Maximizing Liquidity with Effective Net-Terms Management

Country music legend George Jones once asked a very important question in a semi-famous song:

“When you reckon we gon’ get paid for this?”

The answer to this question is crucial in any business transaction, it can be the source of tension between suppliers and their customers, and can even make or break the health of a supply chain. Suppliers want the answer to be “as soon as possible” and customers want the answer to be “as long as I can stretch this out”.

Enter payment terms.

Terms are the payment rules agreed upon by suppliers and their customers that are imposed to ensure that payments are received by suppliers within a reasonable period of time.

This may seem pretty straightforward, but the world of payment terms can be anything but, with things like “net 10,” “net 30,” “net 45,” “ net 10 EOM,” “1/10 net 30,” or “2/10 net 60.”

As defined: “Net” means that the full amount is due for payment. Thus, the terms of “net 20” mean that full payment is due in 20 days. Discount terms are provided as a two-part statement, where the first item is the percentage discount allowed, and the second item is the number of days within which payment can be made to receive the discount. Thus, terms of “1/10” mean that a discount of 1 percent can be taken if payment is made within 10 days. The abbreviation “EOM” means that the payer must issue payment within a certain number of days following the end of the month. Thus, terms of “net 10 EOM” mean that payment must be made in full within 10 days following the end of the month.

The benefits of longer payment terms

Longer payment terms mean higher days payable outstanding (DPO). A higher DPO is more advantageous for the buyer (and disadvantageous for the supplier), as higher DPOs result in more near-term liquidity — if a buyer can wait longer to pay its bills, it can put any excess cash reserves to work on short-term investment opportunities. For many organizations, this line of credit with their supplier is more practical than bank loans. When a longer DPO is coupled with shorter days sales outstanding (DSO), a company can create a shorter cash-conversion cycle that further increases liquidity, allowing the company to grow.

Suppliers are not thrilled about longer payment terms, but they do accept them if they trust the buyer and know they will eventually get paid (or if they lack the leverage to negotiate). But in reality, accepting extended payment terms more agreeable to the buyer can help a supplier win more business.

The benefits of shorter payment terms

While the buyer in a supply chain relationship wants longer payment terms, suppliers are vying for the opposite. The faster they get paid for their invoices (short DSO), the more cash they have on hand to keep operations running and invest in business growth. Shorter DSOs are important to small businesses as they depend on shorter payment windows to maintain cashflow. Small businesses generally do not have large cash reserves, so incoming cash is vital.

Discount terms

Discounts play an essential role in payment terms management. Some companies pay early to capitalize on discounts (those 1/10 net X terms) or to avoid paying late fees. These terms can be beneficial for both the buyer and the supplier. For the buyer, discounts help them improve the cost of goods sold (COGS) and leave extra cash to invest back into their business.

For the supplier, receiving the payment earlier – and the ability to apply that cash sooner – is more valuable than the usual one- or two-percent discount (or a diminishing percentage over time in a dynamic discounting program). In addition to the supplier’s improved cashflow, discounts improve customer relationships and give the customer an incentive to pay early (or pay at all, in some cases).

What are your terms?

Aside from those working in accounts payable (AP) or procurement departments, executives are mostly unaware if they have standardized their payment terms to suppliers. This is because there are typically several different decision-makers that must agree to terms with suppliers across departments. If neglected, and no terms standardization strategy is in place, a large company may find, over time, that it has more than 50 different net terms agreements in place.

So, while the goal for buyers is to lengthen terms or leverage discount terms, many don’t know which suppliers’ terms are already extended or discounted. On the contrary, many suppliers find it difficult to manage terms across their customers.

Managing terms effectively

Managing liquidity between buyer and supplier is the key to long-lasting relationships. While every business relationship is different, the best answers to the payment-terms puzzle are the ones that strike a balance between supporting the health of suppliers and buyers while maximizing working capital and reducing risk across the supply chain.

The first step for a buyer looking to get a handle on payment terms is to gain a thorough understanding of how and when they are paying suppliers. Depending on the accounting software systems an organization is using, this can be easier said than done.

Esker helps companies understand the current state of their AP practices, how they measure up to industry benchmarks, where liquidity is being strained, and how to unlock working capital. Esker evaluates credit, applies benchmarks, and suggests areas where businesses can see the most improvement through better terms management.

Esker’s experienced data team evaluates all dimensions of AP spending and accounts receivables (AR), including payment terms by type, discounts and fragmentation (one supplier having multiple terms). This data can be used to make recommendations about new AP practices, such as the standardization of terms to be more in line with industry benchmarks, that can improve liquidity and save company money. For receivables, suppliers can use the data to examine the terms on which they are being paid by their customers to aid in standardization across their customer base to create more informed cashflow forecasting and stronger liquidity overall.

Payment terms to mitigate risk

The data is also useful in identifying vulnerabilities in your supply chain based on: seasonality, location, supplier concentration, etc. Esker also uses the data to help you understand which suppliers could benefit the most from an early payment program to mitigate risk to their business and enhance their liquidity.

On the supplier side, Esker’s experience provides the credit services suppliers need to help evaluate the financial strength of their customers to be able to pay for the invoices or the amount of credit and what payment terms are appropriate for that business relationship.

Terms management at scale

One of the key features of Esker’s data resources regarding payment terms is the ability to scale across 1000s of suppliers and customers and exponentially more transactions. It’s easy to break down and analyze data for a handful of supplier/customer transactions. However, beyond say 25 relationships, many finance or procurement departments are stretched too thin and don’t have the data, credit or terms expertise to handle the data volume, much less make informed decisions about how to better manage terms.

There isn’t a single answer about payment terms that applies to all transactions for all businesses in all industries – the variables are virtually endless. But no matter the case, reducing risk and maximizing liquidity is absolutely critical to supply chain health and productive buyer/supplier relationships. Fortunately, that’s where Esker excels: our 25-plus years of experience can help businesses like yours better understand its terms position and help you properly manage your AP and AR processes to keep your business growing and thriving.

And, most importantly, to make sure everyone knows when they are getting paid.