120 days credit - when the customer makes you an early payment 'offer you can't refuse'....

Given the possibility that 120 days credit may become the ‘norm’, and the likelihood that retailers may offer ‘easy invoice’ arrangements for suppliers in need of cash, it may be useful to explore the financial options in advance…

In other words, when the choice amounts to 120 days net, or ‘early’ payment @ x% off invoice, what financing are we talking about?

Assumptions:
Annual invoiced sales to the customer/annum = £9.5m
Customer wants to pay in 120 days
Supplier wants to be paid in 5 days (after all, little point in going back to your current 40 days if you need money now)
i.e. a 115-day reduction in payment period

At 120 days, customer pays 3 times per year i.e. 365/120          

At 5 days, supplier wants to be paid 73 times per year i.e. 365/5                          

Amount customer owes when paying in 120 days
                                                = £9.5m/3          = £3.17m
               
Amount customer owes when paying in 5 days
                                                = £9.5m/73         = £0.13m
                                                   
i.e. Cashflow saving = £3.17m - £0.13m
                                                  = £3.04m

Say the cost of borrowing is 10% interest per year
Then the cost of borrowing £3.04m for a year
                                                  = £0.304m

Which is equivalent to 3.2% of supplier sales to customer
                                          i.e. £0.304m/£9.5m x 100%
                                                     
Then any extra discount above 3.2% is more beneficial to the customer than investing the money at 10%.

A 3.2% discount off invoice seems reasonable?
If the above supplier is making a Net Profit margin of 5%, then the £0.304m discount represents incremental sales of £6.08m, a mere 64% increase in sales to the customer, to recover the discount…

NB. Best check the above application to your latest annual results with Finance, before leaving the building…

120 days, just a Lidl bit of extra credit?

According to The Sunday Times, Lidl UK are allegedly asking some suppliers to accept 120 days payment terms.

Apart from the usual cost/risk balancing act required in unprecedented times, suppliers have to ask themselves why the extending-credit option is now featuring so prominently in supplier-retailer relationships.

Given that a retailer's working capital is made up of bank overdraft and creditors (i.e. suppliers, mainly), minus stock, debtors (i.e. shoppers, mainly) and cash, when profits are under pressure, few squeeze-options remain.

With price-cuts obligatory, bank overdrafts expensive, stock rotating 20 times/annum, the retailer's only opportunity to supplement the bottom line is via extended trade credit - apart from selling off underutilised stores (!)

Obviously, some suppliers will try to pass the cost of additional credit back up the pipeline by taking longer to pay ingredients and services suppliers. But, given the difference in added value within supplier and retailer business models - ingredients cost a supplier say 10% of their trade prices, whilst retailers pay 75% of their Net retail sales for products - a supplier would have to take 10 times longer to pay, in order to neutralise the cost of trade credit given to retailers. So a supplier is only reducing some of the pain by extending their supplier payment periods to 120 days.

However, the real issue is the need for fair payment - based on order cycle time i.e. the gap between delivery and payment by shopper - rather than the current justifications such 'on time payment' in compliance with current legislation, and trading 'norms'.

With some major suppliers moving to 120 day payment of their suppliers (see Ad Age, KamBlog) there is a very real danger that a new 'norm' of 120 days (4 months!) is being established by suppliers(!)...and retailers would be unwise not to move to this new credit period 'norm'.

In fact, it could be said that Lidl UK are simply first out of the frame, again...

The Hungarian Revolution in retail competition legislation - Why this matters to the UK NAM...

Following on from yesterday morning's post re the new trade law in Hungary re closure of unprofitable supermarkets (below), it is obvious that the Hungarian competition authorities have evolved a very effective way of neutralising some of the scale-power of major retailers.

A new model in the management of anticompetitive behaviour
Unlike more 'sophisticated' markets where a set of rules is established, and transgression is detected, proven and penalised, the Hungarian authorities have identified the ways in which large companies can exercise scale-power and are taxing such uses in order to neutralise their impact on smaller players, fast.

