EU late payment regulation: the working capital impact

On 12^th September 2023, the European Commission (EC) proposed a new late payment regulation that would revise and replace the Late Payment Directive 2011/7/EU. The proposed regulation could have significant implications for companies in Europe. So why is this new regulation being proposed, and what could the working capital impact be?

A summary of the EU Late Payment Directive

The existing EU Late Payment Directive was adopted in February 2011 to protect European businesses – particularly small and medium-sized enterprises (SMEs) – from the impact of late payments. However, in practice, late payments continue to be a significant challenge, with half of invoices in the EU paid either late or not at all.

And, while the Directive stipulates a payment term of 30 days for B2B transactions, this can be extended to 60 days or more “if not grossly unfair to the creditor”. In some cases, this means that payment terms extend to 120 days or more.

To address these issues, the EC proposes replacing the current Directive with a Regulation that would help bring fairness to commercial transactions, improve the resilience of SMEs, foster digitalization, and improve entrepreneurs’ financial literacy.

Crucially, the proposed regulation included a single maximum payment term of 30 days for all commercial transactions across the EU—a detail that has led to some controversy about the regulation’s impact on parties’ freedom to negotiate payment terms and on the supply chain finance sector as a whole. As such, the regulation has subsequently been amended to provide more flexibility regarding payment terms.

Understanding late payments

In a nutshell, late payments are payments that do not meet the contractually agreed due date. There are a number of reasons why companies may pay their invoices late: the buyer’s accounts payable processes may be inefficient, errors may occur during the invoice processing, or the buyer may deliberately delay payments to hold onto its cash for longer.

While delaying payments can improve the buyer’s working capital position, it has the opposite effect on the supplier, lengthening their Days Sales Outstanding (DSO) and reducing the predictability of their cash flows. When suppliers are paid late by customers, they may struggle to pay their bills and invest in growth. Late payments can, therefore, damage a company’s relationships with its suppliers and may even lead to less favorable terms in the future.

The EC argues that the root causes of late payments include “asymmetries in bargaining power between a large or more powerful client (debtor) and a smaller supplier (creditor)” – a factor that can result in suppliers having to accept unfair payment terms and conditions. As such, the new regulation proposes to redress this asymmetry by introducing measures to protect creditors from their debtors.

For example, under the new rules, interest on late payments would be automatic and compulsory, with creditors unable to waive their right to claim interest. The proposal also includes enforcement and redress measures to protect creditors from bad payers.

The burden of late payments explained in statistics

According to the EC, late payments cost the global economy $1 trillion annually. Stats uncovered by research conducted around the world continue to show that late payments have a significant impact on businesses and economies:

• In the U.K., research by the Federation of Small Businesses (FSB) has previously found that poor payments cost the U.K. economy £2.5 billion each year and that 50,000 business closures a year could be avoided if companies were paid on time.
• A 2021 survey by QuickBooks found that mid-sized businesses in the U.S. were owed an average of $300,000 in late customer payments, with 89% saying that late payments were holding back growth.
• According to research included in credit management services provider Intrum’s European Payment Report 2023, the cost to European businesses of chasing late payments equates to €275 billion.

Over the last couple of years, research by Taulia has found that late payments are on the rise. Our 2023-24 Supplier Survey found that 51% of respondents are paid late by their customers, up from 36% in 2021. Likewise, more suppliers receive payment very late: 8% of this year’s respondents said they receive payments more than 45 days late, compared to 3% in our 2019 survey.

Notably, the impact of late payments is all the more significant in an inflationary environment, as the value of cash is eroded over time. As such, it’s no surprise that a quarter of suppliers said they were interested in taking early payments every time and for every customer, up from 21% in 2022.

Variance in payment term lengths

While late payments present a significant challenge, it’s important to understand that payment terms can vary considerably between companies, as illustrated in Taulia’s International Payment Terms Database.

One reason for this variation is the impact of individual negotiations. However, different countries and sectors may also have their norms for payment terms: depending on the industry, standard payment terms could be net 30, net 60, or even net 90. A 2019 survey by Atradius, for example, found that average payment terms in Western Europe ranged from 21 days in the consumer durables sector to 37 days in the manufacturing sector.

In some industries, longer payment terms can play an important part in alleviating businesses’ cash flow burden. Longer payment terms tend to be more widespread in industries where large and complex projects are commonplace, such as construction and manufacturing. In addition, longer payment terms can be advantageous to buyers as a way of alleviating their cash flow challenges – and suppliers may offer their customers longer payment terms as a competitive differentiator.

Unforeseen consequences of the new EU Late Payment Regulation

This means that while the proposed regulation may address the challenge of late payments, there are also concerns that the new rules could negatively impact pricing, competitiveness, and business operations in the EU by adopting a one-size-fits-all approach. This could potentially result in certain unforeseen consequences.

For example, there has been concern that the proposed regulation does not account for cases where there may be good reasons for agreeing to longer payment terms. An article published by PwC Legal Germany argued that in the proposed regulation, “no consideration is given as to differing needs across various sectors where longer payment terms are normal and crucial to the functioning of markets”.

It’s possible that reducing payment terms could mean that large corporations renegotiate their prices with suppliers to reflect the need to pay invoices earlier. The proposed rules could also shift how working capital requirements are balanced between different parties in the supply chain. In addition, there is a risk that restricting all payment terms to 30 days could have an adverse effect on the viability of supply chain finance (SCF) in the region.

In light of these concerns, the proposed regulation continues to evolve. In March 2024, a draft version agreed by the Internal Market and Consumer Protection (IMCO) Committee included an option to extend payment terms to 60 days if contractually agreed and to extend to 120 days for ‘slow and seasonal’ goods. At a plenary session on 23^rd April, MEPs voted in favor of the amended proposal, with a notable exemption for the books industry. The proposed regulation is due to be put forward to the European Parliament following the European elections in June.

Conclusion

In summary, late payments continue to be a major challenge for suppliers everywhere. There is a clear need for a balanced regulation that can address the issue of late payments while also considering the complexities of commercial transactions.

Given that the implementation of the proposed regulation is likely to be a gradual process, companies will need a well-developed working capital strategy. Taulia provides a full suite of working capital solutions and is well-positioned to support businesses as they adapt to the new regulations.

Speak to Taulia for advice on how your business can adapt its strategy in response to these potential regulatory changes while meeting the challenges presented by today’s economic environment.

Or use our EU Late Payment Calculator to give you a snapshot of how this legislation, if passed, may impact your business and your suppliers.