As big companies struggle with cash flow, smaller suppliers are taking up the slack

As big companies struggle with cash flow, smaller suppliers are taking up the slack

The new year has brought little cheer for suppliers. Their banks are cutting credit lines and customer companies are demanding longer credit terms. Some risk losing payments altogether as business customers cut back orders or go under. Even the once safe letter of credit, commonly used in international trade, is no more a guarantee of payment if intermediary banks fail.

Small suppliers, so often at the mercy of larger companies and with little capital, are the worst hit. It is estimated that in most economies, small and medium firms account for more than 95% of all businesses and between 50% and 60% of gross domestic product. According to European Union statistics, 99% of businesses in the EU are small and medium-sized enterprises employing a combined 75 million people. A squeeze on this group can have disastrous effects on the overall economy.

The global financial meltdown has prompted large companies to further tighten supplier payments to improve their own cash flow. UK retailer Alliance Boots has asked UK suppliers to wait for up to 105 days for payment, up from the previous term of 45 days. It also asks suppliers to pay a 2.5% settlement fee to get payments. And Tesco, the UK’s largest supermarket chain, has told local non-food suppliers to expect payment in 60 days instead of the usual 30 days.

In China, industry sources say a number of US retailers are asking suppliers to increase payment terms from the previously agreed 30-45 days to 90-120 days after shipping. Suppliers who cannot raise the money to meet extended credit terms are going out of business.

China’s commerce ministry took an unprecedented step in January by issuing a warning to exporters that they should closely monitor credit ratings of foreign banks and importers to avoid loss of payments. In a related move, the country’s sole export credit insurance provider, China Export and Credit Insurance Corporation, downgraded rating of 48 nations including the US. The insurer, which paid $210m in indemnities in the first 11 months last year – an increase of 175% on 2007 – might consider increasing premium rates.

Tim Cummins, president and chief executive of the US-headquartered International Association for Contract and Commercial Management, a global body with 5,000 members from 1,600 companies, says: “Our members are under increasing pressure from their [senior] management to renegotiate and extend payment cycle times in view of the ongoing financial crisis.” But he says that smart managers should tell boards that doing so is a threat to the reputation of the company and it may also threaten the security of supply chains. “It is not smart to put your suppliers out of business.”

Teresa Fabian, director of sustainability at consultants PricewaterhouseCoopers UK, agrees, saying: “In the current economic climate, paying suppliers according to agreed payment terms is not just about being responsible, it’s about not increasing risk of supplier failures.” She argues that in debates about corporate responsibility, supplier payment terms have not been a key focus to date.

In December, the UK launched a Prompt Payment Code, through the government’s Department for Business, Enterprise and Regulatory Reform, “to help increase the speed of payments to smaller companies”. John Lewis, British Gas and Asda were among the first to sign up. But the code, which is voluntary, does not stipulate how long companies should take to pay suppliers.

In the past few years, several governments, including the EU, have stepped in to protect small businesses from late payments by making rules that allow suppliers to claim interest on late payments. But small firms hardly insist on charging interest for fear of losing business to rivals. In the UK, big businesses owed a massive £18.6bn in late payments to small and medium-sized enterprises in 2007, up from £16bn in the previous year, according to Bacs, a non-profit payments industry body. The report also found that 80% of small and medium-sized firms were not exercising their legal right to charge interest on late payments.

Late payments

According to the UK-based Institute of Credit Management, in 2007, the average payment across all FTSE 100 and FTSE 250 companies was 34 days, while the figure for all listed companies was 44 days. However, two-thirds of the firms who took part in a poll conducted by the institute in December said they had been asked by customers to extend the payment terms. The UK’s Federation of Small Businesses says that some of their members are being made to wait up to three months to get payments.

European businesses lose an estimated €25bn every year because they are obliged to finance unnecessary credit. The European average for the amount of time to receive payment was 55.8 days in 2008, a slight decrease from 2007 when the average stood at 58.6, according to the European Payment Index, compiled by Stockholm-based credit management bureau Intrum Justitia. However, payment delays increased from an average of 16 days in 2007 to 17 days in 2008, the report highlighted.

The Forum of Private Business (FPB), which represents 25,000 small and medium-sized enterprises in the UK, found in a survey in August last year that 72% businesses state 30 days as standard payment terms while 9% have 60 days terms and only 8% have 14-day payment terms. But in practice, small businesses receive payments between two and six months, the survey revealed.

Phil McCabe, spokesman for FPB, says: “We have a problem when bigger companies make sudden and unilateral changes in payment terms, at times doubling it from 30 days to 60 days, without any discussion or dialogue with suppliers.”

