This blog explores the concept of extended payment terms in procurement. It discusses how such extensions impact both buyers and suppliers, affecting cash flow, supplier relationships management, and financial planning. The article provides insights into the reasons behind payment term extensions, including cash flow management and strategic procurement, and examines the implications for various industries with practical examples.

The payment term in supply chain management is a very standard term; this is an agreed-upon invoice clearance period for a buyer to pay its seller. This is usually a 45-60 day time frame. This term can also be affected by several anomalies leading to an extension in clearing the invoices, known as payment term extension.

For example, in the pharmaceutical industry, the buyer may decide to stall an invoice until it is sure that the raw materials sourced through its seller have produced the desired results and were not fake or substandard. So, from a 45 -60 day period, the buyer can suggest deferring the payment by an extra number of days which the supplier is ready to honor because, more than the buyer, it is compliance; after all, why should a buyer pay for counterfeit supply that can potentially affect many lives.

So then you may be thinking, what about companies like AB InBev, Kellogg, Diageo, and Mars in the FMCG industry that extend their payment terms anywhere from 90 to 120 days? Well, here you are, where we discuss the relevance of it, the niche that benefits from it and the niche that’s hurt.

What is Extended Payment Terms?

The payment terms extension refers to lengthening the period allowed for payment on invoices or credit sales. It can have implications for both the payer (buyer) and the recipient (supplier), impacting cash flow, supplier relationships, and financial planning at both the end.

Definition and Basics of Payment Terms

• Payment Terms: Conditions under which a seller will complete a sale. Typically, these terms include the time a buyer has to pay for the goods or services purchased.
• Extension: An agreement to increase the duration from the standard payment period (e.g., from 30 days to 60 or 90 days) before the payment is due.

Why to Extended Payment Terms?

• Cash Flow Management: Extending payment terms can improve a buyer’s cash flow by allowing them to use the cash on hand for longer periods.
• Strategic Purchasing and Investment: Longer payment terms allow businesses to invest in other areas or handle unexpected expenses without the pressure of immediate payments.
• Negotiation Leverage: For suppliers, offering extended payment terms can be a competitive advantage or a way to secure larger orders.

Extended Payment Terms Examples

• Scenario 1: We know why a pharmaceutical company, large or small, may ask for a payment extension. But for most other firms that are large and sit on wads of cash, asking for such extension implies multiple stakeholders and unwarranted processes complicating on-time invoice clearance. Here it is more of prevalence than relevance.
• Scenario 2: Payment Extension is relevant for firms who need trade credit, an alternative to high-interest bank credit as they are operations heavy. Large operation heavy firms are strategic about payment extensions and if they are sure about it in the event of cash crunch or re-deployment of its fund as an income instrument, they offer perks to earn the supplier’s buy-in. This practice is nothing new but pretty old and completely fair where both buyer and supplier have benefits to harness.

The average payment duration in the USA was 61 days in 2022, as reported by Atradius in the research

You may ask, so should payment extension be a prerogative of large firms and their competent supplier management? Well, there is nothing absolute about it but we know that while failure to make a scheduled payment could result into a loss of reputation for the buyer-enterprise, failure to accept a payment extension can result into loss of financial credibility of the supplier and its long term business potential with the buyer. Below are a few ways by which extended payment terms affect suppliers and buyers.

As per research Cash Flow would increase by 66 % if payments are made within 30 days.

The Cost of Extended Payment Terms

For Suppliers

• Burn out: SMB suppliers with limited manpower and production capability can only take up limited projects and contract management. At such a juncture, having funds withheld by their buyer precludes them from investing in enablers (including payments to their suppliers) for ongoing sustenance. Imagine this snowballing into a cash crisis or depletion of working capital and even an out-of-business scenario.
• Employee Productivity: Do we forget how a company’s financial burnout impacts employee productivity and morale? Payroll being a major cost, a payment term extension has a major impact in it. While in most cases, efforts are put in to pay the salaries, it is not imaginary that SMBs fail to pay their people, which impacts productivity and employee wellbeing.
• Credit Crisis: Needless to say, SMBs are not a bank’s favorite investment option. SMBs have nowhere to go seeking credit except for these banks that either charge a hefty interest or mostly refuse funding, which is as high as 50%.

For Buyers

• No Escape: Unreasonable invoice clearance impacts buyers, too, as it levies risk in the supply chain.
  i) A supplier may compromise in the quality or delivery time that may affect buyers’ production and catch them unaware, or
  ii) a trustworthy supplier when forced out of business or pushed into poor productivity because of pending clearances, it affects the entire ecosystem.
• Pay Penalties: Oh well, when you see big companies going for trade credit, do not take it for granted that it is always by force but also by accepting to pay penalties (in case of failure of the new revised payment date) as included in the contract. They incorporate the loss amount from penalties in future purchases if it is not a big but small supplier.
• Losing to Competitors: The essence of your product lies in the ingredients you’ve used and their quality and exclusivity. Losing such supplier to your competitor with friendlier payment terms impacts your business and the market desirability of your product.

The most favorable and win-win strategy is to use an advance payment method that helps both buyers make strategic savings management by paying early, and suppliers get better cash liquidity to help sustain their production profitably.

Common Invoice Payment Terms

While using net payment terms is the norm for most industries, other jargon describes different payment patterns. Here are some of the most common acronyms and terms:

• 1MD: Monthly credit payment of an entire month’s supply
• 21 MFI: 21st of the month following invoice date
• Accumulation discount: Discounts on large orders
• CBS: Cash before shipment
• CIA: Cash in advance
• CND: Cash next delivery
• COD: Cash on delivery
• Contra: Payment from the client, offset by the cost of supplies purchased
• CWO: Cash with order
• EOM: End of month
• Forward dating: Invoicing for payment to be made after the customer gets the order
• Partial payment discount: When a seller offers a partial discount due to low cash flow
• PIA: Payment in advance
• Preferred payment method discount: A lower or “zero-fee” transaction for customers who pay with your preferred method.
• Rebate: Refund sent to the buyer after they’ve bought a product or services
• Stage payments: Set payments over some time
• Trade-in credit: A discount for something that is returned

Key Takeaways

Managing credit between buyer and supplier is the key to a lasting relationship. There is no hard and fast rule about whether to go with a payment term extension. It all depends on how you improve your cash flow; whether you really need a low-interest tax credit, need to disinvest your fund for an expedited return, or totally go against the tide of payment extension and offer your suppliers an advance payment option that takes care of the overall wellbeing of our supply chain environment.

This strategy depends on the size of the buyer, credit needs, nature, and size of supplier network. However, to perfect the balance for a better relationship, we recommend going with an agile technology that can facilitate both payment extension and payment advancement as per the changing business needs. This agility will help you switch your payment strategies conveniently and gain a competitive edge by building long-lasting, stronger supplier networks.

Conclusion

Payment terms extension is a powerful tool in business finance, offering both opportunities and challenges. While it can significantly cut costs and improve cashflows management for buyers, it requires careful consideration and management to ensure that it does not adversely affect the financial stability of the sellers.

Businesses should approach payment terms extension as a strategic decision, weighing its benefits against potential risks and ensuring that it aligns with their overall financial and operational goals. clear communication, thorough negotiation, and ongoing monitoring are essential to leveraging extended payment terms effectively and sustainably.

To learn more about how Zycus can help you implement data-driven, integrated, and intelligent request management, request a demo today.

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