When large companies extend payments cycles to preserve cash, it may increase risks in the supply chain. C-level executives need to assess whether this cost management strategy is worth it.
Corporate balance and profit and loss statements are what interest boards of directors, stakeholders, and stockholders, and CFOs are seen as the stewards of these statements. A critical exercise for every company is to turn these statements into acceptable financial results. The task is accomplished by building revenues and controlling expenses.
Expense control in the past has largely been a function of controlling discretionary expenses such as those that are budgeted for in operating budgets. On a quarterly basis, CFOs sit down with other C-level executives to look at how strong revenue streams are, and whether it is necessary to do some "belt tightening" on operating expenses to meet profit projections.
In recent years, new ways for controlling operating expenses have been employed by corporate finance, such as lengthening the accounts payable payment cycle. When this cost management strategy is employed, companies are able to hang onto cash longer because they are paying their bills in 90 or even 120 days instead of on net 15-, 30-, or 60-day terms.
An attenuated accounts payable strategy works great on balance sheets and in presentations to boards and stockholders, but for the many small and midsize suppliers that support these larger enterprises' supply chains waiting long periods of time to be paid can be a disaster.
When large companies adopt very long accounts payable cycles and impose these cycles on their small and midsize suppliers that have very little leverage over the AP policy, they are actually letting their suppliers help finance their businesses — at the same time that they preserve their own cash. This strategy introduces risks for the supply chain and strains relationships with suppliers, because long payment cycles string out smaller suppliers to where they can't afford to finance the production that enterprises expect from them. Many of these suppliers aren't in a position to obtain credit or to operate on credit while they wait to get paid; this is what makes it essential for large companies to strike a balance between extending their payments cycles to preserve their own cash, and keeping their suppliers afloat.
Chrysler Group introduced a new online invoice system for vendors earlier this year that caused delays and nonpayments for dozens of suppliers, causing the company major perception issues and relationship damage with its supplier base. At least 50 indirect suppliers were not paid by the new system, and many others experienced significant delays in getting paid. There was enough turmoil for Chrysler vice present Jay Wilton to hold a "town meeting" with suppliers to clear the air.
Over the years, the automotive industry has learned from a series of painful experiences with its supplier base that extending payment cycles is not good for the sustenance of healthy supply chains. In other consumer industries such as household goods, large enterprises like Procter & Gamble have increased its supplier payment cycles by 30 days to free up over $2 billion in cash.
As a result, the question is still on the table: is extending the "wait times" of your suppliers for getting paid really worth it?
In the supply chain, managers are beginning to rigorously assess where their supplier risks are, and what the repercussions are likely to be if a supplier fails to deliver on an order. As supply chain managers drill down into the tier 2 and tier 3 suppliers that are the suppliers of their suppliers, they are uncovering visibility of very small but very important companies that might be responsible for producing a tiny screw or other component that makes or breaks the ability to assemble, complete, and deliver an entire product. If a principle (tier 1) supplier in the supply chain must wait for the enterprise to pay it, and in turn must delay payment to its own suppliers, the entire supply chain could fail. This is the current disconnect between the CFO's and the supply chain executive's office, and between the argument for "free and available" cash and the risk of suppliers that could fail and damage corporate brands.
Finding the right balance between supply chain risk and healthy balance sheets is a difficult task, but it's one every CXO in a company with a supply chain should consider.