A dollar today is worth more than a dollar tomorrow so it is not surprising that firms would prefer to defer paying suppliers for as long as possible. As the Wall Street Journal tells it, many large firms like Procter & Gamble and DuPont are working to redefine “as long as possible” when it comes accounts payable (P&G, Big Companies Pinch Suppliers on Payments, Apr 16).
What began as a way to preserve cash when markets dried up a few years ago has become a means of freeing up money to fund expansions, buy back stock and support dividend payouts at a time of lackluster sales growth and shrinking profit margins.
P&G is actually late to this game. It currently pays its bills on average within 45 days, faster than the 60 to 100 days that other consumer products makers and large companies in other industries generally take, according to industry experts. The company is looking to move its payment terms to 75 days and recently started negotiations with suppliers, people familiar with the matter said.
As the quote acknowledges, this move to stretch out payment terms has been going on for a while. Indeed, one of the first posts on this blog deals with this topic. Of course, one firm’s payable is another’s receivable. “Borrowing” from a supplier is not necessarily for free.
The moves are creating ripple effects. Companies that hold on to cash longer create deficits at suppliers that have to find financing, raise prices or squeeze other firms along the supply chain. Smaller companies with little bargaining power and less access to credit ultimately could see their costs rise, pinching funds that could otherwise be spent on hiring or investments. …
The risk in pushing out payment terms is that it puts financial strain on companies that supply key inputs and are themselves big employers. Unhappy suppliers could try to respond by taking their business to rivals, reducing the cost of producing their products or raising their prices, increasing costs for buyers.
Consequently, some big firms are trying buffer their supplier from longer payments terms by helping them secure preferential financing. Essentially buyers are working with banks to advance cash to suppliers who are willing to put up their receivables as collateral. Here’s the explanation in the form of eye candy.
The article says that banks are doing these deals at rates as low as 1.3% for receivables from the likes of P&G. P&G, for its part, is pitching this as good for everyone.
Of course, such lending against receivables is not completely new. (See, for example, here.) As far as I can tell from the article, the novelty here is the willingness of large buyers to be actively involved in working with the banks as opposed to the supplier bargaining on its own with a lender.
There are a few interesting twists to this story. One is whether the buyer is actually better off in the long haul with stretching payments out. To use the example in the diagram, the supplier has agreed to basically take a price cut in order to get paid sooner than the status quo. This obviously could be negotiated directly the supplier and buyer. There should be room for a deal since their will no longer be a bank getting its vigorish on the deal.
A second is how this creates additional exposure to interest rates for the supplier. This currently works because interest rates a very low. That can’t last forever. If rates go up significantly, suppliers could be left in a lurch as their cash flow takes a hit. Said another way, under this arrangement suppliers have granted a price cut to assure earlier payment. However, unlike a negotiated price cut, the drop in payment that will prevail in the future lies largely outside their control.