The good news is that they will pay more for more strategic skills…
Here is my lecture to reinforce all of this…
A Purchase Order is a contract between a buyer and supplier. Over half of our students get their first full-time jobs in procurement/purchasing/sourcing in a buyer type of role. One of those job responsibilities will be 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/service. However, in business-to-business transactions, the supplier usually does not get paid right away. Usually, the buyer will receive the goods/parts/material first, and then the buyer will pay for it later, sometimes very later. Buying organizations are often cash strapped, or simply put, they are cheap and greedy. Buyers will try to negotiate not paying for something as long as 30, 60, 90, 120 days after they actually get the stuff. Suppliers are not thrilled with this, but if you trust the buyer and know that you will eventually get paid, why not? Usually, large buying organizations have this kind of leverage over smaller suppliers. So, what is the current standard protocol for payment terms with buyers and suppliers? See below.
• 2/10 net 30
– 2% discount if paid within 10 days, full payment 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 get the parts. However, if you pay them within ten days of getting the parts, you only pay $98. Here is the thinking part of this reading assignment. I think there are a lot of VP’s of SCM and VP’s of Finance that are not talking to each other very much. My impression is that most companies are obsessed with negotiating payment terms with net 30, 60, 90, and 120 days. This makes sense to me if a company is cash strapped, but I do not think most are. It also 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.
I think most companies have some cash on the sidelines (The Great Recession of 2008) and 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, here is my point – 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 2-3% in interest today. So, what is the strategic SCM opportunity here? How about this:
• 4/10 net 30
– 4% discount if paid within 10 days, payment required within 30 days
Let’s say you could actually negotiate these payment terms with a supplier, which I think they would go for if they could get 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%). I also bet you there a lot of banks out there that would do all of this for you (all you have to do is sit back and enjoy the cost savings, and look like a superstar to your boss).
SCM is a very cross-functional discipline. Effective SCM requires working with your suppliers, their suppliers, your customers, their customers, and internally with engineering, sales/marketing, and even finance. For the first time in American history, interest rates and the cost of borrowing is at record lows, combined with money actually out there in the system to be borrowed. I personally feel corporate America (on the procurement side) is leaving money on the table with its antiquated payment terms with suppliers. I hope this makes sense to you. Please let me know if not.
Let me know if you have seen this stuff in previous course work. All of you are required to take FIN 3200 and I assume you saw this there. How did FIN 3200 go. Are any of you currently taking it 100% online. Note, long term in your careers, understanding SCM Finance will be critical. At the end of the day, SCM executives are evaluated on generating shareholder value (bottom line financial kind of stuff). Also, more and more SCM VP’s are reporting directly to the CFO of the company (because SCM is that important to the bottom line). Students often ask me, if they go on to get a graduate degree, what should they get it in. First, do not get an MBA from WMU if you are getting a BBA from WMU. You would not learn a lot more than you already know because of the overlap. I say get a graduate degree in something you are weak in but will matter in your career (especially long term). You will hit a ceiling professionally if you do not understand SCM Finance. So, I would give that serious consideration in your graduate education.
Since covid, the worlds of Finance and SCM have collided. Your opportunities are endless if you learn how to talk to the CFO…
The Monthly Metric: Cash Flow From Operations
The speed of change and the severity of challenges facing supply management organizations show no signs of abating, especially as a once-in-a-century pandemic remains uncontrolled.
So, it makes sense that measurements of organizational procurement and supply chain performance should be reevaluated to reflect changing priorities and tailor to company-wide goals. That is the focus of Metrics of the Future: Moving Supply Management Beyond Cost Reduction, a report released in September by CAPS Research, the Tempe, Arizona-based program in strategic partnership with Arizona State University and Institute for Supply Management® (ISM®).
This space covered an accompanying webinar and suggested that analytics detailed in the report would be the subject of future editions of The Monthly Metric. That process begins this month, appropriately, with a measurement that has increased in importance at many procurement organizations, due in part by the coronavirus (COVID-19): cash flow from operations (CFFO).
