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What to Do When Your Finance Manager Insists on Extending Payment Terms

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Different perspectives of the corporate functions 'purchasing' and 'finance', concerning payment terms

Wall Street Journal article from summer of 2018 indicates that US public companies are delaying their payments to suppliers longer than ever before - an average of 56.7 days, up from 53.3 days in 2016. These policies usually emanate from Finance chiefs, but they reverberate throughout the supply chain. Why are Finance chiefs extending these terms—and how should people in supply chain respond when they do this?

First, the reason that companies keep extending payment terms is probably obvious—they want more cash and working capital. It can be used to invest in their operations, or just to make their financial statements look better. Those in finance often focus on the external appearance of the firm—financial statements, required quarterly and annual reports, external funding and how the organization is viewed in the stock market. They are not focused on relationships with suppliers or supplier financial stability—unless these directly affect firm financial performance.

So, a second issue is that finance and purchasing view the world through a fundamentally different lens. Supply management is concerned about the quality and continuity of supply—at a fair price. Finance is several levels removed from this, focusing on how to conserve funds in order to make the company’s financial statements look better and to free up cash for opportunities. 

While most organizations have a chief financial officer that represents the views of the finance function in the C-suite, a recent study indicated that only about 2% of US manufacturers have a Chief Supply Chain Officer (CSCO), while around 32% said they had a similar role, such as Chief Procurement Officer. Thus, if the idea of extending payment terms to suppliers to free up cash comes up in the C-Suite, there may be no one to represent the view that “this may not be the best idea” and can strain relationships and supplier financial viability if not handled properly.

A partial listing of the contrasting views of supply chain management and finance towards extending payment terms to suppliers are summarized in the table below:

Finance View

Purchasing and Supply (Chain) View

“Free” source of cash for operations and investments

Suppliers will make us pay more if they have to finance our operations

“Easy” to change terms

Suppliers want cash just as much as we do

Just another negotiating point

This could be a big deal that could strain relationships

Just part of business; everyone is doing it

Paying our suppliers on a timely basis helps give us preferred customer status

Looks better than loans as a source of cash in the finance community

Very painful and will make it tough for us to achieve our other cost savings goals

Whatever the view of purchasing, it is likely that the view of finance will prevail, and extended payment terms will be implemented. How can purchasing do this in the least painful way possible? We recommend the following approach.

Implementing extended payment terms in the least painful way possible

Before you approach the finance person to discuss their new policy, it is a good idea to take a look at your supply base. You should be familiar with the general financial condition of your suppliers.

  • Who is on solid financial footing?

  • Which of your suppliers are you a major customer—so that your delayed payments may represent a large part of your business?

  • Which suppliers are small and minority-owned enterprises (SMEs), who might have a hard time—or a very expensive time getting credit in the current financial environment?

This would be the time to formulate your needed exceptions to the new extended payment terms, as well as a justification of those exceptions. For example, an SME trucking company has the payroll as a major expense. That cannot be delayed, especially when truck drivers are in short supply. You might suggest that they, and similar firms, be exempt from this new policy. Likewise, you might suggest exceptions for businesses that are very dependent on you. Finally, you might suggest that the finance group develop a supply chain reverse-factoring solution so that suppliers can elect to be paid on a more timely basis, at a slight discount, if they so choose. [i]

You are now ready to approach finance. First, explain to the finance person (in a respectful way, of course), that the money is not “free”. While there is not a separate line-item cost charged for extending payment terms, the supplier does realize that it is going to cost them money, and will attempt to adjust their pricing accordingly. The costs are going to come back to you somehow—whether it be in price, reduced service, or some other type of adjustment. Next explain, if that is the case, that your suppliers’ cost of capital may be higher than yours.  As a result, you may end up with a higher supply chain cost—by passing your supply chain financing costs on to someone with a higher cost of capital. Also, vulnerable suppliers who depend on you for a large share of business may face bankruptcy and thus pose a risk of supply disruption. Given that basis of understanding, it is likely that Finance will tell you to proceed anyway.  But now you have entered into a dialogue, rather than a one-way conversation.

This is now the time to bring up your proposal for segmenting your suppliers to offer alternative payment terms based on the supplier’s ability to absorb this extension. This is important for you to maintain good working relationships as well a financial viability of suppliers you have cultivated. You may not be able to prevent finance from extending payment terms, but you can work with them on the implementation to make sure that it does minimal damage to the key relationships you have cultivated.

It’s all part of being strategic rather than proactive during times of change.

 


[i] Ellram, L.M., W.L. Tate and R. Fernandes (2019). Supply Chain Finance (Scf): History and Future Directions, Chapter 2  in Tate, Wendy L., Bals, L. and Ellram, L.M. (2019): Supply Chain Finance: Risk Management, Resilience and Supplier Management, Kogan Page.