Payment terms involve a specified time period allowed to a buyer to pay off the amount due to the seller. Suppliers across different categories wait for a minimum of 30 days post invoice generation to receive payments on the goods and services provided. Large enterprises tend to have a longer payment term of 90 to 120 days. In fact, some oil and gas companies have been known to even have 180 days as their standard payment terms. Such prolonged payment terms create operational issues for suppliers of small-and medium-sized enterprises (SMEs).
Treasury departments at large companies push for longer payment terms to have bigger cash reserves, as this helps them plan expansion strategies both organically and inorganically. However, to maintain good terms with suppliers, companies provide them with alternatives to agreed payment terms for expedited payment processing.
Some of the policies companies adopt when it comes to making early payments to suppliers are as follows:
Static Discounting: Under static discounting, early payments are made to suppliers by buyers in exchange for a fixed discount on the goods or services provided. An example is “2/10, Net 30,” which translates to, “Pay under 10 days for 2 percent discount; otherwise, the full payment is due within 30 days.”
Dynamic Discounting: Here, the discount offered is similar to that in static discounting. However, the dynamic component refers to the option of providing discounts based on the dates of payments to suppliers.
Supplier Financing: This is a third-party provided service for early payments to suppliers. Supplier finance companies optimize cash flows for businesses by permitting them to stretch their payment terms to suppliers, while providing the option for suppliers to receive payments earlier. A supply chain finance company extends trade credit and acts as an intermediary between the buyer and supplier. If the supplier has a cash flow crunch, they can get paid earlier with an interest component; the cost for this early payment is charged to the suppliers.
New Tools for Early Payments Programs
Amex launched “Early Pay”— a supply chain finance and dynamic discounting solution. Companies can leverage this solution to increase cash flow, generate working capital and make the supplier payment process more efficient. Suppliers can also use the platform to have their invoices paid earlier than the original payment due date at a discount.
Meanwhile, Tradeshift — a supply chain management solution provider — expanded its portfolio for B2B payment solutions with the launch of Tradeshift Pay. The solution offers early payment via dynamic discounting and is powered by blockchain.
Caveats for Applicability of Early Payment Programs
The usage of alternative solutions to payment terms gets restricted due to differences in economic conditions across geographic regions and the operating nature of different categories.
Profit margins of suppliers also directly impact adoption of discounting programs for early payments. For example, suppliers of manufacturing goods generally operate at low-profit margins — steel suppliers operate with a net margin of 3-4 percent. The industrial MRO category also has low margins. Certain manufacturing categories operate with less than 1 percent net margin. Suppliers in these industries are typically not keen to offer a discount.
However, service-based industries generally have higher margins. The information services industry operates at a net margin of 13-14 percent, while the HR services industry has an 8-10 percent net margin. Suppliers in these industries are more likely to provide a discount in exchange for early payment.
In some APAC countries, the cost incurred by suppliers for earlier payment is higher compared to the interest on working capital loans taken from banks. However, supplier finance is preferred by companies in the North American region.
The VUCA (Volatility, uncertainty, complexity and ambiguity) nature of the business environment drives companies to keep a check on their accounts payable and accounts receivable. To accommodate a request for payment earlier than agreed upon in the contract, the buyers give suppliers options for discounted payments or third-party funding options. The adoption of newer alternatives to traditional payment terms is on the rise, although the implementation is constrained by local economic conditions across countries and sourcing category variability.