A business’ supply chain is a core operating piece, but is not always analyzed closely. Buyers and accountants have competing priorities, and often neither group has time to analyze early payment discounts and payment terms. Wouldn’t you agree that it’s compelling to save hundreds of dollars by taking advantage of these?
First, what is an early payment discount? A basic example is a vendor that offers terms of 1% 10, Net 30. This is to say that you have Net 30 days to pay the invoice in full, but if you pay within 10 days you can take a 1% discount.
The raw dollars can add up quickly. If you spend $50k at vendors that offer a 1% discount, and you’re not currently taking the discount, you’re losing $500/year! What other business function can you think of that would willingly leave $500/year on the table?
Still not convinced? When you look at a 1% discount from a finance perspective, the math is illuminating. Think of borrowing money from a bank. A bank will generally charge you interest stated as an annual rate, expressed as 360 days. If you compare Net 10 to Net 30, you’re looking at a difference of 20 days.
By dividing 360 days (1 year) by 20 days (the number of days you’re paying early), you get a multiplier of 18. For a 1% discount, multiplied by 18, your annual yield is expressed as 18%!
Converting this concept back to raw dollars, that earlier-mentioned $500 on a $50,000 investment (1%), obtained over the course of 20 days, would be expressed as an 18% annual yield. If a vendor offers even a ½% discount, that still yields 9%!
The obvious risk is cash flow. Do you rely on that extra 20 days to stretch out payments? Are you already pushing your vendors’ limits by paying them late due to cash flow problems? If you have to dip into a line of credit, borrow money, or suffer overdraft fees to obtain this discount, the early payment benefits quickly disappear.
That brings us to the second improvement topic – payment terms. If you’re struggling with cash flow for vendors that typically charge Net 10 to Net 30, why not ask for extended terms? Even an extra 10 days (Net 10 to 20, etc.) can significantly improve your cash flow.
Have you or your accountant looked at your cash conversion cycle? This metric uses a mix of sales/collections, inventory movement, and payables, to give you the approximate number of days it takes to convert these inputs into actual cash flow. One of my favorite resources, Investopedia, has a great article that explains this concept. It is truly illuminating how a small shift in payment terms can positively impact this metric.
You might ask then, how do you improve these payment terms?
In both of the above cases, you can improve terms by contacting your vendors. Don’t be shy! If you have a good relationship with them, you’ll often find they will work with you to either extend payment terms or offer early payment discounts. Strategically, most companies realize it’s a worthwhile trade-off to retain a good customer account even if they lose a small amount of financial leverage.
However, some vendors simply won’t budge. It does no harm to quote out your needs to a few other vendors who may offer more flexibility. They’re hungry to earn new business, and that gives you negotiating power to ask for improved terms from the start. You may find additional positive aspects of improved services or lower prices.
It’s your cash, and we firmly believe it’s worth the time to communicate with your vendors!
Want some help getting these hundreds back in your pocket? By leveraging technology (from a simple phone call to a Skype call or Join.me meeting) we can help you regardless of your location! We offer free consultations up to 60 minutes, and we’re available during non-traditional business hours. Contact us today to schedule your free consultation!