22 July 2010 | David Brown

Paying suppliers early can revolutionise your cash flow situation and avoid the need for painful cost-cutting measures. David Brown explains how to make it work

Many companies see late payment of their vendors as a way of keeping the organisation solvent or improving their cash flow position, especially in tough economic times. But this practice is a return to unsophisticated leverage tactics that procurement has worked hard to move away from. The cash flow burden is passed down the supply chain and on to the suppliers who are typically smaller, weaker companies. Suppliers must therefore take action, often seeking increased financing at high cost or, worse still, become insolvent.

This presents threats to the buying organisation: the loss of critical supply, reduced competition and increased prices as suppliers seek to recover their growing financing costs. It is doubtful whether a pending EU directive designed to legislate against late payments will have the desired impact. So how can buyers avoid falling into the trap of late payment and the problems it causes for the supply chain?

There are a number of traditional techniques. Accelerating receivables is a common approach, where the buying organisation tries to collect payment from its customers more quickly. But this method is often out of the control of procurement and if customers do not oblige there is little you can do.

Another option is to reduce inventory levels. But this can be complicated and moves risk to the front of the business, resulting in possible absence of stock. Buyers could also look to implement austerity measures and, as many have already done, close down categories of non-essential expenditure (business travel bans, closing stationery categories and so on). The problem here is the pain and discontent the organisations experience for relatively little material benefit.

There is, however, one initiative that can dramatically improve cash flow without these drawbacks: adopting an early payment programme. Organisations need to take a fresh look at the impact of their financial supply chain on their companies’ cash flow and working capital management. It might sound counter-intuitive, but by adopting an early payment programme the buying organisation need not delay payables or accelerate receivables.

Early payment programmes enable organisations to leverage their credit rating and collaborate in a mature manner. The buying organisation offers suppliers

the opportunity to be paid earlier than existing terms (on day 10, for example, rather than day 45). In return the supplier agrees for an early payment fee to be charged against each invoice (around 1 per cent). This can typically bring a cash flow benefit to both the buying organisation and suppliers that participate

in the programme, leading to a reduced cost of finance for these suppliers. One thing is for sure. This late payment bubble has to burst soon as more stress is put on the economy and behaviour around payment becomes an issue for an increasing number of companies.

Key points

• Paying vendors late will only weaken them, which is against the buying organisation’s interests

• Buyers can charge suppliers a small fee for being paid early

• Early payment gives procurement more control over cash flow

David Brown is CEO of Oxygen Finance

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