Supplier payment terms and supply chain finance

For over a decade, supply chain finance (SCF) has given buyers and suppliers the ultimate opportunity to gain access to cash otherwise trapped in the cash conversion cycle. However, it’s a relatively common assumption that an SCF program can only function by rationalizing supplier payment terms to improve Days Payable Outstanding (DPO) — partly due to the historical marketing of such finance programs.

But that isn’t really the case. In fact, these are two independent activities, and many organizations are using SCF to improve sustainability goals or strengthen supply chain health. Let’s take a deeper look.

Part of a broader relationship

Suppose a buyer wants to negotiate longer payment terms with a supplier to improve their DPO and cash position. The objective may sound simple enough, but buyer-supplier discussions around payment terms ultimately include a range of topics bound to hit the negotiating table:

• Price of goods or services: Inflation will no doubt play a role in buyer-supplier discussions as the cost of raw materials, intermediate goods, and transportation of goods in many industries has jumped over the last several months.
• Quality: Rates around filling the buyer’s order, getting orders right, damage to goods delivered, on-time delivery, and other quality indicators could be negotiated around a discussion on contract terms.
• Delivery schedules: Similarly, if a supplier is asked to ship three times per week to the buyer versus the contracted two, the supplier’s costs will go up, and so this, too, will be part of the negotiation.
• Special packaging: Sometimes, suppliers have the additional burden of pre-packing certain goods to better align with downstream customer needs. These other requirements add costs, so getting faster payment to cover them may be in play, while loosening such provisions could have the opposite effect in a negotiation.

“The bottom line is that payment terms are just one of many things in a customer-vendor relationship that gets negotiated,” said Dave Adams, Taulia’s Chief Customer Officer. “And generally speaking — to the surprise of many finance and treasury professionals — it’s rarely the most important item in a negotiation.”

 

Adams, who spent more than two decades studying supply chain practices and addressing its needs, said that discussing the agreed-upon payment terms is generally part of a broader negotiation with suppliers. Most companies treat them as distinct from an SCF rollout, so suppliers simply enjoy flexible access to cash when needed. Meanwhile, suppliers tend to value SCF for its predictability in getting paid precisely when they want and its competitive cost relative to other forms of financing.

Compelling events trigger SCF participation

Then why don’t more suppliers take advantage of SCF? Adams believes it’s hard for many to make critical thinking adjustments.

“Suppliers have grown used to waiting for 30, 60, or 90 days,” he said. “And so they manage their cash flow according to the status quo rather than get cheap access to earlier payments.”

This stance changes for many suppliers when they experience a compelling event that breaks the inertia. For example, a supplier may need liquidity to build a new factory, or perhaps cash is required to stabilize debt ratios at the end of the quarter. Maybe the cost of securing a line of credit becomes more prohibitive, so freeing the cash tied up in receivables at a low-interest rate is suddenly attractive. Adams says these hypothetical events are triggers that cause suppliers to recall their enrollment in an SCF program.

“That’s when smart organizations decide to lean in and ramp up their participation in SCF, so they can re-balance their cash or optimize their working capital.”

A change in payment terms can also be one of these compelling events. When SCF is available, it can be an easy and effective way for the supplier to manage working capital. On the surface, enrollment in SCF may appear to be linked with the new terms because the timing coincides. In reality, they occur independently.

SCF can flourish on its own

The idea that SCF doesn’t create value for the buyer without DPO improvement is bogus, Adams said. Companies that use SCF can improve the flow of goods and boost resilience in the supply chain with increased liquidity. Others use SCF for achieving ESG goals by financially incentivizing sustainability within their supply chain. And that’s not all. All these benefits can coexist.

“Our most successful SCF programs in terms of working capital benefit to the customer are the ones that roll out SCF to all their suppliers all at once,” he said. “Volume participation is what companies should strive for to realize both the supply chain health and the working capital improvements they want.”

An open invitation and periodic reminder for suppliers to take advantage of SCF can keep the program top-of-mind and prompt participation when a financial need or strategic opportunity emerges. Conversely, Adams warns against tightly controlling when and how companies introduce suppliers to SCF.

This advice may especially ring true in an environment where SCF program disclosures on financial statements will give auditors and the public more insight into the size, use, and impact of SCF on a company’s leverage and debt ratios.

How do I know my program is OK?

Adams says companies can put processes in place to ensure SCF always remains a valued asset to the organization and its suppliers:

• You (the buyer) should never negotiate the rates the supplier will get if they elect to be paid early. This negotiation should occur between the supplier and the SCF provider/bank.
• Companies should also maintain a blissful ignorance about the specifics. “Buyers should never know — or even care — what rates an SCF provider negotiates with suppliers,” Adams said.
• Your team should know and be configured to roll out an SCF program and conduct supplier negotiations in separate and distinct efforts.
• Invite all your suppliers to take early payments in the same outreach effort. Companies that typically use an “all in” approach see a faster time to value and more significant working capital benefits.
• Supplier payment terms should always fall within industry norms.

A ‘fantastic’ stream of affordable cash

Adams is adamant about one thing: SCF continues to be a reliable way to inject liquidity into the supply chain. “SCF programs are a fantastic option for suppliers that want to access equitable cash to serve their customers better, support their employees, and grow their business.”

The perception of the link between SCF and supplier payment terms may always exist, but Adams said one tell-tale sign that the two are not inextricably connected is that the removal of one doesn’t impact the other.

“Take away SCF and the payment terms will still remain as they are written in the agreement,” Adams said. “It’s time we recognize that buyer-supplier relationships are far more nuanced and multi-faceted than we sometimes take them for.”

“Buyers know that when they foster the growth of their suppliers, everyone wins. Providing access to affordable capital with SCF is an easy and effective way to make this a reality.”