Looking for a win-win solution to overcome the late payments challenge

By Kyriba January 30, 2015

It’s widely known that payments from large buyers can often be slow, and this can cause a significant pressure on SMBs’ working capital. Just last week, Diageo created waves by announcing that it would extend payment terms from 60 to 90 days1. Even though large corporates’ cash reserves grew 78 percent from 2008 to 2013 (compared to just 27 percent in the preceding eight years), that hasn’t meant that they are spreading the wealth by paying their suppliers more quickly2. Payments slowed down during the recession and stayed slow. Research from the Kauffman Foundation showed than the amount of small businesses who cited late payments as their largest challenge rose seven-fold from 2008-2010.

Combine this with the challenge that many SMBs have trouble raising capital (66 percent of small businesses say that they find it “difficult to raise new business financing,” according to a 2014 study conducted by Pepperdine University and Dun & Bradstreet), and you have the recipe for severe working capital issues within the supply chain. This isn’t just a challenge for the suppliers. Any financial benefit of slower payments for large corporations is offset by the real risk of supply chain disruption, should the suppliers be forced into bankruptcy through a lack of cash.

In both the U.S. and the UK, government initiatives have been established to speed up payments. In the U.S., the White House in 2014 launched its SupplierPay initiative (modeled on its earlier QuickPay program), which urges large companies to speed up payments to their suppliers, who are often small businesses. The aim of the initiative is simple – large companies should either commit to paying their suppliers quicker, or otherwise give them access to lower cost capital. The UK launched a similar program back in 2012, under which a corporate will notify its bank(s) when an invoice has been approved for payment. The bank can then offer an immediate 100 percent payment (less a discount) to the supplier, knowing that the bill will be paid on due date. Traditionally in these programs, the discount is usually based on the buyer’s credit risk, and tends to be beneficial for the SMB suppliers as the cost is usually cheaper than their cost of credit.

Unfortunately for many suppliers, the potential supply chain disruption risk does not seem to have provided the necessary encouragement for buyers to speed up payments, and the small number of corporates that have signed up for these voluntary programs (so far, just 47 large companies, such as Apple, Coca-Cola and IBM, have signed up to the SupplierPay initiatives) means that the vast majority of small business still face the challenge faced by slow payments.

So, how can this issue be resolved? There needs be a real – i.e. financial – incentive for corporates to speed up their payments, above and beyond the PR halo impact of signing on to such a high-profile, government-sponsored program. The most obvious one of these is an early payment discount program, such as “1/10 net 30.” The upside of this to the buyer is substantial. If a buyer can make 1/10 net 30 payments, this is equivalent to an 18 percent – risk-free – return on corporate cash.

The challenge with this is that it gives an “all or nothing” discount, so if the buyer is unable to process payments in less than 10 days (which is frequently the case, as many large companies simply don’t have the ability to process invoices that quickly), it has no incentive to make payments any earlier than usual, which can often make the program unworkable.

There need to be more flexible solutions, which continue to incentivize the buyer even after the initial early payment window has closed. Two of the most effective and flexible programs that large companies can take to speed up supplier payments are dynamic discounting and reverse factoring, both of which are initiated by the buyers themselves.

Dynamic discounting offers greater flexibility than a traditional early payment scheme by providing a sliding scale discount (starting at whatever level the supplier is willing to accept)that  moves toward zero as the payment moves towards its due date. This enables the buyer to benefit from an early payment discount without the need to completely overhaul its payment processes. For major organizations with billions in annual invoices, cutting just a few tenths of a percent of each invoice could lead to millions in savings each year. For the supplier, it gives them the ability to incentivize an early payment, without the rigidity of a traditional early payment program.

Another early-payment approach that is has been around for a while, but recently gaining traction is reverse factoring, and is already used by Diageo, as well as companies such as Wal-Mart, General Motors, Siemens, Rolls-Royce and Vodafone, among others. Reverse factoring enables buyers to keep, standardize, or extend their payment terms while enabling suppliers to get early payment options through a participating bank. With the advent of technology platforms these programs are becoming easier to implement, where the platform connects buyers, suppliers, and multiple banks to support the early payment of invoices to a company’s suppliers. The solution provides visibility to invoices that the buyer approves for payment, enabling suppliers to opt for early payment of the approved invoices – at a favorable discount compared to financing they could receive on their own. Pre-arranged financing is provided by the banks that participate in the buyer’s supply chain finance program.

While both of these approaches certainly speed up the payment process and help keep working capital flowing at the often-small suppliers, they can also have a significant benefit for the buyers. With dynamic discounting, buyers   can leverage their own cash reserves to get a risk-free return that is many times greater than other vehicles. From this point of view, as long as the buyer has adequate cash reserves (and most large organizations have significant funds), there should be no reason for them not to use these approaches. With reverse factoring the buyer can realize working capital benefits by keeping or extending its payment terms.

These two approaches can also be used interchangeably, depending on the buyer’s availability of cash at various points throughout the year. While it’s likely that the companies who initially signed up to SupplierPay and its UK counterpart are cash-rich throughout the year, others may have periods where they require external funding in order to make the program work. If this is the case, they can then use their own high credit rating to secure low-cost financing for suppliers, without the need to dig into their own funds. Corporates’ ability to optimize these approaches is also connected on the quality of their cash forecasting, so they know how much cash is available for allocation to supplier financing.

Other solutions to speed early payments are also gaining traction. One example of this is an online marketplace, where organizations can place their approved accounts receivable. This program is managed by the supplier itself, and is particularly useful for suppliers dealing with buyers who haven’t established their own supply chain finance programs. Once an invoice is placed on a marketplace, investors, such as banks and hedge funds, can then bid on it, offering an early payment in return for a discount on the invoice’s value. The supplier then chooses the most favorable offer, and sells the invoice through the marketplace. This removes the need for the buyer to actively participate in a program, while still providing quicker payments for the supplier. It also benefits financial organizations by providing a new source of low-risk investments.

None of these programs will solve the late payment challenge overnight. However, the ever- increasing range of options available, combined with greater awareness of these solutions throughout the supply chain, will give organizations both the ability and the incentive to speed up their payments, without requiring them to make any sacrifices. For once, this could be a win-win.

Abhinav Saigal is director, supply chain finance at Kyriba. This article first appeared on gtnews.com on January 30, 2015.


1. Diageo Under Fire for Extending Terms to 90 days – Supply Management, January 29, 2015

2. How Record Cash Reserves Influence Corporate Behavior – Wall Street Journal, October 29, 2014

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