For most buyers the obvious answer is YES, you should pay suppliers on time. Contracts and General T&Cs (Terms and Conditions) define payment terms and the number one argument is; if the buying party do not follow the contract, why should the seller – hence open for change in other conditions as for example price.

But if the supplier does not always fully honor agreed lead-time and pre-stipulated delivery performance? Isn’t adding a few more days to the credit time just fair?

It goes without saying, there are conflicting interests here. Getting the customer to pay quickly is important to be able to create liquidity on the supplier’s side, i.e. that the supplier have money to move around with. Unfortunately, from the seller’s perspective, late payments are not uncommon. 

The supplier’s perspective 

Are you a lender to your customer? The question is extremely relevant – if the buyer does not pay, the supplier become the buyer’s lender, which burdens its finances. It can also be uncomfortable if the buyer does not pay the invoice because it can disrupt the chances of maintaining a good relationship. Sometimes it can feel pressing to have to call a buyer and ask about the payment but calling and talking directly to the buyer is the most effective way to get the invoice paid. 

The supplier can leave their invoice to a professional player to avoid handling them, and in this way, the supplier can focus on the positive part of the customer relationship – in cases where the buyer would not pay. 

The supplier can outsource the entire invoicing to a partner or can do so at times when the invoice is not paid. 

Maybe the buyer offers Supply Chain Finance and/or if the buyer has a long-term relationship with a company that handles invoices, the seller can set up an individual agreement with them. 

If the supplier hire a factoring company, for example only when they do not get paid, the factoring partner will take a percentage of the invoice, pay the remaining part to the supplier, and then take care of the collection. Usually in these agreements the seller still bear the risk if the invoice is not paid. It is very rare for a factoring company to be prepared to take over the risk, and if they were to do so, it would be much more expensive. Note that factoring, to sell invoices, is costly and something many business managers advise against doing.

Other tools at the disposal of the supplier are reminders, which can be sent via letter or email (but this is not as effective as calling the customer) and add a reminder fee. If payment is not made, the supplier can send the invoice to a debt collection company. However, this means that relationship will most likely not be as good as when parties collaborate.

Collecting interest from day one of a delayed invoice is also an option. Many contracts include this opportunity. The basic idea is that the buyer should consider a delayed payment of invoices a very expensive way to improve buyer cash flow. The interest must be significantly higher than the current market price for raising funds from the market. 

As a buyer – pay suppliers on time. 

The buyer’s perspective

Depending on country (and the local legislation), there are different possibilities to share the burden of financing the supply chain with suppliers. Especially if the buying company are significantly larger (in terms of turnover) than the seller, there are country specific regulations stipulating payment terms to, for example 30DN. 

The optimal situation is of course that the buying legal entity gets paid from customers before paying suppliers. The key measure is Cash-to Cash (how many days from payment to supplier until you get paid from customer). The buying party has a strong incentive to constantly improve Cash-to-Cash by extending payment terms. Especially around Fiscal Year end this becomes apparent, and it is not uncommon that CFO put pressure on the procurement function to hold payments during this period.

Basic tools for the buyer – pay suppliers on time

The comments from the supplier’s perspective are of course relevant also from the buyer’s side, but from the other side of the table. 

It is in both parties’ interest to create the most competitive supply chain and the best-case scenario is that the party (buyer or seller) with lowest weighted average cost of capital (WACC) should finance the supply chain. And if you have that kind of relationship with your supplier…You should pay suppliers on time.

Learn more about payment terms in Learn How to Source’s course Payment Terms

As a procurement expert, understanding the importance of payment terms in the buyer-supplier relationship is crucial. Payment terms are not just about when payment is made; they encompass a range of factors that can significantly impact both the buyer’s and the supplier’s cash flow, risk, and overall relationship dynamics. Here’s a breakdown of why understanding payment terms is vital for buyers and why you should pay suppliers on time:

1. Cash Flow Management:

For Buyers: Understanding and negotiating payment terms that align with your cash flow can prevent liquidity issues. For instance, longer payment terms (like net 60 or net 90 days) can allow buyers more time to generate revenue from the use of the purchased goods before payment is due.

