Archive: March, 2014

Payment problems

I’ve always had an issue with negotiating extended payment terms with suppliers. Firstly, receiving the goods and then not paying for them for months seems wrong. Secondly, my colleagues in the Finance Department were often unable to provide a compelling case, that is, the savings from extending payment terms were insignificant compared to those from a well-managed sourcing process. Finally, the P2P process was often so dysfunctional that there was no way of guaranteeing payment on time.  Rather than risk the potential supplier getting spooked, the subject of payment terms was avoided.

The issue of extended payment terms and late payment has become increasing prominent in UK. This is because the value of late payment is significant and people have started to take notice. The BACS payment processing reported that £36bn is owed to small firms in late payment. This works out as an average of £30,000 per small company. Successive governments have said that it’s unacceptable and large companies have faced a public outcry when they have been found out. The introduction of the Prompt Payment Code in 2011 made a clear statement of intent. This voluntary code aims to establish a clear and consistent policy in the payment of business to business bills. There are now over 1600 signatories to the code. There are numerous examples of companies that have tried to extend payment terms and found themselves caught up in a press storm. For example, in 2012, Sainsbury’s increased standard payment times to certain suppliers from 30 to 75 days which led to accusations that the big supermarkets were pushing small, hard pressed farmers out of business. At a similar time O2 wrote to inform their suppliers of an increase to 180 days. Again, it led to accusations that SMEs were being treated unfairly.

One way to address the issue of late payment or extended payment is supply chain finance (SCF). Major UK companies generally have strong credit ratings and excellent access to finance. This contrasts with the SME suppliers to those major UK companies, who often have relatively more expensive finance and more limited access to equity capital.

The largest component of SME financing is “working capital” funding. SMEs generally fund their working capital via overdrafts, invoice discounting or factoring.  These products are generally more expensive than their customer’s cost of credit and provide the SME with an advance rate of around 80% – with the rest coming from equity capital.  This makes it relatively more challenging and expensive for SMEs to grow.

With SCF a bank is notified by a large company that an invoice has been approved for payment; the bank is then able to offer a 100 per cent immediate advance to the supplier at lower interest rates based upon their customer’s credit rating (i.e. the major UK company), knowing the invoice will be paid.

Pete Loughlin recently wrote about SCF in Purchasing Insight. He believes that the transformation of supply chain finance is just around the corner. As he points out, the key drivers for SCF, that is, a combination of very low interest rates and constrained liquidity, have been a feature of the market for a number of years. However, recent changes in the use of technology to reduce the time and costs of on-boarding suppliers mean that one of the main barriers to entry is being lowered.

SCF has been something that large buyers and sellers have been able to utilise for many years. Changes in the use of technology will open up the solution to a much wider market which will benefit both buyers and SMEs.