Finance Directors will understand better than anyone the challenge of delivering a significant risk-adjusted yield in the current environment.
Collaboration across a global supply chain is not easy. Working across borders, time zones, currencies and culture presents a particularly nuanced challenge for buying organisations and their suppliers. Buyers will typically have to manage hundreds of international suppliers and arrive at trading terms that fairly compensate these suppliers whilst still extracting the best commercial deal for their organization.
One area that is often viewed as a zero-sum game is payment terms. Since the financial crash in 2008 the funding landscape has dramatically changed. With increased regulation on banks, in particular their capital requirements under Basel II & III, there is far greater uncertainty in the credit markets. As a result, there has been a trend for buying organisations to place added focus on their cash position and liquidity needs to hedge against volatile macro-economic conditions. One obvious tactic for buyers to improve their cash position is to push out their supplier payment terms. Whilst there are variations across countries and sectors, it is very common for suppliers to be on 60-90 days plus.
Many buying organisations have cash surpluses year round, whilst others have a more cyclical cash cycle - clothing retailers for instance will often have a strong cash position after heavy promotional periods over Christmas and Spring. Whilst pushing out supplier payment terms will certainly increase their Days Payables Outstanding (DPO), satisfying shareholders and senior management, the genuine benefit of holding on to this excess cash is certainly questionable. Indeed, since the crash in 2008, western governments have kept interest rates at historic lows to try and kick start their fledgling economies, with varying levels of success. Some countries have even gone as far as implementing negative rates to penalise savers! So, for many companies with strong liquidity, adding additional cash to the balance sheet delivers negligible benefit. Finance Directors will understand better than anyone the challenge of delivering a significant risk-adjusted yield in the current environment. Based on our research, UK banks are currently quoting a woeful 0.04% to 0.2% APR for business savings or overnight money market accounts.
On the flip side, the impact of lengthened payment terms hits small and medium sized suppliers the hardest. Whether it’s buying new equipment, paying down debt or making payroll, these suppliers rely on steady cash flow to stay in business. To compound matters, many suppliers have to deal with payment delays on top of lengthy payment terms - indeed, it is estimated that UK SME’s are owed £67bn in unpaid invoices. As a result, some suppliers will have no choice but to enter into expensive factoring arrangements with third parties or setup a loan facility from the bank, assuming they are able to do so.
A major inefficiency is at play here. Buying organisations see their cash position improved by extended payment terms, yet this excess cash sits on the balance sheet earning a negligible return with finance departments struggling to “put it to work” in a meaningful way. At the same time, suppliers are forced to look for financing alternatives to meet their short-term liquidity needs. As usual, the winner here is the bank; which offers immaterial returns on buyer savings, whilst applying a sizeable spread to supplier financing.