Article Source: http://online.wsj.com/news/articles/SB10001424127887324010704578418361635041842
As a major manufacturer of consumer goods, Procter and Gamble must buy large quantities of raw and unfinished materials from suppliers. Like nearly all large corporations, P&G buys their supplies on credit from their distributors. This represents an accounts payable for P&G, and an accounts receivable for the supplier.
According to the Wall Street Journal article, as of April 2013, the average payable for P&G to their suppliers was roughly 45 days. While this is better than the typical “net 30” terms a smaller company may see, company executives at P&G saw an opportunity to safely increase the amount of time that they could leverage to pay their suppliers. It is in a company’s best interest to have as much time to pay for services/goods as possible, seeing that they could use that time to generate income through operating or investing activities.
The greatest benefit for Procter and Gamble to delay their payables is that it can free up $2 billion dollars in cash. P&G could use that cash to fund a variety of things, such as stock buybacks, investing in operations, etc.
Any benefit to P&G in terms of delaying payables will have an inverse effect on their suppliers. Taking longer to receive cash will cause the supplier’s AR to swell, and may be forced to take out bridge loans from banks to cover any liquidity problems this may cause. The Wall Street Journal talked to the CEO of a Eastek International, who is a contract manufacturer of medical equipment and industrial products. Mr. Rocco stated that extended payment terms “become a cost of doing business”. He also elaborated by stating that the increased working capital demands make a company become more conservative about hiring additional employees and expanding their business in other manors. While Eastek is not a supplier of P&G, their plight regarding having the accept extended payment options from important customers is quite similar to the situation that will be facing many of P&G’s suppliers.
As seen in the article, Procter & Gamble believes that it can raise its average payable time from 45 days to 75 days. While this seems significant, many other companies in the consumer goods industry often take 60-100 days on average to square up on their payables. In order to make this change somewhat more palatable to its suppliers, Procter & Gamble is “working with banks that will offer to advance cash to suppliers after 15 days for a fee.” This would definitely help solve some of the problems that can arise when liquidity for a company dries up, but obviously is not an ideal situation for a supplier to get in. Below is a graphic illustration of the original “net 45”, and the possible implications of the new “net 75”.
One last topic the article discusses is the ripple effect that extending the time on payables can have on an industry as a whole. The larger companies will be significantly more effective in leveraging their size to receive better terms, but that may not be the case for smaller entities. These smaller companies may not receive extra time to turn around the raw goods to pay for them, and may see their suppliers increase the cost of goods, almost as a subsidy to the larger companies that are taking longer to pay for those same suppliers.
In class we have discussed different aspects that surround accounts payable and accounts receivable. Depending on whether you are a supplier or a producer, extending payment time can have either a positive or negative effect on the corporate entity. For the producer, especially one that ages their receivables, longer time frames to get paid represents a greater and greater liability (contra account) in the form of an allowance for bad debts. On the other hand, the producer, who is dealing with an accounts payable, has no such predicament. The positive nature of this for the producer comes from the extra time given to generate cash, and use it in different manors that management sees fit.
Overall, credit terms are extremely important to both parties. A producer needs some time to generate cash and pay back the supplier, while the supplier needs to be paid on a regular basis so they can maintain liquidity, and sustain their own operations. This article points out that companies with economies of scale have more leverage to dictate their payable terms, and the inverse effect it has on smaller companies in its industry, and for the suppliers that do business with those companies.
-Andrew Barnett