Credit Risk Analysis: The Real Meaning Behind Extended Terms Requests

The Real Meaning Behind Requests for Extended Terms

Are your customers asking for longer to pay?  If so, you’re not alone.

A recent working capital survey found a shift towards extended terms, and several other trends with important implications for finance professionals.  

Requests to stretch payments can be a trouble sign, but may also signal a "new normal" working capital strategy, regardless of cash flow or ability to pay.

3 Working Capital Trends to Consider

The Hackett Group’s 2016 U.S. Working Capital Survey evaluated recent working capital trends for large corporations, looking at three important metrics: DSO (Days Sales Outstanding), DPO (Days Payable Outstanding), and DIO (Days Inventory Outstanding).

Here’s what the survey found:

Receivables have been flat: In the wake of the financial crisis seven years ago, companies put processes in place to tighten up the cash conversion cycle and reduce DSO.  However, in the past 3 years, that metric has been flat, which may mean that there are few opportunities for A/R to generate further efficiency improvements in this area.

Steady improvement in payables: Companies, especially large customers like P&G, Diageo, Mars and Kellogg, have been extending terms to 75, 90 or even 120 days, even when they expect their customers to pay in 30.  Your company may be doing this with suppliers, too.

According to Craig Bailey of The Hackett Group, “We’re seeing a lot of businesses moving to extend terms. Net-60 is becoming almost standard in the United States, and some companies are pushing that out to 90 or 120 days. I’ve even come across some organizations pushing terms out even further”.

Deterioration in inventories: Inventories have been increasing, for several reasons. One reason relates to off-shoring. As companies move manufacturing offshore to reduce costs, it extends lead times and extends the supply chain, and working capital tied up in inventory increases.

hackett group 2016 working capital survey

Credit Risk Analysis: Requests to Stretch Payments

The Hackett Group working capital study also found that high performing companies were making permanent policy and process changes to manage terms, as opposed to using them as temporary measures to address short-term problems. And when interest rates rise, more companies will employ this strategy.

So when a customer wants to pay late or extend terms, how to determine the real reason behind the request?  Here are three things to consider:

Know your customer: As payment behavior shifts and longer terms become more standard, stretching payment terms may simply be an expression of leverage that your large customer knows it has. Talk to your customer, and learn the real reason for the request.

Analytics-based credit decisions: As always, there's a pattern that signals financial distress, and a data-driven financial risk score, when available, is still the best way to detect financial risk.

Look beyond payment history:  Review financial reports and ratios, market signals, and other facts to get a true picture of financial health. And when checking payment history, remember that timely payments can mask public company financial distress.

Learn to recognize the pattern of financial red flags that signals increasing credit risk. Read the bankruptcy case studies

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