For Suppliers: Conversely, suppliers prefer shorter payment terms for faster cash turnover. If a buyer understands this, they can use it as a negotiation point, perhaps in exchange for discounts or other benefits.

2. Cost Savings and Discounts:

Many suppliers offer discounts for early payment. By understanding and taking advantage of these terms, a buyer can save significantly on procurement costs.

3. Supply Chain Stability:

Timely payments contribute to supplier stability and reliability. A buyer who is known for adhering to payment terms is more likely to be prioritized by suppliers, ensuring consistent supply and potentially better service.

4. Building Strong Relationships:

Fair and mutually beneficial payment terms help in building strong, long-term relationships with suppliers. This goodwill can be crucial in times of supply shortages or when requiring expedited deliveries.

5. Risk Mitigation:

Understanding payment terms helps in assessing the risks involved. Longer payment terms might mean a higher risk of price fluctuations or changes in market conditions. On the other hand, prepayments or deposits can pose a risk if the supplier fails to deliver.

6. Negotiation Leverage:

Knowledge of standard payment practices in the industry gives buyers leverage in negotiations. They can negotiate terms that are more favorable by understanding what is typical and what can be adjusted.

7. Compliance and Ethical Considerations:

Payment terms must comply with legal and ethical standards. Late payments can lead to legal penalties and damage a buyer’s reputation.

8. Budgeting and Financial Planning:

Clear payment terms aid in accurate budgeting and financial planning. Knowing when payments are due helps in forecasting cash requirements and avoiding unexpected expenditures.

9. Impact on Total Cost of Ownership (TCO):

Payment terms can affect the total cost of ownership of a product or service. For instance, shorter payment terms may lead to a need for short-term financing, which adds to the total cost.

10. Market Dynamics Awareness:

Understanding payment terms also involves being aware of current market conditions and financial environments. For example, in a high-interest-rate environment, the cost of capital increases, making the length of payment terms more significant.

In summary, a comprehensive understanding of payment terms is a strategic component in procurement, affecting everything from cash flow management to relationship building and risk mitigation. Smart negotiation and management of these terms can lead to significant benefits and cost savings for the buyer. But, always Pay suppliers on time. 

Here’s a list of the 10 most common payment terms used in business transactions:

• Net 30, 60, 90, etc.: This refers to the full payment due within 30, 60, 90 days (or other specified period) after the invoice date.
• 2/10 Net 30: This implies a 2% discount if payment is made within 10 days; otherwise, the full amount is due within 30 days.
• Cash on Delivery (COD): Payment is made at the time the goods are delivered.
• Prepayment: Payment is required before the goods or services are delivered.
• Down Payment: A partial payment made upfront, with the balance due at a later specified date.
• End of Month (EOM): Payment is due at the end of the month in which the invoice was issued.
• Letter of Credit: A document from a bank guaranteeing that a buyer’s payment to a seller will be received on time and for the correct amount. Common in international trade.
• Stage Payments: Payment is split into multiple stages, with each part payable after certain milestones or stages of the work are completed.
• Line of Credit Pay: Payment terms that allow the buyer to pay under a line of credit, usually over a set period.
• CIA (Cash in Advance): Payment is made in full before production or shipment of goods.

These terms can vary based on industry, region, and the relationship between the buyer and supplier. Understanding and negotiating these terms is crucial for effective cash flow management in business transactions.  But, always pay suppliers on time. 

If you want to invest more time in learning about Payment terms, Learn How to Source have a 20 min online course, Payment Terms, which you can attend anytime and anywhere.

Note: Illustration to blogpost “Should you pay suppliers on time?” is created by Chat-GPT on February 28, 2024.

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