Procurement Payment Terms

Do You Know What 4/10 Net 30 Means?

We will get to what 4/10 net 30 means shortly but we will provide some background first. A purchase order and supporting terms and conditions make up a contract between a buyer and supplier. One of the job responsibilities of a supply chain management professional is to negotiate payment terms upon which you pay a supplier. When you pay for a product or service in your own personal life, you typically pay for it upon receipt or delivery of the good or service. However, in business-to-business transactions, the supplier usually does not get paid right away. Usually, the buyer will receive the goods, parts or materials first, and then the buyer will pay for it later, sometimes much later. Buying organizations are often cash strapped. Buyers will try to negotiate to push out payments for as long as 30, 60, 90, 120 days after they actually receive a good. Suppliers are not thrilled with this, but if you trust the buyer and know that you will eventually get paid, why not? as offering extended payment terms can help a supplier win more business. Usually, large buying organizations have this kind of leverage over smaller suppliers. So, what is the current best practice standard protocol for payment terms with buyers and suppliers?

2/10 net 30

Is a 2% discount offered by the supplier if the buyer pays within 10 days, and full payment is required if payment is made after 10 days and full payment is required within 30 days.

So, if you buy $100 worth of parts from a supplier, you have to pay them at the latest, $100 30 days after you receive the goods. However, if you pay them within ten days of receiving the parts, you only pay $98. There are a lot of Vice Presidents of Procurement and Vice Presidents of Finance that are not talking to each other often enough in order to coordinate and execute this early supplier payment and discount strategy. Many companies are obsessed with negotiating payment terms with net 30, 60, 90, and 120 days. This makes sense if a company is cash strapped, but many companies do not have cash flow issues. It makes sense if you are broke and would have to borrow from a bank to pay the supplier (and if the cost of borrowing is really high). So, wait as long as possible to pay the supplier with our own cash (and hopefully you can make enough money in 30-120 days to pay your suppliers). If you cannot, then you have major cash flow issues and your margins are probably too tight to keep you in business. In which case, the bank might not even loan you any money.

A lot of companies right now have some cash on the sidelines (2008 and the great recession is over) and if so why would you sit on that cash for 30, 60, 90, and 120 days? Why not pay your suppliers early and make cash (in the form of discounts – a dollar saved is the same as adding one dollar of pre-tax profit to your company’s bottom line). You might argue that keeping the money in the bank and collecting interest on it makes you more than the price discount that the supplier is willing to give you for early payment. However, have you seen how low interest rates are and how low the cost of borrowing is in America? They are at record lows! You can borrow money to buy a house and only pay 2.25% in interest today. So, what is the strategic supply chain management opportunity here?  How about this:

4/10 net 30

Is a 4% discount offered by the supplier if the buyer pays within 10 days, and full payment is required if payment is made after 10 days and full payment is required within 30 days.

Let’s say you could actually negotiate these payment terms with a supplier, which they might go for if they could receive their money sooner, especially if you are a buyer that does not pay them until 30, 60, 90, or 120 days out. As a buyer, even if you did not have the cash to pay them within 10 days, couldn’t you even borrow money from a bank to pay early? You still come out ahead because your cost of borrowing from the bank (1-3%) is less than the discount given to you by the supplier (4%). There are also companies out there that can work with a lot of banks that would do all of this for you (all you have to do is redirect your resources towards your core competencies, assuming payment terms is not one of them, and enjoy the cost savings!).

Supply chain management is a very cross-functional discipline. Effective supply chain management requires working with your suppliers, their suppliers, your customers, their customers, and internally with engineering, sales, marketing, accounting, and even finance. For the first time in American history, interest rates and the cost of borrowing are at record lows, combined with money actually out there in the system to be borrowed. Corporate America (on the procurement side) is leaving money on the table with its antiquated payment terms with suppliers. Exploring early payments paired with discounts with your supply base could tab further costs savings opportunities while enhancing your relationships with your suppliers by creating a win-win for both parties.

-Sime