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Andriy Sichka
Payment terms are a benefit to the customer, and it is important to find the right balance for your company.
By Andriy Sichka, originally published in Credit, Collections and Risk Magazine, www.CCRMagazine.co.uk.
Every financier knows that, if we set credit risk aside, deferred payment term is a technical equivalent of a discount. As such, payment terms are to be negotiated and fixed in the contract together with the price. Quite often, however, parties fix a price and then start to negotiate on the payment terms. This really is a mousetrap for a seller, as, in essence, he is invited to discuss the price when it is already fixed!
Very often, suppliers leave the setting of payment terms to local customs, market practice, or – even worse – the buyers’ wishes. Retailers are very famous for using positions like: “We ask for 90 days payment term as this is our standard for all suppliers.” Very often sales teams bring the deal with fixed payment terms already agreed, but without any explanation for them. They will simply say “customer expects X days” and many companies agree to accept this for fear of losing a customer. While customers are very important, they are not always right. Payment terms could, and should, be mutually acceptable for both the buyer and the seller.
But how can fair terms be found? In many cases, knowledge of customers’ cash cycles would help. Try to find or estimate a customer’s days of inventory outstanding and add it to their days of sales outstanding. A precise result would require a delivery period as well. Then compare the total with the proposed payment term. There are three possible results:
1. The cash cycle is equal to the term – this is very unusual but possible. You give as much credit as your customer needs to trade. Provided you can afford to finance such a term, it would be good to maintain it.
2. The cash cycle is longer than the term – this is negative for your customer. Very likely they would be looking for external finance to trade your products. Sooner or later they will knock on your door, especially if access to external finance became hard.
3. The cash cycle is shorter than the term – you would be giving more credit than necessary. If the figure is substantial (say above five days) then you are financing somebody else’s business and very likely for free! In this case, the seller should clearly understand the benefits they are receiving from the customer. It may be time to re-negotiate terms.
Fear of losing a customer is normally bigger than the actual risk. Companies normally respect those trade partners who stand for their rights soundly and constructively. It is obviously easier to negotiate if the above exercise is done before the contract is signed. CCR