net terms

Part 2 of a 7-part series on the Net Terms Economy

Last week we took a 30,000 foot view of the Net Terms Economy and saw how both buyers and sellers in the B2B world are facing tough challenges. Now, let’s come down to earth a bit, and look at the plights of sellers in this new economic reality.

First, a quick review. Fundbox, a leading fintech company, says one of the biggest challenges of the Net Terms Economy is it leaves $3.1 trillion in outstanding invoices on the table. This is an untenable situation, both for businesses and the national and global economy.

While this situation negatively affects all businesses, this can be particularly challenging for B2B companies. In this article, we’re going to look at the plight of sellers who, too often, have taken on the role of lending institutions, having to extend credit to buyers and the challenges they face as a result.

Why Sellers Act as Banks

Since a seller’s primary function in the business chain is to sell their wares, why are they even venturing into the business of loaning money? Mostly, they’re not doing it by choice. Rather, they got involved in the lending game so they can sell more products and increase their sales from buyers who wouldn’t ordinarily be able to afford the goods. As I explained in part one of this series, Are You Tired of Waiting to Get Paid?, trade credit, otherwise known as net terms, is how most businesses operate these days. Sellers offer buyers terms of 30, 60, 90 or more days, and then the sellers often wait months and months to get paid.

This can be especially hard on sellers. According to a survey conducted by PYMNTS and Fundbox, close to one-third of companies that offer trade credit say it hurts their cash flow making  their day-to-day operations more difficult. Nearly 30% (29.4% to be exact) say it “constrains their abilities to make capital expenditures, expand production (27.2%) and purchase inventory (26.6%).”

The process is also a time suck. It diverts their resources. Instead of focusing on running their businesses, sellers have to spend time evaluating the credit-worthiness of the buyers who need additional funds to purchase products. They take on the risk of a potential buyer default, something that their business was not intentionally designed to support. And then, more often than not, they have to spend even more time trying to chase down late payments. The study shows this is even harder on smaller companies that say offering trade credit prohibits them from being able to quickly purchase additional inventory because their money is tied up.  And, regardless of qualifying a buyer for net terms and the agreement to pay on time, at the end of the day, sellers are still hurt by offering net terms because it locks up their cash flow that could be used to accelerate growth.

Late Payments

Getting paid late can initiate a vicious cycle. Not only can this create an uncomfortable relationship between sellers and buyers, but a report from PYMNTS reveals 13.2% of buyers pay their suppli­ers late on average, while 27.5% of the businesses that frequently got paid late, were then late paying their own bills. This in turn affects a seller’s cash flow, as they start incurring fees for late or missed payments.

Even worse, when you’re unsure how much money you’ll actually receive from outstanding invoices, it frequently inhibits companies from making necessary monetary investments in their infrastructure, technology and more. The PYMNTS report notes, “Making business decisions and budgeting is trickier combined with cash flow constraints, especially when you’re not sure when the funds will be in the bank. This is where late payments start taking a severe toll on the success of your business.”

Ironically, the more generous the terms offered by sellers, the more likely they are to be paid late. The sellers offering payment terms between two and three months are paid late more than one-third of the time.

Even more startling, the PYMNT report reveals, “Com­panies that get paid late more than 75% of the time offer dis­counts of 5.7% on average, which is significantly higher than those offered by firms that are paid late only 10% of the time.” That’s leaving a lot of money on the table.

The worst-case scenario: 67.9% of the companies that receive more than 50% of their payments late experience frequent or routine cash-flow problems.

The larger the company, the deeper the damage: Almost 55% of companies with 500-plus buyers receive more than 25% of their payments late, while more than 72% of those with fewer than 35 clients receive over 75% of their payments on time.

But getting paid late is not the only challenge sellers living in the Net Terms Economy face. The whole process turns these businesses into financiers or “banks.” Now, in addition to doing their actual jobs, they need to dedicate time, personnel, and money into determining another company’s creditworthiness and moni­toring and enforcing their agreements.

How do they do that? The PYMNTS report shows: 26% rely on third-party credit reports to determine whether to extend credit to busi­ness partners, 13.5% consider time in business, 13.2% look at individual references, 11.8% do informal web and social media searches and 11.1% take personal relationships into consideration. That doesn’t sound like a reliable solution.  And given how often buyers are paying late, it’s obviously not.

Compounding the problem, according to the report, sellers try to incentivize buyers to pay up by offering enticements, such as extended terms and early payment dis­counts (those paid late more than 75% of the time offer average dis­counts of 5.7%), but instead of alleviating the problems, these prac­tices often perpetuate them.

This just increases the financial burden on sellers that may already be cash-strapped and facing cash flow issues. PYMNTS research indicates the average amounts to 4% of annual revenues. This translates to $317,000 a year for a firm taking in $11 million annually. Thus, businesses with lim­ited options fall into the late payments trap and struggle to dig themselves out.

How is this sustainable? The obvious answer is—it’s not.

There are solutions out there—the obvious one is to get paid quicker. As we continue this series, we’ll explore those solutions—we’ll look at immediate payment platforms, through which invoices are paid by third parties and fees are incurred if balances are revolved after 30 days. These platforms would help both establish and emerging businesses. They would free up time, money and other resources better put to other use.

Next up: we’ll look at the challenges faced by buyers living in a Net Terms Economy.

In partnership with Fundbox 

 Shutterstock photo of files by Olivier Le Moal