• 7 min read

Protect Cash Flows by Strategizing Contract Payment Terms

Is it easy to find a vendor that would offer you competitive terms of procurement? No, practically, it can take time and effort to find a vendor that fits your criteria. In a complex supply chain system, vendor management can become highly complicated when many vendors are involved, as each will have its pay rates, contract payment terms, and methods of communication. Your sourcing department will spend time looking for vendors, getting quotations, and reading internet reviews, but the final selection will always be based on financial parameters and procurement payment terms. One of the often overlooked criteria in vendor contract management is vendor payment terms. 

Research shows that, in a procure-to-pay cycle, one in twelve businesses don’t monitor their payment processes at all. 

Most businesses prefer keeping their accounts receivable as low as possible, but how about enhancing the potential of the bills you owe – your accounts payable? Payment terms with suppliers will vary from industry to industry. Generally, you want as much time as you can get to pay your suppliers. As far as your cash flow is concerned, money in your pocket is preferable to money in the hands of your suppliers. However, a balance needs to be struck. Pushing for extended payment terms or simply paying invoices late, could be damaging to your relationship with your supplier. 

An overview of procurement contract payment terms and their impact on cashflow

Procurement payment terms - how do they come into play?

You typically pay for a product or service in your personal life upon receipt or delivery of the good or service. However, in B2B transactions, the supplier ordinarily does not get paid right away. Typically, the buyer will receive the goods, parts, or materials first, and then the buyer will pay for it, sometimes much later. 

(Source: Basware and Mastercard)

Buyers will always try to negotiate to push out payments for 30, 60, 90, 120 days after receiving goods or services. Suppliers are not thrilled with this, but they do extend payment terms if they trust the buyer and know that they will eventually get paid. And why not, as offering extended payment terms can help a supplier win more business. Usually, large buying enterprises have this kind of leverage over smaller suppliers. 

And that's when procurement payment terms come into play. Contract payment terms are important because knowing how much money will get debited from your account and when is essential to accurate cash flow projections. Hence, the payment terms are crucial when negotiating a contract. Your procurement contract payment terms should maximize how strategically you pay your vendors to retain working capital longer as well as and minimize inconvenience for them. A good set of contract payment terms should benefit both parties. 

Procurement payment terms - why are they essential to negotiate?

Most companies have a net-45 term. Net-45 means that buyers would make the payment 45 days after the date of invoice. When a supplier receives a purchase order, some terms and conditions apply to all invoices received. The only area of a company that can negotiate net-45 payment terms is the purchasing department. The net payment terms on which an organization will pay will be vital in determining the financial consequences and the financial risk associated with the supply and purchase contract. In some industries, suppliers face lengthening average payment terms – not to mention the challenge of collecting those terms in a timely fashion. 

Choosing net payment terms (of more than 45 days) may inconvenience your vendors as business owners, as they will have expensed the entire project without receiving income. So, your contracts should have an ideal payment term that helps you manage your cashflows as well as does not hamper your vendors’ liquidity. However, monitoring contracts by payment terms will give you a clear picture of what amount is expected to get debit and its impact on the cash flow. Based on the cash flow projection, you may consider negotiating contract payment terms that are in your favor. 

Procurement payment terms -  what if you fail to adhere to negotiated contract payment terms?

Let’s take a look at the below scenario of late and extended payments and their impact on cash flow.

A small business supplies to a large paper, packaging, and recycling company. Although the small business supplier requested 30-day payment terms, the big business applied its own terms of 60 days (on approval of the invoice). However, the company rarely pays invoices within the agreed timelines. On average, the payment is sent within 65-75 days.

Impact to vendor

  • Irregular payments after multiple follow-ups create uncertainty for the small business and impact their cash flow.
  • Due to the delayed payments, the small business is suffering difficulties in meeting tax obligations on time, paying its own suppliers and employees on time. 
  • Late payments are also contributing to the forced reduction of staff working hours. 
  • The small business believes that a termination for convenience clause is included in contracts with big businesses, so they can just get rid of small businesses for any reason. This makes it difficult for small businesses to chase late payments for fear of losing the contract.

Impact to business

  • Since the payments aren’t released on time, the AP team has no clarity on when the next is due.
  • They are unable to leverage early payment discounts, volume discounts, and trade credits as mentioned in the contract terms.
  • At times they have to pay multiple invoices altogether which hampers their cash flow.

New Hackett Group research has found that nearly one-quarter of all supplier invoices are paid late.

While most suppliers would prefer to receive prompt payments, it can help their company earn more business from a buyer. It is the responsibility of a company to review vendor contract payment terms on a regular basis because stipulations can get missed and it will help to manage cash flow more effectively. 

Procurement payment terms: Can a Source-to-pay solution help protect cashflows by monitoring contracts by payment terms?

Within complex supply chains, a single company is typically both a buyer and a supplier, part of a wider network of strategic B2B relationships. Whether you handle buy-side contracts or sell-side contracts, payment terms will have an impact on your cash flow. When an organization makes a late payment to a vendor, the relationship can deteriorate, and penalties might apply because of contractual obligations and government statutes. One way to prevent this from happening is practicing effective communication, processes and setting up automated payments. If you need to make changes to a contract, it is crucial to contact a vendor immediately to enhance the payment process.

An intelligent Source-to-pay solution monitors and analyzes your contracts (by payment terms) and will alert you when a clause or condition becomes a negotiation point. You can then focus on actually getting what you want instead of wasting time and energy trying to remember what you've agreed to. 

How does an intelligent Source-to-pay Solution help monitor contracts by payment terms?

  • Help with appropriate onboarding of suppliers, with relevant information and notification of contract terms, and correct processes to minimize the risk of not being paid on time
  • If the contract is silent on payment terms, AI notifies you to apply standard net payment terms.
  • Monitor the contract terms and payment dates and help you strategically negotiate your payment terms with vendors that can help you retain working capital longer without damaging your trade credit.
  • Intelligent contract review prevents inaccurate, fraudulent vendor billing practices which might result in duplicate payments or overpayments
  • Provide regular notifications on payment terms and the availability of volume discounts, trade credits, or other ongoing or periodic rebates. 
  • Develop supplier performance scorecards for strategic vendors and leverage these scorecards during contract negotiation

Test drive S2P suite on ServiceNow and streamline critical functions of Source-to-Contract and Procure-to-Pay domain by incorporating ML & NLP technologies.

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