Monday, December 2, 2013

Who's the Bank?

Distributors as Bankers?

High interest rates must be on a lot of peoples’ minds these days. During the past month I have received several emails asking my opinion on the distributor’s role as the extender of credit; the organization providing some of the funds necessary for their customers’ operating capital.

Let’s look at the current situation: customers who expect extended terms seem to be multiplying like cockroaches in a roadside diner. In the good ole days, customers paid their local supply house distributor at the end of the next month. Some of us even offered special discounts for those who paid by the 10th of the month.

Somewhere in the late 1990s, a number of large companies (reportedly led by GE) unilaterally made the decision to pay their local distributors in 60 days rather than the normal 30 days. The conversation went something like this:
“The time and effort required to process your invoices takes us longer than 30 days. So, we’re going to start paying in 60 days. If you want our continued business, you’ll accept this policy.”

What’s a distributor to do? This big company represents important revenue; the interest rates were/are relatively low, what the heck- why not just absorb the cost of the extra days?

Fast forward through a decade and a half, and we find the typical distributor’s A/R portfolio contains dozens of companies paying in 60 days and a few who pay in 90 or even 120 days.

(For those of you shaking your heads on the 120 day thing… there are whole industries where 120-day payment is standard.)

Regular readers know I am a big fan of Abe Walking Bear Sanchez, who promotes credit as a business attractant. Mr. Sanchez suggests credit costs are just part of doing business.
I agree, however, I see a shift going on.

More and more customer organizations are coming up with excuses to pay under extended terms. The list of excuses is long but here are a few we have heard:

“Our projects take several months to finish so we don’t pay until the project is complete.”

“We pay our suppliers when we get paid from our customers.”

“All of our A/P work is done at our headquarters location, so it takes us extra time to handle your invoices.”

“Our company only does business with 60 day terms.”

At the same time, distributor supply partners require straight 30 day payment. As customers continue to push for longer payment terms, distributors lose what my dad’s generation used to call “the inventory float”. This was the time he had to sell product before he had to pay his supplier. He often made large purchases and sold them on a cash basis within days of receiving the inventory. The margins generated helped cover the cost of the inventory.

Today we see this “float” going away.

As long as interest rates remain low, the costs of supporting the inventory costs for an extra 30 or 60 days are relatively insignificant. However, an uptick in interest rates could create a negative impact on the distributor business model. And, the impact affects not only stock sales but sales made directly from supplier to customer.

As we move forward (and watch interest rates available to distributors) it may be time to examine the following:
• Is it time for lending institutions to take a new look at how they value distributor A/R numbers? Many currently seriously discount any accounts over 60 days. In a world where large companies are dragging out their payment days, is there any magic in the 30 day number?
• Should suppliers change the terms on products sold to distributors? Does it make sense for distributors to finance the manufacturer’s gross margin? Do supply partners realize how this spread in payment might impact a distributor’s ability to finance growth?

Your thoughts?


Paul Tornabene said...

This topic is of great importance to every distributor large and small. As we all know cash flow is more important than profitability. So yes with the current interest rates as they are, the actual hit to GP is relatively low (for now) the larger impact is cash flow. I hope this article generates enough discussion so that manufactures address the issue and adjust their payment terms to reflect the current environment. While distributors supply "cash float" they are not banks.

J Keith Johnson said...

Great topic!
Distributors are assaulted on multiple fronts. Not only are they losing cash flow from extended payment time frames, the incredible price pressure from those large accounts has a nasty tendency to shrink margins. This will have an exponential effect when the interest rates increase. And they will.
Further, flat sales has complicated the ability to retain or attract good talent. That issue is exacerbated by the current "healthcare" issues arising out of Washington, which is raising labor costs.
The resulting crash is on the horizon.