This is a much simpler process that does not need the help of whistle-blowers to make a case.
Details are given in the posting below of the steps already taken in taxing large companies' ability to cross-subsidise unprofitable store locations, ways of promoting (advertisement tax), provision of food services (food supervisory fee, from 0.1% of sales) and forbidding the sale of some categories (tobacco).

Application of the process to trade credit abuse
It follows that when they come to the issue of trade credit, the Hungarian authorities will not - unlike UK legislators - miss the point of trade credit abuse by penalising breaches in 'on time' payment of invoices i.e. the customer is entitled to negotiate a period of their choice -  45 to 90+ days on a 'take it or leave it basis' and be in breach only if the agreed time period is breached.

Instead, if they follow their current approach, the Hungarian authorities will calculate a method based on transfer of value time-period, plus say 5 days handling to allow for banking system 'efficiencies' which in the case of  weekly deliveries would work out at approximately 15 days from date of delivery.

The authorities would then simply apply a commercial rate of tax - say 5% minimum p/a - on any period in excess of 15 days, thus neutralising the scale power of the customer re credit period. Monies collected in this way could be then re-cycled to subsidise smaller players...

Credit period was never intended to morph from covering the gap between receipt of goods and payment by the customer's customer, to becoming  a source of free credit or working capital, at the expense of a supplier too powerless to object...

The Savvy Approach to Late Payments, Invoice-Haircuts and other power abuse..

A cross party Parliamentary inquiry into late payment will take place next week. The meeting, which will be chaired by Labour MP Debbie Abrahams, will examine just how serious the problem has become for SMEs, but will also look at other issues around poor payment practices, including so called ‘invoice haircutting’.

Catch-up
By way of background, NAMs may not be aware that the legislation is slowly catching up with reality in these matters, in that last month government regulations were updated to define 'late payments' (60+ days)  and impose interest  (Base +8% i.e. 8.5%). However, as always, these developments miss the basic point that unless the Government adopts the get-tough approach taken in other jurisdictions such as France, the measures will fail.

(To really protect SMEs you need to create a non-negotiable time limit for the payment of commercial debts. This is what happens in France, where failure to comply with the Commercial Code can result in criminal prosecution and heavy fines. An excellent article by Ben Gardner, a commercial law expert at Pinsent Masons develops this point in some detail)

The Savvy Consumer Approach
Given the fact that the savvy consumer may be beginning to appreciate that late payments, invoice hair-cuts and other power abuse like off-shore tax avoidance may be part-hindrances in their search for demonstrable value for money, it can only be hoped that any 'naming and shaming' will help to focus consumer pressure on companies that use trading partners' funds to supplement their cashflow and bottom-line.

The Savvy Supplier Approach
Without evidence, the law cannot act. However, whilst we are all aware of the commercial risk in whistle-blowing on a customer, the savvy supplier has to find 'safe' ways of making power-abuse known, hopefully  adding to the anecdotal 'evidence' that may heighten sensitivity to the issue for all parties and stakeholders..
Furthermore, repeated generic references to the increasing cost -and risk- of financing free supply-chain credit and its impact on retail prices may help when suppliers are communicating via mainstream and informal media.

The Savvy Retailer Approach
However, the real opportunity lies available for those retailers that, having run the numbers on the value of 90 days free credit, appreciate the commercial advantage of voluntarily reducing their payment period to a more equitable level, first...

What is 'fair payment'?
The current legislation, here and in France, refers to 60 days as being an appropriate period of credit.
However, whilst 60 days may be appropriate in 'normal'  B2B relationships, we believe that the payment period should be related to the supply-usage cycle. In other words, as many fast-selling SKUs are delivered daily, and food-based retailers hold an overall average of just over two weeks stocks, we would submit that 15 days credit (net) in the case of such supplier-retailer commercial relationships would be more appropriate.

Incidentally, for those NAMs that have a gap in store-visits near the Houses of Parliament next week, the all party inquiry into late payment takes place next Tuesday, April 23, at the Houses of Parliament’s Grimmond Room, Portcullis House, between 2 and 5pm.....

