One of the first places company leaders go looking for savings is supplier payment terms. While this seems simple, payment terms are more complicated than they first appear. Payment terms usually appear in the contract or even as part of the purchase order terms, if a company has written agreements with suppliers. Today we’re going to talk about the different options for payment terms, the true company impact, what payment term negotiations tell suppliers, and how to handle diversity supplier payment terms. 

Payment Term Options

Payment terms are simply the amount of time a buyer has to pay the supplier for the purchased good or product. Sometimes there are other parameters attached to payment terms (such as discounts on price), but at their core, payment terms are about time. Here are some common payment terms, and when to use or negotiate them as a procurement professional.

• Net 15/30/45/60/90/120 – This is the simplest and most common payment term. It means that payment is due 15, 30, 45, 60, 90, or 120 days after invoice. Suppliers typically prefer Net 30, while most large companies push to purchase under Net 60 or at least Net 45. Very large companies often push for Net 90 or Net 120 with their suppliers. Chances are good your company has a “default” payment term preferred, so this is a starting point for negotiation. If you are trying to increase your payment terms with suppliers, start by making sure you are paying your invoices on time for the current payment terms and that you are being a good partner to suppliers.
• Early Payment Discounts – This is a variation on Net payment terms where the buyer can take a set discount if they pay their invoice within a certain period of time. This payment term usually looks like 1%10 net 45, 2%15 net 60, or any other combination. The first percentage is the amount of discount they can take if they pay within the number of days that follow, and then the amount of time they have to pay the invoice without taking a discount. For 1%10 net 45, this means if the buyer pays within 10 days, they can take 1% off the invoice and otherwise they pay the full amount in 45 days. This payment term is best for small or diverse suppliers, or suppliers who are very reluctant to increase their payment term length. It is also most successful to negotiate when interest rates are high so cash flow is worth more to the supplier. 
• Cash in advance/Payment in advance/Cash with order/Cash on delivery/Cash before shipment – This payment term is just as it sounds–the buyer must pay for products or services before or at the time when suppliers deliver those products or services. This payment term is most common when selling to a startup company, or many consultants use cash in advance payment terms. They are also common in some areas of the world, such as China. Buyers very seldom prefer this kind of payment term, so try not to let your suppliers talk you into cash in advance unless it is unavoidable. If it is unavoidable, see if there are any concessions you can get for these supplier-favorable terms, such as additional product discounts. 
• End of Month/15 Month Following Invoice/Net 10 End of Month – This payment term refers to a payment due at the end of the month invoiced, the 15th of the following month after invoice, or 10 days after the end of the month invoiced. These terms are generally best when a supplier is providing a consistent service, such as accounting services every month or even social media management. It can also be handy for the supplier to not have to issue an invoice exactly 15/30/45 days before the end of the month in order to get paid on an expected date. 

Payment Term Impact

While lengthening payment terms looks like a savings, companies must keep in mind that it is only a one-time cash flow benefit. To calculate the cash flow benefit, the formula is:

(Annual spend/365 days)*(New payment term-old payment term)

For example, for a supplier with $1million in spend who you moved from Net 30 to Net 45, the calculation is:

(1000000/365)*(45-30)=$41,096 in cash flow benefit

To calculate actual savings, you have to multiply this by the Weighted Average Cost of Capital (WACC) percentage, usually between 3 and 10%. This is essentially what it costs the company to raise capital or finance new endeavors. In our example above, if the WACC is 3%, the savings from increasing the payment terms would be $1233. This is because the company has more cash available and can invest that cash or otherwise use that cash flow to finance projects and save the cost of capital paid to banks or investors. Don’t claim the $41k as a savings or even a cost avoidance because it’s a one-time increase to cash flow. 

Supplier Perception

Asking for increased payment terms can signal multiple messages to suppliers. First, it can signal that a company is less stable or is having trouble financing projects. It can also mean a company is having issues with cash flow. In these cases, the request for increased payment terms can backfire and actually cause suppliers to try to reduce their risk by reducing payment terms or otherwise adding the cost of risk to their products. 

Second, seeking longer payment terms can signal to a supplier that the company is looking for easy procurement savings. This might be due to a new procurement leader, a consultant project, or general market forces. If those are the reasons you are asking for longer payment terms, work with your supplier to evaluate their total business and make payment terms only a component of the negotiation. Use your negotiation tools to really dig into multiple aspects of risk and cost with the supplier and partner with them on cost reduction solutions that are win-win whenever possible. 

Diverse Suppliers or Small Businesses

Part of being a small business is struggling with cash flow. The natural ebb and flow of business is more pronounced in smaller businesses as they typically have less of a cushion to absorb variances in their business. While there are sometimes financing programs to help them decrease their WACC or otherwise help with cash flow, the truth is that most small businesses or diverse suppliers will feel a longer payment term far more harshly than a larger supplier will. With this in mind, consider a different standard payment term for these suppliers or be more willing to offer early payment discounts. 

In my business, I have very large clients who have policies against my standard Net 15 terms. Because I’m in procurement myself, I don’t require cash in advance terms and generally simply use Net 15. My large clients do not reduce their payment terms for my benefit, but are willing to take a 1% discount if they pay within 10 days, which is a reasonable compromise for my business. Ultimately keeping my cash flowing is more important than capturing every penny. If you’d like to talk about your payment terms and how to approach them, let’s chat.