As the pandemic restricted businesses and slowed supply chains, cash flow became a critical issue for many companies — and especially suppliers, says Lisa M. Ellram, Ph.D., MBA, C.P.M., Rees Distinguished professor of supply chain management at Miami University in Oxford, Ohio. Ellram, one of the CAPS Research report’s authors, says that, unlike during the Great Recession of 2008-09, companies generally did not extend payment terms, a trend confirmed by surveys from ISM Research & Analytics.
“Many companies actually paid their suppliers faster — it was a matter of survival because their suppliers needed the cash flow more,” Ellram says. “So, it started to get attention and become a topic of conversation, and it’s continued to evolve since then. And part of that discussion is the role that procurement plays, and how much money is tied up in accounts payable to suppliers.”
While the report focuses on measuring and improving a procurement organization’s performance beyond cost savings, that remains a high priority for companies. Cash flow is the lifeblood of a business, Ellram says, and payment terms are a big driver of procurement’s contribution to it, though it’s not the only one. “It’s a metric that finance loves,” she says. “It helps get more attention on procurement and the contributions it makes. But it’s important to look at this metric in a holistic way, so the impact of supply chain financing on suppliers is considered. Because it can affect those relationships.”
Meaning of the Metric
The formula for calculating cash flow from operations can vary by company, but Ellram says there is consensus on where procurement organizations look first to increase it: by adjusting payment terms with suppliers. The most common adjustments involve (1) extension of payment terms, (2) discounts, (3) dynamic discounts, in which a supplier can opt to be paid sooner in exchange for a lower price, and (4) supply chain financing, facilitated by a bank or third party.
While adjusting payment terms can provide cash-flow rewards on a financial statement, Ellram says, there can be risk to supplier relationships. She cites a decision by Anheuser-Busch InBev in January 2009 — the heart of the Great Recession — to extend payment terms from 30 days to 120 days with little warning for suppliers. That created US$824 million in working capital for the St. Louis-based brewing and beverage behemoth, but its suppliers lost that capital, and most incurred substantial financing costs.
A global company like Anheuser-Busch InBev can risk alienating a key supplier; most smaller organizations do not have that luxury. In her research, Ellram found a company that extended payment terms but in later contracts with the supplier, was charged for services previously provided for free. “It will look good for the bottom line, but how will it affect other aspects of performance?” Ellram says. “I’ve talked to plenty of suppliers, and they’ll tell you when things get tight, they won’t always work harder for companies that (adjust payment terms). So, there can be competing issues at work.”
Inventory management is another vehicle to free up cash flow, usually through stock reductions or a consignment agreement with a supplier. Though CFFO measurements can be broken down by specific payment-terms or inventory-management process, Ellram says most companies prefer to capture all aspects of cash flow.
Synergy With Finance is Critical
Ellram says that CFFO can be a “dysfunctional” metric when the allure of increased short-term cash flow results in companies paying more in the end. “In many cases, it’s not free money,” she says. If a supplier is aware that payment terms could and will change, it will work that into the price.
This is especially prevalent, she adds, in dynamic discounting, in which a buyer pays the full invoice amount at the end of a payment term and a discounted price if the supplier opts to be paid early. “Suppliers will make an (overall price) calculation based on what makes a dynamic discount worthwhile for them,” Ellram says. “If they didn’t, they wouldn’t stay in business. I could argue that with people in finance until I’m blue in the face.”
That makes a holistic view of CFFO important, she adds, meaning that the procurement and finance departments must be aligned on cash-flow objectives. “It’s critical for procurement to be able to explain why the company should offer dynamic discounting and when it’s beneficial to pay a supplier more quickly,” Ellram says. “I’ve found that in a lot of cases, procurement extended payment terms because it was told to, and there was no discussion about the broader implications of it.”
The opportunity for supply management practitioners to influence organizational cash-flow decisions has likely never been higher, due in part to a pandemic that has raised awareness of the function’s importance at many companies.
“It’s important for procurement to work closely with finance to protect those supplier relationships, and procurement is in a good position to do that,” Ellram says. “That will not only improve relationships with finance and suppliers. And when finance understands that procurement is looking at cash flow in such a strategic way, that will only elevate the position of procurement in the company.”
Remember my discussion on why I recommend a Finance graduate degree for my SCM students:
Thank you. Sime
Dr. Sime (Sheema) Curkovic, Ph.D., Professor, Operations/Supply Chain
Western Michigan University, Haworth College of Business