A common theme I’ve seen in commentary on initiatives to extend payment terms is that it is unfair or unethical. Typical of these comments is a blog post from John Williams in Management Today. John and others aren’t concerned about the investment grade suppliers. They’re concerned about the non-investment grade suppliers who may struggle to obtain bank lending and/or have a high cost of capital.
Most of the companies announcing payment term extension initiatives are collaborating with suppliers as part of their plan to move to industry standard payment terms. They are offering supply chain finance (SCF) to suppliers who wish to get paid early at a discount rate of say 1.5% per year. Suppliers moving from say 60 to 90 days will actually save money as long as their cost of capital is greater than 2.4%. That’s because it’s cheaper to fund a 90 day receivable at 1.5% than a 60 day receivable at 2.4%.
All of the suppliers John is most concerned about will therefore actually be better off. In addition, a supplier with $1 million in sales to the buyer could improve their cash flow by $137,000 if they took early payment on day 10 instead of their current pay date of day 60. John goes on to say, quite correctly, that there is nothing world class about late payments. But there is a difference between late payments and long payment terms. Late payments are so challenging because you can’t plan for them. Long payment terms can be addressed more easily.
With supply chain finance, suppliers are immune from buyers holding on to payments arbitrarily, for example at the end of a quarter or year. They get paid exactly on the payment due date. If a buyer like Mondelez simply wanted to squeeze suppliers they would not offer them supply chain finance and allow them to take early payment. So, with supply chain finance offered in combination with the term extension, suppliers, particularly small business suppliers, will actually save money, improve cash flow and gain greater certainty around their cash receipts.