Are Your Customers Behaving?
Foiling the Scourge of Extended Payment Terms
When you agree to sell to a business customer on open credit terms, common practice involves setting a credit limit aligned to the payment terms you are granting. In preparation for this decision, you should have previously made the new customer sign a credit agreement as part of their application for open credit terms and thereby confirming their acceptance of your terms of sale. Problems arise, however, when corporate customers have payables practices that conflict with their vendors’ terms of sale.
Recent Payables Trends
During 2020 and due to the Covid-19 pandemic, corporate Average Days to Pay (ADP) increased from 57 to 62 days or almost 9 percent, this according to The Hackett Group. That trend continued in the first quarter of 2021 when ADP increased another 5.5 percent. There were two major reasons for this:
During the pandemic, even large companies were worried about severe reductions in their own revenue and cash, and took actions to conserve cash (such as paying suppliers later).
Many large companies also have the market power to make such a move without worrying that small suppliers will stop selling them in protest.
Since then there has been a gradual normalization. As the economy began to recover, demand for extended payment terms started to decrease, with companies gradually reverting to pre-pandemic terms, which incidentally had been increasing for ten years. Moreover, the experience of supply chain disruptions led many companies to prioritize supplier stability, sometimes opting for shorter terms to ensure continuous supply.
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A case in point is Lockheed Martin, the large defense contractor. It reduced its ADP from 21 to 12 during the pandemic and early stages of the recovery. Lockheed depends heavily on many small, high precision manufacturers to build its high performance products. Supporting these suppliers helps ensure they not only survive, but also invest themselves to satisfy the high standards required for Lockheed’s products.
The good news is companies have increasingly recognized the importance of strong supplier relationships and sustainability, leading to more balanced payment practices, especially in regard to smaller suppliers. However, payables policy has varied widely depending on industry as illustrated in the following table. Industry and geographic region can have significant impact as well.
The pandemic also highlighted the importance of flexible and resilient financial practices, leading many businesses to reassess and adjust their payables management strategies. Some companies have adopted hybrid approaches, lengthening their payables cycle with certain suppliers while maintaining shorter terms with more critical vendors to ensure stability and reliability.
Continued global supply chain challenges have kept some pressure on payment terms, with many global enterprises balancing their cash flow needs against the risk of supply chain disruptions. At the same time there has been an increased use of digital tools and fintech solutions to manage payments and cash outflows more efficiently, allowing for more flexible and transparent payment terms.
Where Do We Go From Here?
The trend in regard to customers demanding extended payment terms from suppliers exhibited a pattern of initial widespread utilization during the early pandemic, followed by gradual stabilization and normalization as economic conditions improved. Hackett’s 2023 Working Capital Survey reports that Days Payables Outstanding (DPO) have decreased by 8 percent to now stand at 57 days, similar to where we were pre-Covid.
However, we are in a very different interest rate environment in 2024 as compared to the years leading up to 2021. A higher cost of capital puts a premium on working capital efficiency, but the Hackett study indicates only companies in the upper quartile are holding their own, with all other organizations falling increasingly behind. Consequently, any economic pitfalls could result in another surge of requests for extended terms.
Not surprisingly, cashflow concerns, combined with the market clout many larger enterprises have over their small suppliers, still leads some to do what is in the best interest of their own company (conserve cash) irrespective of the needs of their suppliers, and without any thought to the hypocrisy of insisting on prompt payment from their customers while sticking it to their suppliers. Remember, business is a contact sport and vendors need to be prepaired to respond vigorously to any attacks on their terms of sale and cash conversion cycle
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