What is Your Enterprise Terms Management Strategy? Most Companies Don't Have One - It Requires Tools

July 17, 2012 Matt Wright

strategyEnterprise Terms Management - the practice of combining a companies' cash management goals, working capital resources and borrowing leverage into a lean payment terms policy that ensures suppliers are being paid according to fair and reasonable discount rates in timing intervals that best suit supplier's cash demands.

First some facts:

    1. Corporate cash balances are at an all time high; $1.736 trillion at the end of the fourth quarter of 2011 
    2. Corporate treasuries are investing in low risk vehicles with their cash. Many not yielding enough to keep pace with inflation.
    3. Banks are willing to lend to large corporations against secured assets for affordable rates, usually around 3.3% APR
    4. Banks are reluctant to lend to SMB's, and often for steep rates, after exhaustive approval processes.
    5. Small business loans are effective for large capital expenditures but are generally not appropriate for day to day operational expenses 
    6. The factoring market (the practice of a supplier selling their receivables to companies in exchange for a discount) is growing 28.6% annually and exceeds $2.3 Trillion

In our business we have the opportunity to analyze how large corporations are paying their suppliers with the tools available to them in today's ERP's. In the overwhelming majority of cases, invoices are being paid according to a "standard" payment term. Most often Net 30 or Net 45. The next most common payment term observed in practice today is the discount term, 2%/10, Net 30. It's also not uncommon to have more than one hundred different payment terms in use, many for only a small set of suppliers, or an even smaller proportion of the spend. All of these phenomenon have their own drawbacks, I will discuss them below

Most large corporations see paying in Net 30 or Net 45 as "supplier friendly" terms. In many cases, they're right to some degree; suppliers are quite happy to be paid in 30 days, as it offsets the increasing proportion of their spend that is being pushed to Net 60 or Net 90. In other words, they're trying to keep their DSO from extending as a result of the extended terms being enforced by other customers with these "shorter" Net 30 or Net 45 payment terms. A more effective way to remain DSO neutral in the face of these demands for longer payment terms would be to get paid in even less than 30 days in exchange for a fair discount. But what about the large, cash rich suppliers that are being paid in Net 30, but are tolerant of longer terms? These larger companies whose revenue is diluted across many thousands of customers would not object to a Net 60 or Net 90 payment term, because the effect on their DSO is nominal, and it does not affect their day to day operations.

Now - let's scrap this DSO/analyst perspective, and discuss the practical demands of running a small to medium business. As an SMB in a turbulent economic climate where sales forecasts are educated guesses, and collections are an increasing burden, cash is king. Forget about DSO, these SMB's need to make payroll, or rent, or their tax bill, or pay that sole source supplier that provides the goods they need to keep their production going (think gas for the lawnmower of the landscaper). Getting paid in 30 days might work this month, but when that supplier gets notified that terms are being extended by another customer, with no alternatives available, that Net 30 isn't as good as it was last month. A nominal discount today keeps these supplier's employees from leaving, their doors open, and their lawnmowers cutting.

So the obvious answer is - let's get these SMB's all on our favorite 2%/10 Net 30, right? Not so fast, let's review some challenges with our old friend 2/10N30: A 2% discount for a 20 day payment acceleration is an expensive loan. 36% APR. Granted most suppliers aren't doing this math, but the fact that suppliers have been historically accepting this term, despite it's cost, demonstrates even a nominal discount can yield dramatically higher returns than stuffing your cash in a US T-Bill. How do you convert all those suppliers? Just change them? There's a reason all that spend is on the "standard" term. It's easy. There's no negotiation required. If the buying organization is well run, the majority of this spend will be on a PO - meaning an agreed price and payment term, and those terms require the supplier's agreement to be changed. So if you can figure out a good mechanism to change to 2/10N30, let's discuss why suppliers are reluctant to accept that term: For many of the buyers out there, assigning 2/10N30 to a supplier still means the supplier will get paid in Net 30. Because the buyer simply can't get the invoice approved in 10 days. So this has not been helpful to the supplier Or worse still, the buyer takes the 2% discount, regardless of when it's approved - effectively changing the payment discount into a price discount. This might work for the first term of the suppliers contract, but the next time it comes to negotiate, the supplier will account for this practice in their pricing negotiation. For sourcing representatives of buyers, they become handcuffed, instead of sitting with the supplier and trying to negotiate on 2 separate dimensions; price and payment, they're limited to a one dimensional negotiation of price alone because the supplier realizes they're giving up 2% off the top of each invoice, regardless of when it's paid.

OK, so 2/10N30 isn't the answer, let's get creative. Let's just create a term that works for each supplier. How about 1%, 20, Net 45. Or 1%, 30 Net 31. Before you know it, there are dozens of payment terms created that might serve one or two suppliers well (at the moment they're negotiating), but this myriad of terms was created with no respect to the working capital availability and cash management principles that the treasury team is trying to implement.

Well, if 2/10N30 doesn't work, and being creative is narrow minded, we should just do nothing. This is exactly what's been happening. Large corporates are doing nothing, or if they do anything they simply extend terms. Well, at least extending terms yields a one time improvement in working capital. The result of extending terms has three effects, 1) a reduction of DPO, something only analysts care about (see blog postby Joe Hyland on why this doesn't make sense), 2) provides the corporates more cash to shove into those "risk free" investments, and worst of all; 3) suppliers can't wait 60 or 90 days to get paid, so they sell that receivable to a bank or factoring company, and cut the buyer out of the discounting opportunity.

It's time for Corporate America to begin implementing Enterprise Terms Management programs that take into consideration the unique cash positions, borrowing opportunities and supply chain funding complexities that are inherently unique to each business. One size does not fit all. Taulia has gone to market with a series of Advanced Discounting tools that allow buyers to offer approved invoices for early payment, implement fair and reasonable payment terms, and a series of campaigning tools to facilitate a conversion and consolidation of payment terms.

In my next post I will describe how these Advanced Discounting tools empower business to serve all of these demands efficiently, fairly and profitably.

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