In the last workshop, we considered the financial and ethical implications of extended pay terms with suppliers. While some people tend to view accounting and finance as black and white, with set rules that govern decisions, reality is much more complex. It is not always immediately clear which alternative best aligns with stakeholders’ interests, and we are often placed in the uncomfortable position of balancing competing interests. The decision to lengthen pay terms is a perfect example of such a dilemma. Each alternative has tradeoffs, and these tradeoffs would be viewed differently depending on your perspective. As a decision maker, your challenge is to be able to consider multiple perspectives and to fully understand the arguments for and against a position. With this assignment, you will have an opportunity to stretch your critical thinking and more fully consider the implications of a supplier pay-term decision. Be prepared to have your position challenged. You may even change your mind!
Upon successful completion of this discussion, you will be able to:
In the previous workshop, we learned more about cash flow and its critical importance to every organization. In this workshop, we dig deeper into the accounting process for recording financial transactions. When a company increases the time period it takes to pay its suppliers, it will result in an increase to its accounts payable, a credit. This credit is offset set by an increase to its cash account, a debit. Good cash flow can be used to fuel growth or simply as a safety buffer against the unexpected. Many real-world companies use this strategy, extending pay terms to 120 days or more.
However, the impact to the supplier’s books is exactly opposite to their customer’s. When a company has to wait longer to receive payment, its accounts receivable will increase, a debit. The corresponding credit is the decrease in their cash account. Whatever cash flow gains are made by a customer are exactly offset by cash flow losses at the supplier. It is a zero-sum game.
Suppliers also carry the risk of non-payment. Research has shown the longer a customer takes to pay, the less likely they are to pay at all. In order to maintain their cash flow and to help manage this risk, suppliers will sometimes make special arrangements called “factoring” or “invoice discounting.” However, such arrangements are often expensive. Then suppliers have to decide whether they should bear the cost alone, hurting their profitability, or try to pass on a price increase to their customer.
The stakes are high. Some suppliers have chosen to “fire” their customers rather than accept lengthy pay terms. This leaves the customer with fewer supply options. Other suppliers simply don’t have any choice but to accept the terms of their critical customers. A powerful customer can feign indifference right up until the supplier succumbs to the strain, resulting in declining quality or a disruption to their operations. These are but a few of the tradeoffs that must be considered when making pay-term decisions.