Vendor management and its relationship to cash flowby Udit Jain on June 13, 2007
Part of smarter financial management for many retailers is negotiating favorable payment terms. These terms can dramatically impact the cash fl ow for any size retailer.
There are two main issues when negotiating payment terms with vendors. One issue is when payment falls HOW TO GET TO THE NUMBERS THAT MATTER IN RETAIL due, the second is to negotiate a tiered approach to payment. For example if you secure payment terms of Net/30 – you would be expected to pay the balance in full 30 days from receipt of goods, with no interest penalties. However, many retailers can include other tiers of payment, with rebates for early payment, perhaps a 3% rebate if paid on delivery, or 1% if paid in 15 days, etc. Late payment terms can also be discussed – say, a 1% penalty for paying at 45 days, maybe 3%
for payment at 75 days, and so on.
Why are terms so important? Take diapers, for example. Say a retailer sells on average 1000 units per month. Negotiated payment terms are Net/30. If the retailer purchases 1000 units a month, and pays in 30 days, there is no financial carrying cost. Payment is made about the same time all the units are sold. If the retailer negotiates payment terms of Net/45, then they would have use of the cash for 15 days until required to send payment. The cash can be put on deposit and earn interest. While the interest earned may be a tiny percentage, it is free money. There is a school of thought in the US that many grocery retailers’ entire profit derives from the interest they earn on the cash float. (US grocery retailers average about 1.4% pre-tax profit).
When running the accounts payable and determining what invoices to pay, it is important to review the cash on hand first and assess impending cash needs. If there is sufficient cash on hand all currently due invoices can be paid. If this leaves some cash that is surplus to immediate requirements, it is often wise to review paying some other invoices early. If the settlement terms are such that the interest you lose on the cash fl oat is more than offset by the settlement discount you can take for early payment, then these invoices should be paid early. If there is insufficient cash on hand to meet all currently due invoices, then those invoices delayed for payment should be the ones with the least penalties negotiated when the terms were established. This flexibility can be so important that some organizations base part of their buyers’ bonus on improvements they can negotiate to terms.