A/P and A/R Netting Nets Benefits in the Millions

Microsoft ties for the 2021 Bronze Alexander Hamilton Award in the category Working Capital & Payments!

For a company that does as much business globally as Microsoft does, minimizing foreign exchange risk and bank fees can have a significant impact. That’s why Fanny Niu, a Beijing-based senior finance manager for Microsoft’s Global Treasury & Financial Services division, initiated a project to net the company’s accounts receivable (A/R) and accounts payable (A/P) balances with a major supplier.

The supplier, which is based in Taiwan, produces specific hardware devices for Microsoft. Each company runs both A/R and A/P balances with the other. Microsoft purchases $4 billion to $6 billion of raw materials annually, provides those parts and other manufacturing inputs to the device supplier, and then purchases finished goods from that same supplier. Every month, Microsoft owes the device supplier for the finished goods, and the supplier owes Microsoft for the materials provided.

In the past, the companies would settle their balances via a multitude of monthly payments in both directions. “For a certain month, we might have $500 million in payables due to Partner A and $600 million in A/R with the same company,” Niu says. “Our suppliers bill us upon shipment, and we do the same. So we would have a lot of invoices going back and forth, a lot of dunning letters. I would provide an SOA [statement of account] every week, and they might come back and say they needed extra time to pay because someone was on vacation or something.”

The process created quite a bit of inefficiency. It was also expensive. “Bank fees are small for each transaction, but the frequency is huge with this particular supplier,” Niu says. She saw an opportunity to significantly reduce both staff time spent managing collections with this company and money spent on the many cross-border transactions.

Still, gaining traction for the idea of netting took a concerted sales pitch, both internally and externally. Microsoft would have to develop new functionality within its SAP billing system, and design new processes and procedures. “Traditionally, Microsoft A/P has been aligned with procurement, and A/R has been aligned with the sales function,” Niu says. “This project required cross-functional knowledge that we hadn’t really built before. One example is that we needed someone to figure out how to link the vendor code on the A/P side with the customer number on the A/R side. No one had previously considered how to do that.”

The initiative would also require rewriting the contract with the major supplier. “We couldn’t just send them an email and say, ‘Hey, we’re going to net your A/P and A/R next month,’” Niu explains. “We needed to amend our contract to incorporate specific terms that allow for netting.”

Niu took the lead on developing processes and controls, then got her manager’s signoff. From there, she approached various teams in finance, A/P, legal, sourcing, and engineering. She underscored the efficiency benefits. “I said, ‘This isn’t Microsoft’s largest vendor, but it’s significant. We’re talking about billions of dollars in transactions annually. So, it makes sense to try to make things more efficient,’” she says. She drafted a contract and worked with Microsoft’s legal team to make sure the process would be compliant in all the relevant jurisdictions.

“If we were billing a company based in China rather than Taiwan, we could not do A/R–to–A/P netting,” Niu explains. “China’s tax policy requires the billing amounts and cash flows to be identical. When a company pays tax, it has to provide the invoices and evidence from the bank showing its cash flows. So it’s not possible to net off unless one of the companies is in bankruptcy.”

When Niu had received approval from all the requisite internal functions, she worked with the device supplier to adjust its long-term contract with Microsoft. “I met with their CFO,” she says, “and pointed out the ways this change would benefit them. I said, ‘Look at your bank charge. Look at the process you are performing to get foreign currency. Look at the collection efforts in your organization. Every cash gain has a tangible cost to your business. If you moved to a management system that focused on the numbers rather than the cash gain, you could reduce those costs. And as a manufacturer, you could potentially also extend those gains to your other customers.”

Niu worked with Microsoft’s engineering team to develop functionality that enables the SAP system to net out the A/P and A/R balances. Microsoft’s payment terms with this supplier are identical for both payables and receivables. So, once a month, Microsoft generates a statement of account to send to the supplier. Niu explains, “It lists the A/P for the next month’s payments and the A/R for the next month’s receivables, then shows the netting that is going to happen in our SAP system.”

The automated netting process has significantly reduced manual A/R and A/P reconciliation efforts for both Microsoft and the supplier. Niu’s team is, essentially, saving one full-time equivalent (FTE)—in other words, one staff member who would otherwise be focused on managing and reconciling A/R and A/P transactions can devote attention to more value-added activities. The new process has also reduced the time required to resolve a payment dispute from 180 days to 45 days.

By minimizing cash flows, the process reduces costs related to foreign-currency payments for both Microsoft and the supplier. And by reclaiming cash tied up in raw material inventory, and removing it from the balance sheet during the production process, Microsoft frees up $400 million of raw material inventory each year. With a weighted average cost of capital (WACC) of 10 percent, that would equate to a $40 million annual benefit.

Now Niu is working to extend the netting process to other suppliers with which Microsoft runs both A/P and A/R balances. The success of the first project put her in a solid position to sell the idea internally. “I have a very clear message for our leadership team: This same solution could provide great benefits to other lines of business as well,” she says. “Now that we have the SAP functionality available, and since Covid has been impacting our partners’ cash flows, the upside of this kind of project is pretty obvious.”

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