A Win-Win Solution to Solve the Late Payments Challenge

Although large US corporates’ cash reserves grew by 78% from 2008 to 2013 compared to just 27% in the preceding eight years (according to a
Deloitte analysis of S&P global non-financial companies
), that hasn’t meant that they are spreading the wealth by paying their suppliers more quickly. Payment speeds slowed down during the recession and stayed slow. Research from the Kauffman Foundation showed than the amount of small businesses citing late payments as their biggest challenge rose sevenfold from 2008 to 2010.

Combine this with the challenge that many SMEs encounter in raising capital. Two out of three small businesses in the US report that they find it “difficult to raise new business financing,” according to a 2014 study conducted by Pepperdine University and Dun & Bradstreet. The result is 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.

On both sides of the Atlantic, government initiatives have been established to speed up payments. In the US, the White House launched its SupplierPay initiative in 2014, modelled on its earlier QuickPay programme, which urges large companies to speed up payments to their suppliers, which 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 programme 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% payment (less a discount) to the supplier, knowing that the bill will be paid on due date. Traditionally in these programmes, the discount is based on the buyer’s credit risk and tends to be beneficial for SME 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. The small number of corporates that have signed up for these voluntary programmes – so far just 47 large companies, such as Apple, Coca-Cola and IBM, have committed to the SupplierPay initiatives – means that the vast majority of small business still face the challenge faced by slow payments.

Incentive Needed

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 initiative. The most obvious one of these is an early payment discount programme, 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% risk-free return on corporate cash.

The challenge with this is that it gives an “all or nothing” discount. Consequently, if the buyer is unable to process payments in under 10 days – which is frequently the case as many large companies simply lack the ability to process invoices that quickly – it has no incentive to make payments any earlier than usual, which can often make the programme unworkable.

There needs to be more flexible solutions, which continue to incentivise the buyer even after the initial early payment window has closed. Two of the most effective and flexible programmes 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 steadily moves closer to zero as the payment moves towards its due date. This facility enables the buyer to benefit from an early payment discount without the need to completely overhaul its payment processes. For major organisations with billions in annual invoices, cutting just a few tenths of a percent off each invoice could lead to millions in savings each year. For the supplier, it gives them the ability to incentivise an early payment, without the rigidity of a traditional early payment programme.

Another early payment approach that has been around for a while, but recently gained traction is reverse factoring. Already used by Diageo, it has also been adopted by companies such as Wal-Mart, General Motors, Siemens, Rolls-Royce and Vodafone among others. Reverse factoring enables buyers to keep, standardise or extend their payment terms, while enabling suppliers to get early payment options through a participating bank.

Technology Assists

With the advent of technology platforms these programmes 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 favourable 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 programme.

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, provided the buyer has adequate cash reserves (and most large organisations have significant funds), there should be no reason for them not to use these approaches. With reverse factoring, the buyer can realise 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 to have 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 programme work. When 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 optimise these approaches is also connected to 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 organisations can place their approved accounts receivable. This programme is managed by the supplier itself, and is particularly useful for suppliers dealing with buyers who haven’t established their own supply chain finance programmes.

Once an invoice is placed in 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 favourable offer, and sells the invoice through the marketplace. This removes the need for the buyer to actively participate in a programme, while still providing quicker payments for the supplier. It also benefits financial organisations by providing a new source of low-risk investments.

None of these programmes 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 organisations 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 situation.

39 views

Related reading