The EU Directive on Late Payments: Three Months and Counting

The EU Directive on Late Payments will have to be transposed into national law no later than 16 March 2013 by all EU member states. The provisions of the new directive include, among others:

  • Public authorities will usually have to pay for the goods and services that they procure within 30 days or, ‘in very exceptional circumstances’, within 60 days.
  • Enterprises will have to pay their invoices within 60 days, unless they expressly agree otherwise and if it ‘is not grossly unfair to the creditor’.
  • Invoices trigger requests for payment and are important documents in the chain of transactions for the supply of goods and services and for determining payment deadlines.
  • EU member states should promote systems in the field of electronic invoicing (e-invoicing), where the receipt of invoices could generate electronic evidence of receipt.

Apparently the situation for small and medium-sized enterprises (SMEs) will improve once the EU directive is enforced in all European major countries. The directive is relatively stringent for the government-to-business (G2B) space, while it leaves room for interpretation in the business-to-business (B2B) arena.

Implications for SMEs

The directive appears to be the right counterpart in reflecting concessions by governments to their suppliers who are continuously forced to issue invoices electronically. SME suppliers however do not enjoy any significant benefit by e-invoicing if the only attainable result is increased efficiency due to reduced manual operations and less paperwork. The frequency with which an SME sends its invoices to a major customer – as generally this is the size of organization that demands to receive e-invoices – never goes beyond a monthly issue. With such a low frequency of invoice exchange, no efficiencies can be achieved by moving from manual to electronic. Moreover, SMEs still have buyers who do not ask to receive invoices electronically. So e-invoices for SME suppliers represent more an additional layer of complexity than a tool to enhance efficiency.

However, if the e-invoice process is instead offered as a means to access better financing, then the story changes and there is a benefit for the SME also. It is no secret that the current credit crunch is forcing companies of all sizes, especially SMEs, to seek alternative sources of liquidity to the traditional bank channel. Supply chain finance (SCF) refers to the financial instruments that support a company’s working capital through targeted financing of the company’s supply chain processes. The directive goes in the direction of supporting one of the most relevant components of working capital: receivables. By reducing payment delays and fixing an exact date for payments, public authorities allow their supplier counterparties to cash in earlier, thus reducing their days sales outstanding (DSO) exposure.

As good as it might look on paper, the directive raises some causes for concern. The main problem inherent in the directive is the asymmetry between buyer and supplier as illustrated in the table below.

Table 1: Effects of the EU Directive on Late Payments on Buyers and Suppliers, Depending on Their Reciprocal Business Relationship
Effects of EU Directive on Late Payments

The analysis of the results in the table show that companies supplying to government offices, whatever their size, will benefit from the directive because their clients will be forced to reduce payment delays and commit to fixed payment dates. The situation is instead likely to remain unchanged in almost all private business-to-business (B2B) scenarios where the buyer has higher – or at least equal – negotiating power vis-à-vis its supplier. The directive is applied unless business parties expressly agree otherwise and if the deal “is not grossly unfair to the creditor [i.e., the supplier]”. It is very unlikely that an SME supplier can impose a change in the contractual conditions with its large buyer by claiming they are ‘grossly unfair’ without running the severe risk of losing the business. 

Things may change significantly however in the private B2B space when the relationship is between a small buyer and a large supplier (i.e. b2B). This would be the case when the large supplier can ‘impose’ on  its smaller client to change the contract, by significantly reducing the days of payment while still complying with the provisions of the directive. The buyer is now faced with the risk of losing important supplies from its dominant vendor. A contractual reduction of days of payment represents reduced DSO for the (large) supplier and reduced days of payments (i.e. days payables outstanding (DPO)) for the buyer; evidently a severe hit to the buyer’s working capital ratio.

Conclusion

The effects of the directive still need to be analysed within the context of each country. While benefits for small suppliers of government agencies are clear, the same cannot be said for those operating in the private B2B space. Initial optimism should give way to a careful assessment of all potential scenarios introduced by the provisions.

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