Cash flow is the lifeblood of any company. It’s extremely important for businesses to optimize this aspect of financial performance to ensure they maintain a steady course in these uncertain times. Working capital is the cheapest source of cash. Its management is fundamental to a company’s financial health and operational success.
Improving working capital by a very achievable degree could reap sizeable benefits. PwC’s annual global Working Capital Study shows that, if all the companies in the study were to improve their working capital efficiency to the level of the next performance quartile, it would represent a cash release of €1.3trn for the global economy.
Long payment terms are creating significant problems for suppliers, especially for small businesses with weaker balance sheets
When improving working capital, one of the first places CFOs turn is how long it takes to pay supplier invoices. Businesses currently take on average 68 days to pay invoices, but many sectors continue to increase their payment terms. Since 2016, 11 sectors have further stretched their payable days. Extending payment terms often feels like the low-hanging fruit, improving cash flow almost instantly at the stroke of a pen. However, long payment terms are creating significant problems for suppliers, especially for small businesses with weaker balance sheets, stifling their cash flow and forcing them towards expensive credit options.
While a holistic and balanced approach to optimising payment terms and payment strategies is a legitimate and widely practiced approach, special consideration needs to be given to smaller suppliers. In a bid to extend payment terms while avoiding impacts on their suppliers, many companies are turning to supply chain finance (SCF). However, the Working Capital Study shows that the majority of SCF programmes cover only 20% of overall spend. In fact, almost half of all SCF programmes cater for just the company’s largest 25 suppliers, meaning that when a company extends its payment terms and uses SCF to buffer the impact on its suppliers, the large volume of smaller suppliers have to cope with extended terms.
While SCF can be a useful tool to help a large company manage its working capital, it is ineffective for the smallest suppliers. However, these are exactly the suppliers which struggle most with long payment terms, according to Previse data shared in the report. They are also the companies which are most likely to want access to an early payment programme, and which find it the hardest to access finance.
If we are going to make progress, businesses need to be mindful of how their decisions impact their suppliers
How then do we square the circle? From an outsider’s perspective, it is tempting to simply say we should demand buyers pay their suppliers earlier. The reality is, however, payment processes can only move so fast. Companies still have to check invoices are correct, the right goods are delivered and complete a host of important compliance tasks.
Getting suppliers paid faster is in everyone’s interest. No one benefits from 50,000 suppliers becoming insolvent each year in the UK alone. At the same time, we have to be aware of the limitations finance directors are under, and the pressures they face to improve their working capital.
If we are going to make progress, businesses need to be mindful of how their decisions impact their suppliers. This is where CFOs can show leadership in challenging their operational and commercial functions to drive structural change. This would improve working capital as well as enable relieve the pressure on suppliers.
About the authors
Daniel Windaus is a partner at PwC UK and Paul Christensen is co-founder and CEO of Previse.