Procter & Gamble (P&G) used to pay suppliers in 45 days, though that is 50% longer than normal "30 day" terms. Other consumer products and large companies are holding payments to vendors even longer, from 60 to as many as 100 days. P&G is said to be looking now for 75-day payment terms, a program that would be phased in over three years. Estimates are that this change would improve P&G's annual cash flow by some $2 billion annually, given its annual procurement spend of some $50 billion.
This change helps companies reduce their working capital, and therefore improve cash flow. Improving that cash flow enables companies to fund investments without the need to borrow any money, return some of the cash to shareholders as dividends or buybacks, and/or bolster the cash flow numbers that are closely watched by Wall Street analysts.
Working capital changes are a function of moves in three measures: days sales outstanding (accounts receivable, or how fast a company collects from customers), days payables outstanding (how fast it pays suppliers), and changes in inventory levels. Stretching out supplier payments is often the easiest of the three measures to improve - though of course, companies employing that strategy may be seeing their own customers pulling the same trick on them.
Of course, the improvements in working capital and cash flow for a company like P&G comes at the expense of the cash flow of its suppliers, which now see their own days sales outstanding rise in exact reverse fashion to the improvement in payables at their customers.
To help its suppliers weather the change, P&G is working with banks that will offer to advance cash to suppliers after 15 days of the invoice, for a fee, the Wall Street Journal says. The business of "factoring" receivable of course has been around for many decades, and while it gets a company its money faster, that comes at a price in terms of margins. The good news is that with interest rates so low currently, the hit is not too bad. For invoices from a large, financially sound company such as
P&G, the current charge for the early payment by the bank may be as little as 1.3%.
But if interest rates rise, the factoring charges will of course go up too. In the end, it means suppliers costs in effect rise, so they would have to increase prices to keep the same level of profitability. But in this environment, large companies have the real clout, and many suppliers will just have to eat the additional financing costs and find other ways to eke out a profit.
The Wall Street Journal says that auto parts maker Federal-Mogul reported its cash flow took a hit after it agreed last year to extend payment terms on $285 million in receivables from several large retail customers. But on a conference call with Wall Street analysts in February, executives said that they don't intend to continue extending payment terms in the future.
Since the recession, most companies have increased their attention on "supplier risk," with many adopting sophisticated tools to monitor their suppliers’ financial health. The irony of course is that extending payment terms will have a negative effect on a supplier’s own cash flow and financial health.
According to Financial Times, P&G’s move has resulted in other consumer goods companies upping the extended terms ante again. For example, Mondelez, the former snack foods side of Kraft before it was split off as a separate company in 2012, recently told suppliers it was extending payments terms out to 120 days, starting July 1 - that's a full one-third of a year.
In a late April letter to suppliers delivered under the subject heading of "World-Class Payment Terms," the company wrote that "Through an extensive analysis we have determined that in order to remain
competitive, reflect current industry standards, and drive world-class growth, we need to change our payment terms. Effective the week of 1 July, acceptance of orders placed by us shall be expressly conditioned on the term for payment being 120 days."
A Mondelez spokesperson told the Financial Times that "Extending our payment terms allows us to better align with industry and make sure we compete on fair grounds, while simultaneously improving transparency and predictability of payment processes."
The letter adds that Mondelez hopes the changes "will make us a more attractive and reliable customer."
The letter is from Mondelez is as follows:
Source: SCDigest