Winning the Payment Terms War

A recent article in The New York Times reported that an increasing number of companies are using payment terms of 120 days or more with their suppliers. This has the potential to cripple the suppliers, especially mid-market and smaller companies. The article names food and packaged goods companies, but GE and other large companies also use lengthy payment cycles.

This is an interesting example of non-partnership behavior. Many of the companies that take over 100 days to pay have 30-day payment cycles with their own customers. Analysts cite this as a new strategy to increase cash and shareholder returns, though I‘ve seen it in industry for over 15 years.

In the Executive Command Center™ I use the cash-to-cash cycle (accounts receivable days + inventory days – accounts payable days) as an indicator of company health. By stretching out accounts payable, particularly in situations where the company has low inventory turns or long receivables cycles, the company can reduce the cash cycle, but they do so on the backs of their suppliers.

Is It Really a Trend?

The article suggests that companies are trying to “align with industry practice,” but major players set the trends in their industry. Looking at industry benchmark reports to see how companies perform against industry averages, I see that most companies use payment cycles of 32 to 45 days, so 100+ day payment terms are the exception rather than the norm.

This practice particularly hurts small and mid-market suppliers who often don’t have large cash reserves. They finance their working capital through bank lines, and the covenants of those lines often forbid receivables over 90 days. For the smaller suppliers, this can be a crushing blow, resulting in tight cash or even threats to survival. In these days of heightened bank regulation, bank terms are growing tighter.

What Your Company Can Do

There are two approaches a company can use to counter the impact of longer payment cycles: contingent and preventative action.

Contingent action is how you deal with customers that extend their terms. There are several steps you can take to mitigate the circumstances:

  1. Talk to your customer – explain the situation and ask for more generous terms. Many of the larger companies will often not cooperate on this due to internal requirements.
  2. Talk to your banker – since the longer terms often come from larger companies with (presumably) better financial stability, the bank may consider lengthening your terms and conditions to move from a 90 day exclusion to a 120 day or even longer. Note that this can be hard to do, due to the regulatory environment.
  3. Take corrective action internally – review your own receivables to be sure you are collecting as fast as you can. In particular, review your inventory. Inventory is often the largest consumer of cash and it is possible to greatly increase cash flow through better inventory and supply chain management. Improving your inventory turns and reducing slow moving and obsolete inventory can free up large amounts of cash.

Preventative action can save customer relationships and improve cash flow.

1. Carefully select your customer partners – have a process in place for customer acceptance that is as rigorous as your process for supplier selection. The thirst for revenue often overrides good judgment in doing business with companies that aren’t good for you.

An Illinois company, Supplied Industrial Solutions, chose not to do business any longer with customer Anheiser-Busch InBev because it made more financial sense to lose the business, which made up 5% of their sales, than accommodate the 120 day payment terms the customer demanded.

2. Don’t put too much focus on one or two large customers. This seems obvious, but I’ve seen several companies fail recently that relied on one or two customers for over 50%, or even up to 80% of their business. When those customers force longer terms on you, you have no choice but to acquiesce.

3. Manage your cash-to-cash cycle to build cash. In particular, manage inventory to world-class levels with turns well over eight, preferably above 12. Many of my clients have started in the range of two turns and achieved turns of eight or more in less than two years.

4. Offer early pay discounts of 1.5% to 2% to encourage customers to pay in ten days or less. Most CFOs with total cost awareness will take those discounts. One middle market company I know added several hundred thousand dollars of additional profits to their bottom line by taking early pay discounts.

Managing cash cycles provides fuel for growth and profitability for your company. Partnering with customers that consider your needs on par with theirs generates strong relationships built on a solid foundation of cash management benefiting both parties – a true win/win relationship.

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