The world economy is facing a black swan event. It’s also uncertain how long the Australian economy will remain in a relative state of hibernation. In these difficult times, working capital management is a key priority on any CFO’s agenda to ensure that the procure-to-payment process remains intact, whilst simultaneously preserving cash to respond to market changes and take advantage of growth opportunities.
Early payment discounts are simply one lever within working capital management that you can leverage – so let’s explore how to best access their benefits.
Why requesting early payment discounts should be a priority
Supply chain finance is a legitimate and effective tool to free up cash flow for SMEs. However, that’s not to say it can’t be misused, and Rio and Telstra are recent examples who used supply chain finance to enforce extended payment terms on their far smaller SME suppliers.
As a result, new legislation (The Payment Times Reporting Bill/Scheme 2020) was passed by the Australian Senate in September 2020, stating that as of 1st January 2021, businesses with $100M+ turnover will need to pay their suppliers with less than $10M turnover within 30 days. Clearly, the objective of this new legislation is to improve payment outcomes for smaller businesses, whilst holding bigger entities more accountable for their treatment of suppliers.
What this means for businesses everywhere, is that it’s time to be proactive. Speak to suppliers both domestic and cross border, assess liquidity levels, and avoid supply chain disruptions that could disadvantage all parties.
In an environment of drying capital markets and new legislative restrictions regarding how and when suppliers can be paid, Early Payment Discounts can be an effective tool for both Buyers and Suppliers to address these challenges – with suppliers getting paid more quickly, in return for agreed early payment discounts.
For CFOs confronted with the dilemma of having to pay suppliers quicker, versus the pressure to drive additional shareholder value and preserve cash for a rainy day, it will come down to their ability to enhance efficiency across their invoice to payment cycle (especially in companies with more indirect spend and high volumes of lower value invoices). By embracing technology however, and improving their collections, they will be able to not only pay suppliers more efficiently, but also streamline their supply chain processes.
The advantages of early payment discounts for your business
With early payment discounts, you benefit by saving on the order cost and your supplier benefits by getting funds owed to them faster. This win-win scenario can benefit both businesses in ways you may not have considered. Here are some examples:
Protecting your supply chain
Banks and even some alternative financiers are restricting their lending globally right now and access to funds is limited, even for businesses with a strong track record. Offering early payment discounts can help keep stock moving, improve liquidity, and protect your supply chain by ensuring your preferred suppliers have sufficient liquidity.
Reducing the need for funding
Paying early can help your suppliers with their financing. If the timing is managed well, your suppliers can reduce their need for funding, use their improved cash flow to grow their business or pass the liquidity onto their suppliers. In countries where interest rates are high, this can be a huge advantage and can help you build valuable goodwill.
Help maintain your supplier’s financial position
It’s important to consider the financial position of suppliers offering longer (30-60 day) payment terms. In order to provide such terms, they likely have to make use of an overdraft or receivables finance through their bank, with additional collateral being put up so as to give the provider more comfort, which can be expensive and cumbersome. By understanding their suppliers’ financial performance and offering accelerated payment, buyers can help protect their supply chain and also allow suppliers to piggyback on the their own better credit standing. Octet offers an unsecured working capital facility (Supply Chain Accelerate) that allows buyers to pay suppliers faster, in exchange for a discount, while not impeding the buyers’ debt covenants via their incumbent lender. This allows both buyers and sellers to fuel growth without impacting their balance sheet.
By offering early payments, your supplier reduces their risks of not getting paid. In an environment where there is genuine fear about businesses not surviving or coming into financial difficulty, you can build confidence and trust with your supplier.
As you can see, the advantages of an early payment discount go well beyond the cost savings. It can be a great relationship building tool that creates benefits for your business for years to come. Whether it’s reduced disruptions, priority shipping or negotiating more favourable payment terms, having strong supplier relationships can play a key role in building your competitive advantage.
Disadvantages of early payment discounts for your business
If you’re considering using this approach as a customer, you’ll need to consider the impact of early payments on your working capital. The main disadvantage is the need to impact your own cash flow in order to secure them. If you have long payment terms with your customers, this can create gaps in your cash flow.
Another point to consider is if in order to secure early payment discounts your company would need to utilise debt or equity – if your company sits on large cash reserves made up of equity, then this should generate higher returns than what you could achieve with early payment discounts, and it wouldn’t make sense to trade one for the other.
Many businesses also collect on invoices slower than they have to pay their own, which deteriorates their working capital. As additional debt leads to higher gearing, and could make it harder to service the debt and comply with key metrics imposed by the incumbent, these businesses should consider steering away from negotiating early payment discounts. However, this gap could be bridged by making use of unsecured working capital facilities, that provide additional cash while leaving your existing debt covenants untouched. This is where Octet can offer Trade Finance solutions and Supply Chain Accelerate to complement existing arrangements in a smarter way.
This approach works well in a few scenarios, including:
- If your early payment discount advantage is greater than the transaction cost being charged.
- If your early payment discount advantage is greater than your short term weighted cost of capital.
- If you’re looking to grow fast and traditional lending is capped.
The best suppliers to approach for an early payment discount
If you’ve identified early payment discounts as a good move for your business, the next step is to identify the right supplier opportunities.
You’ll be in the best position to know where to secure discounts if you get to know your suppliers and their financial situation.
Here are some ideal supplier profiles for this approach:
- Suppliers critical to your supply chain: consider how you could benefit most by strengthening relationships with certain suppliers. Do they supply a key product line, offer fast turnaround times or have the potential to support future growth plans?
- Suppliers in countries with high interest rates: a high cost of funding can be a significant expense for a business that they may be looking to avoid. As mentioned earlier, early payments can provide valuable access to lower cost funding and improve their profit margin.
- Suppliers most at risk of cash flow squeeze: if they have lengthy payment terms, difficulty accessing funds or regular financial commitments, they may welcome early payments.
- Suppliers with whom you already have great relationships: they’re most likely to accept and want to maintain the mutually beneficial relationship.
- Suppliers with a healthy profit margin who can absorb the discount.
Can you think of your suppliers who may best fit one of the profiles above? Getting a list together will help you see strategic opportunities for your business to take advantage of early payment discounts.
Looking to make an early payment request? Here’s a sample script to help
Now that you’re across the advantages of early discount payments for your business and have a list of ideal suppliers, you may be ready to take that next step.
How you approach suppliers will be key to getting buy-in. To help you start the conversation, here’s a sample email script you can adjust for each supplier or use as a basis for a phone conversation.
We’re pleased to be an ongoing buyer of your [product] and would like to thank you for your help during this challenging time.
We’ve been reviewing our payment policies recently and wondered if you’d be open to discussing an early payment discount?
We’re proposing paying your invoices within [XX] days, instead of [XX] days. In return for a faster payment, we ask you to take [X]% off the invoice.
There might be some key benefits for both of us in adopting this model, so let us know your thoughts.
Think early payment discounts may work for your business? We can help you find the best solution. Get in touch today.
Disclaimer: This article and any associated content are only our views and should not be construed as advice. You should act using your own information and judgment. Although information has been obtained from and is based upon multiple sources the author believes to be reliable, we do not guarantee its accuracy and it may be incomplete or condensed. All opinions and estimates constitute the author’s own judgment as at the date of publication and are subject to change without notice.