The Supplier as a Lender

Most companies may not realize that by providing goods and services to Buyers, their payment terms provide a form of a loan to their Buyers. This Loan, or Trade Credit, can be the largest user of Capital for most businesses.  Customer demand for trade credit requires sellers to provide free and flexible funding for their customers. This is called “Giving customers a free loan!”  The supplier (even a highly distressed one) is a lender, providing the next step in the chain (distributor, manufacturer, end  user etc.) with credit through payment terms.  Sometimes suppliers are the only or main source of credit for companies.

Buyers of the goods can effectively provide money to the seller through reduced payment terms without taking risk (providing the supplier fulfilled the contract).  While the decision should come down to who has the better borrowing or in finance speak (weighted average cost of capital), in reality it comes down to who has the leverage.

Payables represent the largest source of capital for more businesses than any other source.  Think about that for a minute.  If I can go to my suppliers and have the leverage to pay them in 90 days versus 45, that’s a win for me.    Companies have stretched payables over these last few years, particularly the Fortune 500, and certainly the Big Buyers have leverage to do so.

People ask me well why don’t cash rich companies pay their suppliers faster?  And it’s a good question, a relevant question.  The fact is you really need to understand how incentives work at your organization and how the Governance structure works.  Part of the reason is there is no CLEAR way to measure if earlier payment leads to reducing COGS.   Procurement staff are measured and incented to control costs. Finance staffs are incented partly to manage working capital. Conflicts exist. So this is really a Governance issue. Many corporates just dont want to be a bank to their suppliers or customers. Of course, the smart ones have designed a menu of payment options to their suppliers.  We will be exploring these subjects more in the months ahead.

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