'Settlement fees' for early payment

Given that some retailers are offering suppliers earlier payment for a discount, it might be helpful to run the numbers and explore the financial impact on a supplier.
Assumptions
-  sales of £1.5m per annum to the retailer
-  current payment period                                 75 days, net
-  Discount for 21 days settlement                    5%

Customer now pays in 75 days
We want him to pay in 21 days
i.e. a  54-day reduction in payment period

Customer now pays 4.87 times per year i.e. 365/75          

We want him to pay 17.38 times per year i.e. 365/21              
Amount he owes us when paying in 75 days
= £1.5m/4.87 = £308,000
 
Amount he owes us when paying in 21 days
= £1.5m/17.38 = £86,306

 Cashflow saving = £308,000 -£86,306
    = £221,694
Settlement discount for 21 day payment
                                                                 = 5%   i.e.              (5% of £1.5m = £75k)
Cost of the 5% settlement            =  33.8%                (£75,000/221,694) x 100  
i.e. the supplier is paying 33.8% 'interest' on the cashflow saving

Settlement discount - how to negotiate earlier payment

Given the news that HMV and Blockbuster 'owed £490m' to creditors when they collapsed after Christmas, it is important that suppliers attempt to reduce credit periods in unprecedented times. Calculating and explaining the financial benefits of an appropriate discount for earlier payment therefore becomes a required skill in the NAM role…

S:   Given our need for reduced exposure, coupled with your constant requests for lower cost prices, we may be able to help each other out…
B:   Agreed, but I don’t see the exposure on your side? We are one of your biggest customers…
S:   So was HMV in the home entertainments category, yet they went bust ‘overnight’ leaving suppliers to find incremental sales of £4.9bn to cover losses of £490m!
B:   ??
S:   Another time…let’s focus on our trade partnership. As you know our annual sales to you are £14m, and you pay us in 45 days net.
B:   Those are our standard arrangements for all suppliers
S:   Let’s just focus on you and I…. Given the global financial turmoil, our company would feel more comfortable with 25days credit, a reduction of 20 days, and we are prepared to pay to reduce that risk…
B:   How much?
S:   Great you find it interesting… Let me work you through the calculation…
B:   Convince me…
S:   At the moment you pay us 365/45 times a year, i.e. 8 times a year, meaning you owe us £1,7m at any time… (i.e. £14m/8 = £1.7m)
B:   So?
S:   We want you to pay us 365/25 times a year, i.e. 14.6 times a year, meaning you owe us £0.96m at any time…(i.e. £14m/14.6 = £0.96m), a reduction of 20 days
B:   We would need a big discount for 20 days…
S:   I thought the same, until I worked up the numbers.  Let me show you…
B:   I have another meeting in five minutes..
S:   Won’t take that long. At 45 days you owe us £1.7m, and at 25 days the amount you owe is £0.96m, a difference of £0.74m
B:   Like I said, I’m busy…
S:   Say the cost of borrowing is 9% interest per year, so the cost of borrowing £0.74m for a year is £0.067m
B:   Where is this heading?
S:   I am trying to show you how little you need off invoice to beat 9% interest on your money…
B:   OK, another minute…
S:   That £0.067m represents 0.5% of our annual sales to you i.e. £0.067/ £14.0m x 100 = 0.5%
B:   ??
S:   In other words, 0.5% off invoice is equivalent to an interest rate of 9% per annum on your money!
Buyer:             Run that by me again?
SuperNAM:    No problem, and I’ll leave you a couple of slides to talk it through with your finance guys…

Adventures of SuperNAM (17)

Sainsbury's changes to non-foods payment terms...the bottom-line impact

According to The Telegraph, Sainsbury’s have extended its standard payment terms to 75 days for all non-food suppliers. In some cases, this will mean suppliers waiting more than twice as long for payment. In the unlikely event that a supplier decides to withhold supplies, or even attempts to negotiate a compromise, it is vital that such decisions be fact-based.

