There's Nothing Good about Extended Payment Terms
Protecting Your Cash Flow Requires Relentless Vigilance
Payment Terms define when a customer is supposed to pay your invoice for the products and/or services your firm provided . . . at your expense, using your cash. For many industries the “norm” is 30 days from invoice date (Net 30), but there are many variations. Some, such as food distributors, may offer as few as 7 days (Net 7), while other industries require payment on a specific day of the month for all purchases made anytime during the previous month (e.g., Net 10th Prox). Problems arise when customers try to extend payment terms by another 15 to 30 days or even more.
Trade credit terms are intended to provide a convenience for the customer and unlike most loans are generally unsecured, in large part because they have a short term. Outside the USA, and in export markets, payment terms typically range from 60 to 120 days. For a foreign buyer, it is a lot easier to convert a purchase to cash in 90 days than in just 30 days. Besides offering convenience, payment terms represent an accommodation between your cash flow and that of your customer. It is not surprising then that longer credit terms, such as Net 90 and above, are more likely to be secured or backed up by some other sort of credit enhancement.
Problems Associated with Extended Terms
Extending payment terms delays your incoming cash flow. If too many customers request and are granted extended terms, it will cause a substantial strain on your cash flow. To compensate, you may have to borrow funds, pay interest and submit to the lender’s conditions and covenants.
In addition, extended terms increase your exposure to customer bankruptcies and the resulting non-payment. If a customer has 60 day payment terms, and pays 30 days late, you will have three months of sales dollars at risk versus one if the customer had 30 day payment terms. Also, once granted, extended payment terms are very difficult to rescind.
If other accounts learn of your granting extended payment terms to one customer, it is likely they will demand the same, further increasing your investment in Accounts Receivable (AR) and straining your cash flow. Actually, this is a reasonable request on their part because the Robinson-Patman Act (which deals with anti-price discrimination) stipulates that competing customers be treated predominately the same because terms are considered part of the price.
As we say in the title, there’s nothing good about extended payment terms . . . except if they enable you to secure an additional customer whose business is contributes significant profits, and whose credit risk is low.
During the pandemic induced economic slump, many companies reported requests for extended payment terms from their customers. The smart ones extended them for a limited defined period (e.g. 3 to 6 months), at which time they automatically reverted back to the original shorter terms.
In our current elevated interest rate environment, cash flow has taken on added importance. This is because the cost of money (borrowing to be specific) is significantly higher than it was before the pandemic. That creates a powerful incentive for buyers to find ways to delay payments to their vendors. Some will just pay late, but your more honest customers will request extended terms.
Unilaterally Imposed Extended Payment Terms
Unfortunately, many large companies impose extended payment terms as a condition of doing business, and offer their suppliers no opportunity to negotiate. Their value as a large customer enables them to do this. Some implement this with a formal change to any sales agreement and reflect it in their purchase orders. Others do not. They just take the extra time to pay your invoices.
Unfortunately, there’s not a lot that can be done other than choosing not to sell to the customer. You can try to resist, but unless you are a providing a unique product or service (have market power), your chances of success are slim.
To continue reading and learn 6 things to consider when confronted with a request for extended payment terms, as well as how to combat Payment Timing Optimization, you need to be a paid subscriber to Your Virtual Credit Manager. The good news is that until Wednesday May 1, 2024, annual subscriptions are only $29.40 . . . forever . . . that’s 40% off the standard price.
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Please share this newsletter with your small business customers . . . it just might help them collect faster and pay you sooner.