The true cost of extended payment terms

By Don Frazier, VP, Network Revenue, Tradeshift

This article about extended payment terms first appeared in April 2020. All content and relevant statistics have been updated as of June 2022.

Closing a sale with a Fortune 500 brand is a thrilling moment for small and medium-sized businesses (SMBs). It’s the big payoff after all those years spent struggling to make ends meet while pursuing a dream. The new commercial partnership is a game-changer, the start of a new chapter in the company’s history. And it may be, but not for the reason they expect.

In reality, many commercial partnerships between large brands and SMBs aren’t partnerships at all., at least not equal ones. One party usually ends up holding all the cards: the enterprise buyer—and that’s because of extended payment terms.

What are extended payment terms?

Extended payment terms are a strategy buyers use that leverages paying invoices over a longer-than-normal period, which can sometimes exceed 120 days or more. Buyers have deployed this tactic with success since the global financial crisis in the late 2000s. I know from my conversations with SMBs that bigger companies are often the root cause of their cash flow pains. And the research backs that up.

Small business owners claim that bigger companies are responsible for more than half of the late payments they receive, according to Zurich. While data from J.P. Morgan shows that large enterprise buyers generally take two weeks longer to pay their sellers than small companies.

Behavior like this puts the seller in a perilous position. Either they accept the terms and figure out how to plug the hole in their cash flow, or they push back and jeopardize the deal they’ve worked for years to close.

What would you do? It’s a difficult position to be in, right?

Nobody wins by extending payment terms

Despite the pain that extended payment terms cause sellers, I understand there is logic behind the practice. Pushing out payment terms is a quick way for enterprise buyers to generate free cash flow, which, in turn, allows their treasury departments to clean up their balance sheets.

A tidy balance sheet with plenty of free cash flow is enchanting for the investment community. Now the company’s stock price increased. And when investors make money, they thank the CEO. And the CEO congratulates the CFO. And the CFO’s confidence in the treasury team grows. Everybody wins.

#DidYouKnow: 45.12% of invoices that use “Thank You” in the payment terms get paid in fewer than seven days with an additional 12.70% getting paid in fewer than 14 days?

Well, not quite everybody. What about the seller that now has to wait 90, 120, or 360 days to get paid? Do you think they’re happy? They’re lending cash to their buyer for free. Even my kid will tell you, that’s not a good strategy.

To plug this cash flow gap, sellers often turn to expensive forms of financing. Even in a low-interest-rate environment, it’s not uncommon for SMBs to have to borrow at a rate of 20% APR or more.

Who ends up paying for that? The buyer. Commoner’s 4th law states that there is no such thing as a free lunch: everything costs something. And financing is accounted for in every purchase of goods or services.

So don’t let the short-term allure of extending payment terms deceive you. It isn’t a fruitful long-term strategy. You’ll only end up paying elsewhere through price increases, reduced product quality, or reputational damage.

Consider another way forward

I understand payment terms are part of a complex financial strategy built to maximize company performance. So I’m not expecting you to slash your payment terms as soon as you finish reading this article.

But what I would like you to consider is another way forward. What if you could achieve all your cash flow objectives without negatively affecting your sellers? What if you had a strategy that generated long-term value rather than deceitful short-term gains?

It might sound too good to be true. But the next generation of supplier financing is here. And the difference is that it’s using data to accelerate payments to your sellers instead of delaying them.

In these grueling times, it might just provide your sellers with that extra bit of support they need to make it through. And, when this period of disruption is over, it will give your business a chance to reset its relationship with its sellers, ensuring that you both get maximum value from the relationship.

Find out how Tradeshift can help ease late payment worries through automation by reaching out to our team today.