By Christiaan de Goeij and Michiel Steeman
Windesheim University of Applied Sciences / Supply Chain Finance Community
In recent years, many small and medium sized enterprises (SMEs) have faced extended payment terms, mainly from their larger customers. These large buyers represent a big part of their sales volume and therefore extended payment terms have a big effect in terms of working capital.
Since March 2013 there has been a law in the Netherlands to protect SMEs against late payment. The law requires that every invoice should be paid within 30 days, unless the buyer and supplier mutually agree on other payment conditions. If the buyer and supplier agree on a payment term of more than 60 days, the payment conditions should not be ‘inequitable’ for the supplier.
The current laws are not yet helping SMEs, however. There are still many suppliers who get paid after 90 or 120 days, for example. Often there is an unequal power distribution between the SMEs and the big buyers they supply. When SMEs are very dependent on a buyer, it is unlikely they will be able to change the payment terms to their own benefit.
New payment term law
Because current laws are not helping the SMEs, another new law was approved by the Senate of the Dutch Parliament in March 2017. This law says that buyers can’t offer their small and medium sized suppliers payment terms of more than 60 days. Past agreements with payment terms longer than 60 days will no longer be valid and will be converted into 30 days, after which the supplier can claim interest. This interest claim is enforceable for five years.
The law is made specifically for SMEs. SMEs are defined as companies with at least two of the following three features:
- fewer than 250 employees;
- maximum net turnover of €40m; and
- maximum asset value on the balance sheet of €20m.
Starting 1st July 2017, companies have one full year to adapt their contractual payment. On 1st July 2018, the law will be enforced for all payment term agreements in place between buyers and their small and medium-sized suppliers.
One of the concerns, especially for the group of smallest companies, is enforceability. If a big buyer pays too late it remains to be seen how a small company, with limited funds for any possible legal costs, is going to make sure they will get compensated. Also, multinationals can explore the opportunity to purchase via entities in other countries which don’t have the same payment term laws.
The new law is made to help a specific category of suppliers. It could be a lot of work for a buyer to collect all the necessary information to figure out which suppliers are in this category. Buyers do not know everything about their suppliers. Therefore, it might be better to look at other criteria which are easier to trace, such as purchasing spend.
Effects on supply chain finance instruments
Reverse factoring (RF) is currently the most used supply chain finance (SCF) instrument. Often an offer from a buyer to a supplier to join an RF programme is combined with a payment term extension. There are examples of RF programmes with payment term extensions to 60 days, but also to 90 or 120 days. Therefore, when the new law is enforced it will be less interesting for buyers to offer RF solutions to SMEs. For a certain group of SMEs that is already participating in RF programmes, and is facing payment terms above 60 days, buyers will have to look into new solutions. Buyers might offer dynamic discounting (DD) to their small and medium sized suppliers instead. Unlike RF, DD is combined with shortened payment terms. In return for that, a buyer asks for a discount on the invoice. With DD a buyer can pay a supplier in time, and still get benefits in terms of lower purchasing prices.
Consequences for buyers
A big risk for the buyer is that if they don’t change the payment terms, a supplier can claim interest – even 5 years later. Especially when a buyer-supplier relationship is over, a supplier will not hold back in making the claim. Also, the supplier can sell the interest claims to a third party. In case of a supplier bankruptcy a liquidator will go after these interest claims.
Because of the new law there will be more pressure on the buyer to provide clarity about their payment terms. Some buyers, for example, state that they will pay 60 days after the end of the month, or 60 days after the invoice approval (which often also takes 5-15 days). This means that in reality suppliers will get paid after more than 60 days after delivery. Not all suppliers, especially SMEs, are always aware which payment conditions are really agreed upon. For both buyers and suppliers it needs to be very clear when the payment term starts.
Disputes about invoices are a reason why actual payment terms might be different from contractual payment terms. For example, if a supplier makes a mistake in the invoice and has to submit a new one, the time between sending the goods and actual payment might be much longer than agreed upon in a contract. Uncertainties like this can pose a threat for buyers, who might be faced with unexpected interest claims.
Supplier segmentation expectations
For most buyers, when it comes to supplier segmentation 20% of the total number of suppliers represents around 80% of the total purchasing spend. The other 80% of suppliers represent the remaining 20% of purchasing spend. For corporates a rough classification into three groups could be made. For example (see figure 1):
- Supplier group 1: suppliers which represent a purchasing spend of more than €5m per year. There are not many suppliers in this group; however, they represent a large percentage of total purchasing spend. The biggest part of this group consists of large companies.
- Supplier group 2: suppliers which represent a purchasing spend between €200,000 and €5,000,000 per year. This group will generally consist of a mix of SMEs and large companies.
- Supplier group 3: suppliers which represent a purchasing spend that is lower than €200,000per year. Usually this group consists of a lot of companies, but they represent only a small percentage of the total purchasing spend. By far the largest part of this group will consist of SMEs.
For the three different groups of suppliers we would expect corporates to put different strategies into place. Group 1 consists mostly of large suppliers, but the new payment term law does not apply to them. Therefore, customised agreements can be made with them. It will still be interesting to offer RF programmes for suppliers in this group. There might occasionally be SMEs in group 1, but corporates with a professional purchasing department should have enough information about all suppliers who account for such a large purchasing spend and should know the size of the companies in this group. Therefore, they should be able to easily identify the suppliers in this group that cannot be offered payment terms of more than 60 days.
For the suppliers in group 2 corporates might choose a payment term in between 30 and 60 days, because these suppliers have a reasonable impact on the working capital position. Cash rich companies can consider offering these suppliers dynamic discounting, so that the buyer can get benefits from lower purchasing prices while the supplier can be paid quickly.
The suppliers in group 3 can be paid within 30 days. This will not have a big effect on the working capital position of corporates, because they only represent a small percentage of total purchasing spend. However, for this group of mainly small suppliers, fast payment can have a large positive impact.
How to prepare for the new law
Because the new law will be in effect soon, it is important for buyers and suppliers to get familiar with it soon, and make an estimation of the possible effects. There are three considerations for every buyer:
- To avoid being confronted with unexpected interest claims, buyers should be clear in their agreements with suppliers about the start of the payment term;
- Buyers and suppliers have to agree on what happens when contractual and actual payment terms are different, in case of a dispute about an invoice, for example;
- Buyers need a good supplier segmentation strategy to deal effectively with the new payment term law. In order to do that, buyers have to decide how to categorise suppliers into different groups in terms of purchasing spend. In our example, spend for Group 1 is more than €5m, spend for Group 3 is less than €200,000 and spend for Group 2 is in between. However, buyers need to decide on which exact numbers suit their supplier population best. After that, they should see which payment strategies, possibly combined with SCF instruments, they choose for these different groups of suppliers.