360° Vendor Management

Paying Outsourcing Vendors

Most good outsourcing contracts require the customer to fulfill only two primary obligations: protect the vendor’s intellectual property and to pay for services in a timely manner. While most buyers have little challenge with upholding it’s confidentiality obligation, vendors universally will point to timely payment as the number one problem they experience with their customers after implementation. As an executive managing an outsourcing vendor, mundane invoice processing unfortunately gets second billing. The process of paying vendors actually is more strategic than you think - and it is the subject of this article. Read on to learn how to manage this important vendor management process more effectively.

As a background on outsourcing financials, vendors universally focus on cash flow. The reason is simple: The vendor’s largest expenses are labor, telecommunications, leases, depreciation, and maintenance. Large equipment, software, and facility costs tend to be financed separately, often using a client’s “initial payment”. If clients have net 30 or net 45 payment terms, vendors must still pay their employees, landlords, and other service providers in a timely manner. As a result month-to-month liquidity is the most significant business challenge small and medium-sized vendors must resolve. Usually, the issue is resolved through a commercial line of credit, but most vendors want to avoid carrying multiple months of expenses using interest-bearing vehicles. Obviously, 30-45 net payment terms create stress, but late payments create even more stress, which leads to the escalated communications that vendors’ account management teams are compelled to use.

More importantly, however, invoice payment has a true strategic value because what shows up on the invoice may not accurately reflect contractual obligations. While timely payments are definitely an issue, compliance with contract pricing terms is more important to vendor management teams. For some reason, when it comes to invoicing, vendors begin to add new fees, reflect inaccurate quantities, and forget to assess service level credits accurately. In fact, a number of procurement and strategic sourcing analysts have suggested that compliance with contract terms can cost a company up to 15-20% of a contract value. After spending so much time in tense negotiations to make a deal, don’t allow the vendors to tack-on new fees.

Sometimes, vendors leave items off invoices and carry them over to the next invoice, which affects your budget accruals. Surprisingly, invoices are rarely submitted on time, which can also affect budget accruals and financial reporting.

Finally, the vendor invoices are incredibly hard to read and understand. Auditing vendor invoices is similar to reading Egyptian hieroglyphics. When your internal auditors show-up, or your finance team begins to ask questions, you’ll be hard pressed to appear knowledgeable if invoices are formatted oddly.

Effective outsourcing executives use the following best practices to transform problematic invoice processing into a strategic vendor management process.

Dictate Invoice Format and Content - If you didn’t negotiate this in the contract, make the change now. Vendor management teams should create an invoice format using Microsoft Excel, preferably. The format should be an easy to read table with the following columns: item number, item/service description, quantity, unit price, and extended price (quantity * unit price). In regards to content, don’t leave the table empty. Create a row for every contractually allowable vendor fee. Examples include cost per transaction (if you have multiple transaction types, use a different line for each transaction type), voice telecommunications, data telecommunications, toll, service level credits/incentives, volume discounts, and training fees. Fill in the descriptions, contractual unit prices, and create the formulas. Then lock the worksheet and allow the vendor to only fill in quantities or undefined pricing elements.

Require Supporting Data Be Attached - It’s not that the vendor shouldn’t be trusted, but that effective vendor managers double check everything to ensure invoices are accurate. The invoice should contain a page where other files can be attached, such as SLA results, expense receipts, and telecommunications details. We recommend that vendors be required to attach root cause analyses of failed SLAs to their invoices, which encourages the analyses to be completed in a timely manner if the vendor wants to be paid. If the vendor attaches data that you cannot understand, create formats for this or ask them to provide a master “how to read” document.

Assign Clear Internal Roles and Responsibilities - Assign responsibilities for people who will receive the invoice, review the invoice, and communicate disputed amounts. Don’t have the invoice mailed to Accounts Payable - the vendor management team needs to review. Finally, know who has to approve the invoice before paying it and be sure that person is senior enough to understand the other conversations occurring with the vendor so that approvals are aligned with other corporate objectives.

Hold Invoice Review Work Sessions - One best practice is to include invoice review in your monthly close meetings. Include the vendor in the conversation, in fact, make them present the invoice. It’s a great way to quickly get approval to pay invoices.

Pay Undisputed Amounts on Time - Not early. On time. If you negotiated net 30, pay on the 30th day every time. Depending on your accounts payable processes, you may need to submit the invoice a few days early to make the cut-off. Some accounts payable systems have the ability to withhold payment until the term requires payment. Regardless, no matter how much the vendor whines about “quarterly reporting” or “annual closes”, you should pay on time and never early. The exception is if the vendor offers you fast pay discounts. If so, hopefully the discount offsets our company’s internal cost of capital and you can save the vendor and your company a few dollars by paying early.

Pay Disputed Amounts After the Dispute is Resolved - No early. Not on time. Only when the dispute is resolved completely. Ensure the vendor is aware that you’ve withheld a portion or the entire payment due to a dispute. Do not go easy on the vendor who has an obligation to invoice accurately. Incorrect invoice amounts should be rejected and vendors should submit revised, accurate invoices. Never agree to pay the vendor until the dispute is resolved. Good vendor managers understand that regardless of the relationship with the vendor (good or bad), invoice disputes need to be resolved before payment is made. Finally, do not focus on the bottom line total of an invoice. The line items need to be accurate.

Coordinate with Accounts Payable - Large multi-million dollar payments need to be coordinated with your AP team, especially because you may have internal chargebacks and multiple cost centers and GL accounts to consider. Design a process that gives AP the time to pay your invoices accurately and on time. Do not let AP approvals hold-up your payments - work out a process that ensures there is no hold-up in invoice processing or cause to have invoices lost. Furthermore, your treasury or cash accounting teams may want some heads-up on large payments.

Measure Invoice Payment Metrics - Good vendor managers measure a few key invoice metrics. First, invoice payment accuracy, which is measured as the sum of all absolute values of the inaccurate invoice line item variances divided by the number of numbers of dollars the invoice should have contained. This means that dollar amounts cannot offset - over billing one item cannot offset under billing of another line item. Second, invoice receipt timeliness, which is the variance from the date of the vendor’s required invoice submission (vendors should be required to submit invoices on specific dates). Third, invoice payment approval timeliness, which is the number of days after receipt that the vendor is paid.

Do you have other ideas? Let us know by commenting below or pinging us with a question here.

This entry was posted on Friday, February 22nd, 2008 at 12:03 pm and is filed under Discipline, Outsourcing, Outsourcing Vendor Management. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.