7 HUGE Risks of Stretching Invoice Payments …
Posted by Steve Wilcox on Tue, Sep 01, 2009 @ 01:57 PM
O U C H!
Head butts hurt ... for BOTH head butters ...
You see, it's a law of physics; Newton's 3rd Law to be precise:
"For every action there is an equal and opposite reaction."
This law applies in the business world too:
"For every financial action there is an equal and opposite reaction."
Think about this if you are stretching payments to your suppliers and making them suffer by not paying on time. Sure, your actions will increase your short-term cash reserves but the "opposite reaction" from your unhappy suppliers may be quite detrimental to your core business. There are tradeoffs here that need to be carefully considered.
Before I go into more detail, let me provide some background.
Yesterday's Wall St. Journal had a front page article titled "Big Firms Are Quick to Collect, Slow to Pay." The gist of the article was that large companies are shafting their smaller suppliers by paying invoices late while at the same time squeezing their customers to pay earlier. The motivation to collect fast and pay slow is something I have written about extensively in past blog posts (see related blog posts below) and is summarized well in the following excerpt from the WSJ article:
"As credit markets remain tight and banks rein in lending, corporations are being forced to squeeze more cash from their day-to-day operations at a time when revenues are slowing and the economy remains weak. Companies are finding they can rely less on external funding and costly bank lines if they can bring cash in the door faster and hold on to it longer. The cash they save can be used to pay off debt or be invested in other parts of the business."
Companies with more than $5 billion in annual revenue took an average 55.8 days to pay suppliers and trade creditors in the second quarter, up 5% from 53.2 days a year earlier, according to REL. They also collected faster on their bills, taking an average 41 days versus 41.9 days a year earlier.
Businesses with less than $500 million in sales paid vendors in an average 40.1 days, down 6.5% from 42.9 days, REL found. They took roughly 8% longer to collect payments, or an average 58.9 days, versus 54.4 days a year earlier."
So big companies are paying slower and collecting faster while small companies are paying faster and collecting slower. In other words, "the biggest and fittest companies are often flexing their financial muscle, benefiting at the expense of smaller and weaker ones."
But are they really benefitting or are they being short-sighted?
So What are the Downside Risks of Stretching Payments?
The upside of stretching payments is obvious - you get to hold onto cash for longer. Since the days of easy credit to help fund operating expenses is over, you don't want to run the risk of running out of money. Keepiing cash for as long as possible has clearly become a strategic financial priority.
So what are the downsides - the "opposite reactions" - of stretching payments? Here are 7 HUGE risks:
- Higher Prices: Suppliers are NOT Banks. Suppliers will notice when shamelessly used as a no-interest loan source. Late payments may undo the favorable prices negotiated by purchasing. Vendors may simply raise prices to cover the costs of financing tardy invoice payments.
- Supply Chain Disruptions: Late payments may result in delayed shipments of goods and services. If these delays adversely affect your core business, is it really worth the hassle? If your finely-tuned supply chain is a competitive advantage, paying suppliers late may be like shooting yourself in the foot.
- Poor Quality and Service: Slow pay will probably mean poor quality and service. Responsiveness will plummet since what supplier is going to jump through hoops if they aren't getting paid? Suppliers know who pays quickly and who doesn't. When deciding who to help and who to delay, the answer will be clear.
- Second-Tier Suppliers: Having top-tier suppliers is a competitive advantage but you put that top-tier supply chain at risk if you abuse your suppliers' cashflow. The cash-rich suppliers that don't need your business will drop you for more profitable customers and you will have to go to your second choice supplier or the cash-starved suppliers will go out of business and be replaced by your second choice supplier. Either way, you risk losing your first-class suppliers and replacing them with second-rate suppliers.
- Competition Suffers: In this environment, banks are not taking one iota of risk by lending to small suppliers. If you exacerbate the problem by paying late, you may be driving a good supplier out of business. In the end, there will be fewer suppliers left to compete for your business. How is this good for your supply chain?
- Vexed Vendors: More gripes and kvetching from disgruntled vendors will lead to more disputes. This will suck the productivity out of your AP staff.
- Duplicate Payments: As Mary Shaeffer points out in her newsletter today, you could be making your cashflow situation WORSE by paying late. Why? Unpaid bills lead to duplicate invoices being sent by nervous AR departments. If you pay these duplicates, you are obviously making your cash situation worse!
The bottom line is this: Newton was a smart guy so pay attention to his 3rd Law of Physics: "For every action there is an equal and opposite reaction."
Sir Isaac Newton, Age 46
The opposite reaction may be delayed but trust me, suppliers won't forget.
You just can't stiff a supplier without consequences. Thinking otherwise is just naive.
-Rakesh Shukla
@rakesh170
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