Terms of Endearment

I do not feel obliged to believe that the same God who has endowed us with sense, reason, and intellect has intended us to forgo their use- Galileo Galilei

What are the appropriate payment terms for suppliers? According to CFO Magazine, 94% of firms said their customers were leaning on them for extended payment terms. It’s no secret as to why firms are looking to extend terms, a Global 2000 organization can generate $100 Million to $1 Billion in incremental cash flow from extending supplier payment terms, cash that can be used to invest in their business or support a host of other shareholder value initiatives. That’s attractive in any macro economic environment. Supply Chain Finance is often used by companies to mitigate the negative impact of their term extension initiative on suppliers. With SCF, suppliers can choose when they get paid, irrespective of the negotiated payment term, at a discount rate based on their customer’s credit risk. The first step though is determining appropriate supplier payment terms and many of our clients engage us in part to help them make this determination. Have they gone too far? Not far enough? Should supplier payment terms be 60 days, 90 days? More? Payment terms should be determined independent of Supply Chain Finance and should incorporate payment terms benchmarking across commodity classes. Terms should be based on a host of buyer/supplier specific characteristics including the commodity class of the supplier, inventory turnover, buyer/supplier relationships, the buyer’s corporate objectives, etc. It may not make sense to have the same payment terms for flat rolled steel as for steel castings or wire harnesses. It might not make sense to have the same payment terms for apparel, consumer electronics and home appliances. In the auto aftermarket retail industry, inventory turns slowly so it probably makes sense to have longer payment then an auto OEM where inventory turns more quickly (among other differences). For example, AutoZone’s 2011 Days Inventory Outstanding (DIO) are 220 days while General Motors are 37. These two organizations should have vastly different supplier payment terms and they do. AutoZone’s Days Payable Outstanding (DPO) are 230 while General Motors are 64. Determining appropriate supplier payment terms simply isn’t possible without the context of the specific buyer/supplier relationship and supplier characteristics a well as other aspects of the buyer-supplier commercial relationship. Ignoring these dynamics can lead to supplier relationship management issues among a company’s most critical suppliers.