FPB has a “name and shame” campaign to highlight late-payers. UK companies including Alliance Boots, Allders, Argos, Betterware, BHS, B&Q, Cargo Homeshop, Debenhams and John Lewis, Selfridges, Tesco and Woolworths (now, of course, closed) have appeared on its Hall of Shame list in the past.

Though 30 days’ credit seems to be the most commonly acceptable norm, there is no global standard for an ethical credit period by which companies must pay their suppliers. In practice, payment terms may vary widely from payment on delivery to 90 days or more. Usually, credit for non-food goods is longer than food items. Within the food category, fresh food suppliers are most likely to get their payments earlier than packaged foods. In the non-food category, furniture suppliers, for example, may have to wait for up to 90 days.

The odds against suppliers across the world, for example in India, are stacked even higher. In 2006, the country passed a law requiring large companies to pay small suppliers within 45 days. But according to the Federation of Indian Micro and Small and Medium Industries, most companies still do not pay suppliers within six months. “Big companies have huge purchasing power. Small firms don’t want to file complaints against them for fear of losing business,” says Rajeev Karwal, founder of Milagrow, a firm that helps micro and small enterprises in India.

Small businesses complain that large companies use several ways to delay payments. Some refuse to have written contracts. A survey by the UK Better Payment Practice Group found that one-third of suppliers did not have credit terms in writing in 2006. Others do not abide by contracts.

Cunning clauses are often inserted into contracts to delay payment. For example, some say that payment will be made “30 days after the invoice has been logged into the payment processing system”. Others promise to pay “60 days from the last day of the month in which the invoice has been submitted”.

“We never received your invoice,” is one of the most common excuses. Sometimes it may just mean that the invoice failed to travel from the purchase department to the accounts payable department. Even a trivial error in the invoice can mean no payment. Suppliers do not come to know of this until they follow up. Often companies also impose settlement discounts – a 2% to 3% charge for paying on time.

Stick to agreements

But there are some companies that are setting examples of fair play. UK-based retailer John Lewis, which is among the earliest signatories to the Prompt Payment Code, has a fast-track payment system for new and start-up businesses that begins supplying to its Waitrose food stores under a nurturing suppliers scheme. “We also pride ourselves in sticking to the terms of the agreement we sign with suppliers,” says John Lewis spokesman Sam Hinton-Smith. “Fairness, flexibility and openness are the key principles of our approach to supplier relations.”

FPB’s McCabe says that bigger companies should adhere to existing payment terms and refrain from imposing unilateral changes. “Companies have to consider themselves as part of the community and recognise the impact their actions have on small businesses in the local community,” he says.

“Of course in a recession there will be times when companies may be forced to make suppliers wait for payment. But responsible companies will explain the position they are in, and seek understanding and help rather than trying to offload the problem on to suppliers,” says Mark Goyder, the director of Tomorrow’s Company, a UK-based corporate responsibility thinktank.

The global liquidity crunch is an opportunity for responsible companies to test their principles of ethical behaviour. Companies that align their goals in these difficult times with the goals of their suppliers are likely to be better able to handle the stress of economic downturn.

But companies that try to take advantage of tough times to wring suppliers risk damaging their reputations and weakening of their own supply chain. More ethical rivals, which have the support of trusted suppliers, will be more ready to prosper when the good times finally return.

Responsible payment practices

• Agree payment terms at the outset of a deal and stick to them. 
• Explain payment procedures to suppliers.
• Pay bills in accordance with the contract agreed with the supplier or as required by law.
• Inform suppliers without delay when an invoice is contested and settle disputes quickly.
• Do not reduce your bank borrowing with unauthorised free credit from suppliers.
• Do not use your financial strength to impose abnormally extended terms of payment.
• Do not use a minor invoice error as an excuse to delay payment.
• Pay suppliers on time without attempting to change payment terms retrospectively.
• Pay suppliers on time without changing practice on length of payment for smaller companies on unreasonable grounds.
  Sources: The Better Payment Practice Campaign, Institute of Credit Management, Prompt Payment Code. 

  Financing global customers

  Overseas suppliers of multinational companies, which have traditionally enjoyed a stronger guarantee of receiving full and prompt payment by obtaining irrevocable letters of credit, are now having to deal with riskier payment terms as an increasing number of buyers insist on switching to open account trading.

  A letter of credit guarantees that money will be transferred from the customer’s bank to the supplier’s bank account upon submission of shipment documents. Under open account trading, customers are able to include a payment term. A quick check with some of the biggest US retailers’ suppliers in Asia indicated that the terms varied from 30 to 60 days.

  With a letter of credit, suppliers could easily get up to 85% financing from banks. Suppliers have lost this source of funding as they switch to open account trading – another disadvantage for them. Suppliers are practically acting as unofficial financiers for retailers.