This means calculating the cost of the change in terms along the following lines: (check through the method with your finance people, and substitute your own figures)

Assumptions: 
- Supplier has a net margin of 7.5% and sells £5m per annum to the retailer, payment in 40 days, net
- Cost of borrowing is 8%

Cost to supplier of giving 40 days credit:
- Number of times per annum the supplier is paid, on 40 days        = 365/40
                                                                                                    = 9 times, approx.
- Average amount owed by retailer                                               = £5m/9
                                                                                                    = £556k i.e. a permanent loan to the retailer, interest-free
      -    Cost of borrowing to give 40 days free credit                     = £556k/100 x 8
                                                                                                     = £44.5k

Cost to supplier of payment extension to 75 days: i.e. 35 days extra
- Number of times per annum the supplier is paid, on 75 days        = 365/75
                                                                                                    = 4.9 times, approx.
- Average amount owed by retailer                                               = £5m/4.9
                                                                                                    = £1,020k i.e. a permanent loan to retailer, interest-free
- Cost of borrowing to give 75 days free credit                              = £1,020k/100 x 8
                                                                                                    = £81.6k
- Therefore cost of additional 35 days                                           = £81.6k - £44.5k
                                                                                                    = £37.1k

For the supplier, this is the equivalent of incremental sales of £494.7k (i.e. £37.1k / 7.5 x 100, a 9.9% increase in sales).

In other words, to maintain the status quo in a fair-share relationship, the supplier needs a concession from the retailer of £37.1k, or will suffer a drop in net margin on the retailer’s business from 7.5% to 6.8% (i.e. £5m/100 x 7.5 = £375k - £37.1k = £337.9k/£5m x 100 = 6.8%)

Why not run the numbers on your business, using your figures in the above calculation, to explore the impact on your bottom line, and re-assess your negotiation  strategies…?

Use of Fixed Charge Cover to spot a customer going bust?

Given the financial turmoil of the past three years resulting in further retail casualties such as Game Group, and a number of others on the brink, it is obvious that the ‘usual ratios’ such as ROCE, Net Margin, Stockturn and Gearing may be insufficient in terms of providing early warnings of trouble for suppliers.

What makes a retailer vulnerable?
A recent article in Moneyweek.com flags up the fact that if a retailer leases rather than owns its shops, it is faced with regular fixed charges for rent that must be paid, irrespective of the level of sales and profits. Moreover, if a retailer also has fairly high gearing, the interest payments represent an additional fixed cost on the business.

These Fixed Charges are ‘Lease costs’ and ‘Interest on borrowing’ and need to be compared with the ‘available Operating Profit’ i.e. the Operating profit less Fixed charges.   (these can be found on the P&L ('Interest paid' and 'Operating Profit') and early in the Notes to the Accounts ('Lease expense'), after the Balance Sheet
(NB when you find the figures, check them with your finance colleagues). 

In other words, the Fixed Charge Cover (FCC) indicates the ability of a company to pay its Fixed Charges, irrespective of sales and profit performance. Failure to pay can result in liquidation.

The following analysis compares the ‘big four’ multiples in order to illustrate the calculation in practice.

Given that these are the most financially healthy retailers in the UK, other retailers could be vulnerable..

Some of the differences are interesting in that, for instance Morrisons, because it owns most of its shops, and has relatively little borrowing, combined with a good net margin, means that with an FCC of 13.3, Fixed Charge Payments are no burden to the company. However, in the case of Tesco and Sainsburys at 2.9 and 2.2 respectively, FCC is obviously more of an issue.....
Application to other retailers?

However, the real value of the ratio is in its application to most medium and smaller retailers that are running short of cash and are finding that Fixed Charge Payments are pushing them to the edge….

As in all cases of pending liquidation, those creditors that are first to spot the danger, can have the advantage of withdrawing their credit before the liquidator is appointed.
Ignoring the Fixed Charge Cover indicator?

If you still feel that all such matters are the responsibility of the Finance Department, remind yourself that if a customer goes bust owing you £150k, and your pre-tax net profit is 5%, you will need incremental sales of £3m to recover…

In which case, perhaps the application of Fixed Charge Cover analysis to your customers’ latest Annual Reports will help…?

Optimising the Value of Trade Credit

How to calculate cost to you and value to the customer, of free trade credit
Make trade credit an integral part of the negotiation process, and not just another trade term...