, slow, and error-prone, can transform your processes.

Regardless of your business size, switching to digital and using AP automation software will quickly showcase the benefits of automation, such as reducing the cost of processing an invoice from an average of $15.96 to just $2.94 for top-performing AP departments.

Automating the invoice process relieves your staff from manually tracking each invoice, as the system automatically handles tasks like invoice matching. This is particularly useful during periods of high volume, such as seasonal spikes, because it allows you to manage more invoices without additional hires.

Create Safeguards Against Duplicate Payments

Preventing duplicate payments involves similar steps used to detect and prevent fraud, though usually without malicious intent. For example, a vendor might send the same invoice by both mail and email to ensure it’s received, which can lead to duplicates being processed in manual systems. Your AP software should be equipped to flag and stop duplicates automatically. However, if you’re still approving invoices manually, constant vigilance is necessary to prevent such issues.

Standardise Payment Terms

Standardising payment terms helps streamline operations, maintain better control over cash flow, and optimise the payment process. This is particularly vital when you have many suppliers, each potentially seeking unique payment terms. Standardisation prevents ad hoc negotiations that could adversely affect your Days Payable Outstanding (DPO) and, consequently, your bottom line.

Even with standardised terms, remain open to renegotiation to ensure your terms are competitive. Consider the timing of payments as well; sometimes the benefits of early payment discounts can outweigh the advantages of a longer DPO.

When negotiating with suppliers, also consider transitioning to electronic payment methods like ACH, wire, or virtual cards instead of paper checks, which can reduce costs and prevent delays.

Track and Resolve Disputes Efficiently

Handling exceptions remains a significant challenge for AP, leading to payment delays and considerable time spent addressing supplier queries. Automating the approval process can help, as it sends invoices that match purchase orders directly to your ERP for payment, leaving only exceptions for manual review. Quickly identifying and resolving these exceptions is crucial for maintaining fluid cash flow.

Improving how you track, and handle disputes not only ensures timely payments, which fosters good supplier relationships, but also helps identify problematic suppliers, potentially prompting a search for more reliable alternatives. Moreover, reducing the time your employees spend on calls and emails allows them to focus more on value-added activities.

Leverage Outsourcing

Outsourcing accounts payable (AP) processes can significantly reduce costs and improve efficiency. By partnering with top accounts payable outsourcing companies, businesses can benefit from advanced technology and expertise without the need for substantial in-house investment.

Outsourcing can provide access to best-in-class AP software, streamline processes, and ensure compliance with industry standards. It also allows internal teams to focus on strategic activities by offloading time-consuming tasks such as invoice processing, payment handling, and dispute resolution. Additionally, accounts payable outsourcing providers can offer scalability, enabling businesses to handle fluctuating workloads without the need for additional hires.

RELATED BLOG: 4 Signs That Your Business Needs AP Outsourcing

What’s the Bottom Line?

Throughout this discussion, we’ve highlighted the crucial role of measuring and reducing costs within the accounts payable (AP) process. By understanding where inefficiencies lie, organisations can streamline operations, reduce expenses, and enhance overall financial health.

We encourage all businesses to implement the strategies and best practices discussed, such as embracing automation, standardising payment terms, and diligently tracking and resolving disputes. These steps are not just about cost savings—they’re about transforming the AP function into a strategic component of your business that supports growth and stability.

As a final thought, we urge you to act now. Begin by auditing your current AP processes, identify areas for improvement, and start implementing solutions that can lead to significant enhancements. Optimising your AP processes is a journey that can lead to substantial rewards in efficiency and financial performance. Don’t wait to start making these critical changes. Your business—and your bottom line—will thank you.

Originally published Jul 24, 2024 03:07:49, updated Jul 26 2024

Topics: Accounts Payable Optimisation, Finance and Accounting Outsourcing Services