Credit Management in the Face of Increasing Payment Terms

Corcentric

Everyone wants to get paid as quickly as possible, but payment terms are a fine balancing act.

In some industries, suppliers face lengthening average payment terms – not to mention the challenge of collecting to those terms in a timely fashion.

Long payment terms were originally designed to support business growth, enabling buyers to reinvest and ultimately buy more as their market developed. For smaller businesses, this line of credit is more practical than bank loans. There is some irony in that large businesses are more likely to insist on longer payment terms when buying from smaller suppliers: however, these same large businesses are able to borrow at lower rates than smaller businesses.

Cash flow is the lifeblood of any business, and lines of credit are often used to demonstrate profitability rather than being a requirement for supporting commercial operations. However, suppliers forced into lengthy payment terms are put at greater risk through this impediment to cash flow.

This may seem unfair, but it’s worth taking a moment to better understand why payment terms are so important to the revenue profile of a company. As one example, investment analysts review average payment terms as an indicator of a company’s strength with its supply base. As another, when businesses agree between them to extend payment terms, the increase in working capital reduces the need for corporate loans and provides more cash stability during peaks of expense flow.

Access to working capital is crucial for businesses, especially when you consider data from the Bureau of Labor Statistics, which indicates that survival of small businesses in the US has progressively declined over the years. Small businesses typically have only 27 days to pay the bills, notes this article in Forbes. In order to support healthy cash flow among buyers, suppliers, and customers, it is incumbent on businesses today to assess where they are, what their customers’ needs are, and what are the optimal payment terms to support strong relationships and foster business growth.

Beyond Net 30 – What is the new normal?

What you can expect customers to ask for will depend on where your customers are located, what industry they are in and their size (read: negotiating power). Typically, businesses in southern Europe expect longer payment terms than those in northern Europe and Scandinavia.

According to a 2018 IACCM article, Extended Payment Terms: Good News for Global Firms, more than one in ten invoices (11 percent) paid to SMEs globally are still paid outside of payment terms, and 7.5 percent of invoices are eventually written off as bad debt.

And that was before the COVID-19 global pandemic hit. Industries, from commercial and retail to industrial and technology, are having to quickly readjust their payment strategies due to the pandemic, including the way credit is delivered and payment terms are managed. Last year, the 2019 Payment Practices Barometer by Atradius looked at businesses across the globe for risks to their financial stability. In Western Europe, businesses were offering customers credit far more often than they did in 2018 to support domestic demand and stay competitive on foreign markets. However, they did not demonstrate a willingness to extend payment terms.

According to research by Atradius, the following average payment terms are seen in these European countries:

Average payment terms:

Great Britain – 20 days
Germany – 22 days
Denmark – 27 days
The Netherlands – 28 days
Sweden – 28 days
Ireland – 28 days
Belgium – 31 days
Austria – 31 days
Switzerland – 31 days
Western Europe (average) – 34 days
France – 34 days
Spain – 48 days
Italy – 51 days
Greece – 66 days

The above are averages across all industries. To get a better insight into specific industries, findings from the Atradius Payment Practices Barometer for the United Kingdom 2019 shows the difference in payment times across a few different sectors:

Agri-food – 14 days
Transport – 17 days
Metals – 26 days
ICT/electronics – 27 days

Payment terms and DSO

DSO is a well-known KPI for any accounts receivable department. The higher the DSO, the more credit is given and less cash there is in the business. This throttles cash flow and introduces greater risk. However, DSO isn’t necessarily a good measure of accounts receivable performance.

Consider a business which suddenly lands a large new contract with an ICT/electronics customer in Greece, whilst downsizing their sales to agri-food customers in the UK. Following average terms outlined above, this example could be expected to massively increase DSO – without being a fault of credit collection processes, or even a bad thing for the overall performance of the business.

The impact of payment terms on DSO is still, obviously, an important factor to weigh up – a business can overextend credit and suffer catastrophic consequences. But sometimes growth requires a more relaxed approach to DSO.

European Directive 2011/7/EU

The negative impact of delays to invoice payments has been recognized as so harmful to businesses that the European Commission has taken steps to limit this impact.

European Directive 2011/7/EU required member states to enact provisions in their national legislation by March 16, 2013 to set maximum commercial payment terms for commercial transactions. The transposition of the Directive, in each case, requires businesses to pay their invoices within 60 days, unless:

a longer payment term is expressly agreed in the contract, and
provided that the payment term is not grossly unfair to the creditor.

If a buyer exceeds the 60-day window, the aggrieved creditor is entitled to interest for late payment and has the right to claim €40 per invoice, plus any other costs that you have reasonably incurred to receive the payment – such as admin, debt collection, and legal costs.

While the directive is intended to limit delays beyond agreed terms, some countries have gone further than the requirements of the Directive. The following are examples of payment terms, for business-to-business transactions, enshrined in national laws. In the cases below, there is provision that higher payment terms may be possible to negotiate, but are likely to be considered unreasonable in cases of dispute.

Germany – 30 days maximum
Austria – 60 days maximum
Spain – 60 days maximum
France – 60 days, or 45 days end of month, maximum

What various industries are seeing, according to the IACCM article, is that late payment remains a chronic concern for large and small firms alike, and that the policy and industry landscape has clearly shifted in favor of fair and timely payment. The article offers advice that would be appropriate for both large and small businesses to integrate into their payments strategy in order to reduce the likelihood and consequences of late payment:

Better education on the effects of late payments
Increase transparency of payment practices
Broaden the adoption of industry-led codes of practice
Improve access to enabling technologies such as e-invoicing

These actions put the onus on the accounts receivable function of a business, but, in the long run, will benefit both the customer and the continued fiscal health of the business.

So here’s to getting paid more quickly in the future.