Think twice before extending terms of payment
- The credit crunch induced by the economic recession of 2008 led many companies to seek extended payment terms from suppliers, in an effort to improve buyer cash flows, THOMASNET.com's Ed Edwards wrote Tuesday on Procurious.
- The effect on suppliers and buyers has been profound, causing choked cash flow, lowered employee morale, poor credit, and ultimately, business failure.
- To solve the problem, companies should consider reverse factoring, or payments arranged through a 3rd party financial institution, which would satisfy both parties while generating enough self revenue to continue the practice.
Extended terms of payment are becoming commonplace, but just because buyers can impose the terms doesn't mean they should — here are just a few reasons.
First, long terms may improve a buyer's cash flow but it could also severely disrupt a supplier's cash flow since the latter must extend their budgets and assets upon short notice, despite the potential for demand surges. The financial strain and fear of lost sales could force a supplier to seek unfavorable terms of credit, which in the long-run would increase financial risk from high debt burdens.
Second, extending terms without a good reason could strain relationships with suppliers and tax performance. Large companies and the usual culprits of this, as their market power over suppliers often allows them to dictate terms, explained Sergio Rodriguera Jr., Chief Strategy Officer of The Credit Junction.
"If the SMB does not agree or cannot fulfill the orders, then the buyer can find another supplier," he added. "Since many SMBs operate on a cash-to-cash cycle they must find alternative financing solutions, especially in today's post financial crisis world."
This form of financial bullying, and the subsequent stresses placed on the supplier, may lead companies to perform at bare minimum standards. Why should the supplier go to extra effort if they feel their money is being toyed with?
Meanwhile, prompt terms and on-time payment performance often allows suppliers greater flexibility with their cash flow. The financial security, in turn, drives happier suppliers, better relationships, and better performance during demand surges since suppliers may prioritize orders in terms of size and payment reliability.
Supply chain management, at the end of the day, is still heavily influenced by relationships. Unless it's necessary, don't mess with the money.
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