As the economy improves, some businesses will find their working capital is tight. (See this working capital article, this article about Caterpillar, and the classic Business Strategy for the Economic Recovery.) As orders come in, raw materials may need to be purchased, new workers hired, deferred maintenance performed, etc. Many of these bills must be paid immediately, even if the customer won't pay for 60 days. This article is addressed to large companies buying at least some of their stuff from small companies.
The large corporations are the tightest, it seems, on payment terms. They often wait 60 days or more to pay vendors. In the case of supermarket chains, they often don't pay until long after the merchandise has been sold to consumers. It's simply a way of saying to vendors, "If you want me to sell your product, make me an interest-free loan."
I understand working capital management, but many of these corporations don't understand. Let's look at some numbers. A large corporation with good credit can float 60 day commercial paper for 0.24%, less than one quarter of one percent. Small companies with bank lines are often borrowing at prime plus two, which today is 5.25%. Many small businesses, though, are going to finance companies to factor receivables, or even using the owner's credit card. So 5.25% is pretty conservative as a borrowing cost for small business.
What's worse for small business is that many of them are constrained and cannot get all the credit they need. They are holding back on their growth because they don't have the working capital they need. Their banks are super-cautious, because conservative bank examiners are looking over shoulders. But's let's stick with the small businesses actually borrowing at 5.25%.
Let's say that the small business sells the large corporation $100,000 of widgets. Instead of paying in 10 days, the corporation demands 60 day terms. OK, that extra 50 days save the corporation $30. (50/365 times 0.24% times $100,000). What does it cost the small business to let the payment wait an extra 50 days? $719. (50/365 times 5.25 times $100,000). So the big fish saves $30, costing the small fish $719.
Here's a better tactic for the big fish: get a reputation for paying quickly, but ask for a discount. If the large corporation gets a price discount of one-half of one percent, it saves $500. It's additional interest expense of $30 is more than outweighed by the price discount. The small business? It's cheaper to give up $500 in price than $719 in interest.
Far too often corporations remove the payment decision from the purchasing manager. The CFO tells the AP department to slow payments. Instead, the benefit of slow payment should be noted on the purchasing department's ledger, so they can manage price and terms to reduce total costs.
Small business owner, what should you do when faced with a slow-paying large customer? When you figure out what price you should ask for, calculate your interest cost on the receivable. When the sales rep asks for a price discount, tell him you've already given a substantial discount in terms. Tell him your cost of credit and work through the example.
For those small businesses really constrained by lack of working capital, don't take orders from slow payers. Tell them sorry, you need to work with the fast-payers in order to grow your business. Instead of prioritizing customers by price or order size, when you are constrained by capital you should prioritize by payment promptness.