It’s widely known that payments from large buyers can often be slow, and this can cause a significant pressure on SMBs’ working capital. Combining this with the challenge that many SMBs have raising financing (66 percent of small businesses say that they find it “difficult to raise new business financing,” according to a recent study conducted by Pepperdine University and Dun & Bradstreet).
In the US, the White House recently launched its SupplierPay initiative (modeled on its earlier QuickPay program), which urges large companies to speed up payments to their suppliers, who are often small businesses. The aim of the initiative is simple – large companies should either commit to paying their suppliers quicker, or otherwise give them access to lower cost capital. While large companies delaying payments certainly helps them to grow their own working capital, slow payments can seriously impact suppliers’ abilities to stay in business. Research from the Kauffman Foundation showed than the amount of small businesses who cited late payments as their largest challenge rose seven-fold from 2008-2010.
It will help to keep the supply chain moving steadily, while avoiding squeezing some suppliers out of the market due to their own lack of cash. In itself, this initiative is nothing new – the UK launched a similar program back in 2012, under which large companies will notify their supplier’s bank when an invoice has been approved for payment. The bank can then offer an immediate 100 percent advance to the supplier at lower interest rates, knowing that the bill will be paid. However, the potential scale of SupplierPay means that its impact could be significantly higher.
So far, 26 large companies, such as Apple, Coca-Cola and IBM, have signed up to the voluntary program. Many of these companies are also viewed as leaders in supply chain management (there is a considerable amount of overlap between this list, and Gartner’s Supply Chain Top 25), so it’s unsurprising that the US President called on them to lead the charge.
By speeding up payments, both countries’ supply chain finance programs, if implemented correctly, will certainly benefit SMBs, and by extension will benefit the economy in general. However, can they be useful the large companies themselves, aside from a healthy dose of good PR?
Simply put, yes, very much so. Two of the most effective approaches that large companies can take to speed up supplier payments are dynamic discounting and reverse factoring. Traditional early payment discount programs – e.g. 1/10 net 30 – give an “all or nothing” discount, so if the buyer is unable to process payments in less than 10 days (which is frequently the case – many large companies simply don’t have the ability to process invoices that quickly), it has no incentive to make payments any earlier than usual, which can often make the program moot. Dynamic discounting offers greater flexibility, by providing a sliding scale discount which moves toward zero as the payment moves towards its due date. This enables the buyer to benefit from an early pay discount without the need to completely overhaul its payment processes. For the vendor, it gives them the ability to incentivise an early payment, without the rigidity of a traditional early payment program.
It’s also worth bearing in mind that if a buyer can make 1/10 net 30 payments, this is equivalent to an 18 percent – risk-free – return on corporate cash. This could lead to enormous returns for the companies who have signed up so far, who spend countless billions with their suppliers.
The other early-payment approach that is beginning to gain traction is reverse factoring, which is similar to the solution that has been proposed in the UK, and is already used by companies such as Rolls-Royce and Vodafone. Reverse factoring connects buyers, suppliers, and multiple banks through a software platform to support the early payment of invoices to a company’s suppliers. The solution provides visibility to invoices that the buyer approves for payment, enabling suppliers to opt for early payment of the approved invoices – at a favorable discount compared to financing they could receive on their own. Pre-arranged financing is provided by the banks that participate in the buyer’s supply chain finance program. As with dynamic discounting, this could provide huge returns for the participating banks, while helping suppliers get quicker access to cash.
While both of these approaches certainly speed up the payment process and help keep working capital flowing at the often-small suppliers, they can also have a significant benefit for the buyers, who can leverage their own cash reserves to get a risk-free return that is many times greater than other vehicles. From this point of view, as long as the buyer has adequate cash reserves (and most large organisations have significant funds), there should be no reason for them not to use these approaches.
These two approaches can also be used interchangeably, depending on the buyer’s availability of cash at various points throughout the year. While it’s likely that the 26 companies who initially signed up to SupplierPay are cash-rich throughout the year, others may have periods where they require external funding. If this is the case, they can then use their own high credit rating to secure low-cost financing for suppliers without the need to dig into their own funds. Corporates’ ability to optimise these approaches is also connected on the quality of their cash forecasting, so they know how much cash is available for allocation to supplier financing.
The President’s launch of SupplierPay is good news for smaller vendors, who will be able to reduce their day’s sales outstanding, ideally without needing to give up too much of their receivables in return. Given that SMBs represent employ 48.5 percent of the U.S. workforce and 59.3 percent of the UK private sector workforce, it’s absolutely critical that this vital sector of the economy is kept running smoothly.
These programs also represent sound business sense for the buyers, who can not only ensure the stability of their supply chains, but also make their own cash work harder. Hopefully the good example set by these initial 26 companies will encourage more large businesses to adopt supply chain finance programs, and give a boost to the economy as a whole.
By Andrew Burns, Sales Director, Kyriba UK