Originally published Payment Terms Are Changing, and Business Operations Must Change, Too on by https://www.sdbj.com/commentary/payment-terms-are-changing-and-business-operations-must-change-too/?utm_source=rss&utm_medium=rss&utm_campaign=payment-terms-are-changing-and-business-operations-must-change-too at San Diego Business Journal
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A strategic approach to setting and maintaining payment terms, especially when it comes to timing, plays a critical role in effective cash management, and today’s economic climate exacerbates the impact of extensions, no matter the industry. Regardless of whether you are actively dealing with — or even aware of — the issue, you can still protect cash and capital from the increasing threat and expectation of extended payment terms.
Previously, many businesses prioritized quickly and efficiently paying suppliers within “Net 30” or similar 30-day terms. Now, the focus seems less about the relationship and more about finding ways to accelerate the flow of inbound cash and extend payables. The new normal spans from 60- to 90-day terms, with some seeking 180-day payment terms.
Unfortunately, uncertainty about how to approach the situation often leads to inaction and a passive approach, but preventing or solving payment term problems can provide a competitive advantage.
Common Issues
Businesses often struggle to push back on extension requests. Even if accepted, variable pricing and/or devotion of more resources to receivables collection might be employed to offset impacts. Regardless, the potential exists to create negative consequences well beyond payables and receivables, including:
- Negative business impact – Asking for longer payment terms can lead to lost clients and compromised relationships with suppliers.
- Stress on success – Landing a new client is an achievement, but payment structure can jeopardize that relationship. Conversely, a company might revise payment terms to gain traction but might then find cash flow issues make formerly productive relationships unsustainable.
- Lack of reinvestment – When a company accepts longer payment terms, investment can lag in areas such as research, development or hiring. Because innovation and talent are what ultimately determine success, this lack of reinvestment is particularly problematic.
- Growth limitations – When high-value clients take longer to pay, difficulty follows in serving their needs. A company might then struggle to pay vendors, which degrades overall quality of service. Paradoxically, growth becomes the enemy of growth.
- Strain on operational costs – Certain bills must be paid: utilities, rent, payroll, etc. If neglected, operations grind to a halt. Payment delays create difficulty in managing ongoing operational costs.
“When extended payment terms can’t be avoided, negative impact can still be mitigated.”
– Ashley Hayslip, Market President, Enterprise Bank & Trust
Fixing the Issue
When extended payment terms can’t be avoided, negative impact can still be mitigated. Companies successfully addressing this threat take early action using these strategies.
- Assess options – Securing a line of credit remains one of the most common actions taken to combat extended payment terms, creating backup liquidity to prepare for expected and unexpected disruptions. While not always viable, understanding the trends and data associated with receivables not only helps determine whether a line of credit makes sense but also helps evaluate any risks in a business portfolio.
- Diverse business portfolios – Trends in the market suggest large companies have a natural inclination to extend payment terms. For this reason, when companies work only with large clients, cash flow issues become much more common. Avoiding concentration in a narrow base of clients can help a company mitigate risks that extended payment terms may pose. That way, if one client extends payment terms, the impact is manageable rather than catastrophic.
Other potential disruptions include receivables with an overabundance of project-oriented work, concentration of revenue/large customers and narrowing margins.
- Maintain open lines of communication – Companies often agree to terms because of a perceived lack of options, but open conversations can lead to more advantageous payment terms with clients or vendors. Avoid the instinct to rely on negotiations with the most senior officer and instead seek out the person who can deliver the most value and who wants to cultivate a long-term relationship.
Payment terms should lock at the same time as pricing agreements. Transparency with lenders about the sources of cash flow issues can have an impact and create trust.
- Use purchasing cards to your advantage – Even for companies with strictly managed payment terms, cash flow issues can still inhibit operations. In these circumstances, a vendor payment program becomes a real asset. These programs turn purchasing cards and other lines of credit into cash flow tools instead of acting solely as instruments of debt. For example, if a company is required to pay in 30 days but must wait 60 or 90 days for payment, a vendor program uses credit to harmonize the schedules. That way, even if payment is technically due in 30 days, the actual financial impact is not felt for 60 days or more when subsequent credit statements become due.
- Explore alternative options – Strategies used to address payment term issues are changing the pricing model, opening a new line of credit, automating timely electronic payments through ACH Collections and discounting prices for early payment. There are numerous options, and there’s no one-size-fits-all approach. In determining the right solution, understanding how payment terms impact a business becomes paramount.
Moving Forward
Extended payment terms have evolved to more than just an annoyance and should never be viewed as obligatory. Making sales is important, but being paid for those sales in a timely manner is what ultimately matters. If a company is serious about actively protecting interests, the payment window must be a constant focus.
Ashley Hayslip is Market President for Enterprise Bank & Trust in San Diego. Hayslip leads the Relationship Management and Business Development teams to expand the bank’s client base, reinforce and grow the bank’s culture, and develop community and nonprofit partnerships in the region.
ASHLEY HAYSLIP
Originally published San Diego Business Journal