accounting academy weekly ledger accounting academy weekly ledger

The Unconventional Business Strategy that's Working: Early Payment

Lauren Ruef

It’s no surprise that most finance departments are looking to cinch the belt when it comes to paying suppliers early.

The longer days payable outstanding, the better—at least—that’s how it used to be. But habits learned from leaner economic times have slipped into the collective unconscious of many AP departments. Extending days payable to the longest possible terms may put companies in a more economically advantageous position, but at what long-term cost?

Stretching days payable outstanding to near-delinquent payment terms has a very clear downside, especially when the economy is good and small suppliers feel shortchanged out of the courtesy of a timely payment. In a strong economy, suppliers are less likely to accept payment terms that don’t suit their interests.

Blue bird pulls early payment dollars from the ground
Created by Ryan Mason

Michael Hinson for CFO shares why:

“When companies strategically choose to take longer to pay their bills, they may indeed achieve a stronger cash position. However, it could come at a price, such as unhappy or cash-strapped vendors. Companies that develop a reputation as slow payers may not have the top vendors lining up to compete for their business and could end up paying higher prices.”

Good suppliers can afford to be picky, and it’s an easy choice when other competitors are offering timely payment options like credit card or ACH instead of check as a reward. Maintaining a strong relationship with suppliers ensures a stable product pipeline for your business, especially when there’s an uptick in demand for the product.

While paying late is certainly a choice for most companies, Richard Hurwitz, CEO of UK-based Tungsten Network, says the effect of late payments is more than just being conservative with cash flow. As it turns out, withholding payment from a supplier happens for a few reasons. Huruwitz says: “Late payments impact economic growth. Chasing payments is a source of frustration for suppliers and buyers alike.”

64 percent of businesses cited “slow internal processes” as the reason for delays in paying suppliers on-time as research by Tungsten Network and the Institute of Finance and Management (IOFM) shows.

While some businesses extend supplier payment terms by choice, many suffer from slow internal processes and lack of automation which lengthens payment cycles. The Institute of Finance and Management cited that 69 percent of controllers say improving cash flow visibility and cash management is their top priority.

Moving from defense to offense in payments.

Extending days payable outstanding (DPO) makes sense in dire straits when cash is needed for other critical areas of business like for a merger or acquisition. But businesses will miss out on early payment discounts and the opportunity to secure loyal suppliers as a trade off. Intentionally paying suppliers late or delinquent slows down the small business economy and makes suppliers distrustful. Technology should support business in these instances to keep payments to suppliers timely and efficient.

Electronic payment and procurement platforms are offering automated options for dynamic discounting and as blockchain enters the supply chain space, hands offs between businesses and suppliers are increasing in transparency.

The inequity suppliers face with uncomfortably long payment terms has nowhere to hide in this new environment of public ledgers and unprecedented visibility.

Though many businesses still rely on checks to pay their suppliers, this method is both time consuming and surprisingly vulnerable to fraud. While risk isn’t completely mitigated with card or ACH, payment data is far safer in the hands of a third party payments specialist than having to secure vendor banking information in-house.

Notwithstanding, it’s time consuming. Bank card programs often require customers to enroll their own suppliers for electronic payment, making any modernization of the AP process an added time burden. And what’s the use in updating your process if it only creates more work?

Paying vendors early is hedging a bet on greater reciprocity in the future.

While there are clear strategic advantages of early payment, its true benefit is something more immaterial. Leaning toward fair business practices for all parties involved paves the way for a more ethical future where suppliers are getting paid for services rendered in a timely manner. Those who have their funds early will reinvest money back into the market, benefiting the larger economy. As with most cash-related phenomena, it’s all a big trickle-down effect, for better or worse.

All of business is a balancing act between short-term gains and keeping an eye out for the future. We hedge our bets on greater reciprocity and transparency in finance, and that starts with the small things, like paying suppliers early. While it may go against conventional wisdom, this kind of reciprocity will set everyone up for a better future in finance.

 

Learn how payment automation improved supplier relations for a leading construction firm. [Get the case study]