Recent press reports disclosed that Woolworths sought to extend payment terms for their food and grocery suppliers. As in many cases, the effort to extend payment terms was met with a lot of supplier resistance and less than glowing press.
Make no mistake, this effort to improve working capital through payment terms extension is not uncommon, and is in fact very much a goal of many corporates looking to optimise their investment in working capital. Extending payment terms for suppliers is a sound strategy to improve cash flow (by delaying cash outflow) for any buyer of goods and services. Payment term extension is becoming a common necessity for all businesses in a world where cash is critical for success. PwC have provided data on this trend in their 2015 Working Capital Survey showing that Days Payable Outstanding (DPO) is increasing as companies seek to improve their working capital management.
We know it’s critical for businesses to strive for best practice outcomes, but if the execution of this strategy is not properly managed there are consequences. This can include negative press, as experienced by Woolworths, as well as suppliers being stretched by this drive for capital efficiency.
So why go through the effort? When managed correctly what is the potential benefit to buyers?
For every $1,000,000 of annual invoices, extending payment by 30 days (say from 30 to 60 days) results in only having to pay 10 invoices (out of 12) payments to a supplier in the first year rather than 11 payments. The result is $83,333 in extra cash at year end. That’s a permanent improvement in the cash position at no cost. In addition, buyers will either save or earn interest by delaying its account payables in this manner.Ask yourself the question, where else in your business could you generate $83,333 in positive cash flow at no cost?
While the benefits to working capital from extending payment terms are obvious, clearly there is a consequence for your suppliers (and therefore a risk to supply chain). The real opportunity is to engage closely with suppliers and support them by recognising there is way to manage the impact of such changes to the buyer–supplier dynamic.
An emerging trend is to facilitate a buyer centric supplier funding program (invoice financing or reverse factoring), where the buyer actively facilitates the introduction of invoice finance to its suppliers. The suppliers retain control of the timing and the cost of funding their invoice and your business pays supplier invoices according to your new extended payment terms.
Benefits of a buyer facilitated program:
- Lower cost of finance to the supplier
- Improve supplier cash flow and provide them cash flow certainty leading to loyal suppliers
- Enable an easy transition to longer payment terms with much lower duress on the supplier – buyer dynamic
The benefits from extending payment terms can be very beneficial. But without a plan to manage the supplier transition to new arrangements, the benefits may be overwhelmed by increased supply chain risk (or in the Woolworths case, reputational damage). The buyer centric supply chain funding program is an ideal enabler for such working capital strategies.
If Supply Chain Finance is the solution that you are looking for contact us today. Or, if you need invoice finance to help fund the gap, you too can find out how Timelio can help your business.