Procter & Gamble’s New Payment Terms
Procter & Gamble (P&G) extended its payment terms for suppliers to increase its working capital. Following the 2008 economic decline, the organization’s profitability and growth had drastically decreased. Therefore, extending the payment period for its suppliers was a part of the company’s wider plans to improve its cash flow and overcome the stagnation caused by the crisis (Esty et al., 2017).
After conducting a benchmark review against other competing organizations, P&G discovered that while it had been disbursing funds to its suppliers within 45 days, its rivals paid their external business partners in 75 to 100 days (Esty et al., 2017). This implied that the firm lacked a competitive advantage over its peers because its limited working capital hindered its ability to invest in projects that would produce higher returns actively. Additionally, P&G’s revitalized emphasis on the Total Shareholder Return (TSR) metric necessitated extending its payment period for suppliers to meet its obligations.
Impact on Procter & Gamble
The new payment terms had various outcomes on P&G’s financial statement and its funding needs. Regarding the former, this strategy increased accounts payable, a liability on the organization’s balance sheet, which represents the debt owed to suppliers, such as Fibria. Conversely, the company may have incurred lower interest rate expenses because its strong AA-credit rating could have enabled it to secure funds for a supply chain financing (SCF) initiative at favorable terms. The program offered a new payment agreement to suppliers that entailed exceeding invoice disbursement periods within 30 days (Esty et al., 2017). This change enabled the firm to retain more money for a longer period, thereby improving its liquidity.
An organization with more funds can allocate them to complete priority projects quickly, driving innovation to stay ahead of competitors. SCF was part of the capital management strategy, and therefore, prolonging days to compensate the suppliers may have improved P&G’s working capital. Therefore, P&G had extra funds to allocate to day-to-day trading operations, such as making investments, business expansion, or covering expenses. Additionally, this implies that it had more cash on hand to meet its financial obligations on time.
Impact on Fibria
The new disbursement contract may have also impacted Fibria’s financial statements and funding needs. In the seller’s balance sheet, more accounts receivable reflected the amount P&G owed it. This figure includes the amount of money for goods and services that Fibria has already provided and, therefore, is recorded as a current asset on the financial statement. On the other hand, P&G’s extending payout meant all the sellers were at a disadvantage. Working under this arrangement may have caused delays and reduced their working capital. For example, this situation may have prevented Fibria from meeting its financial and operational requirements.
The terms of payment may have also affected Fibria’s funding needs. Late payment might have forced the enterprise to seek external borrowing or explore other options to access funds to sustain its ongoing operations. Although debt can allow P&G’s external partners to have more flexibility in sustaining their operations, it is also associated with high interest costs, which can impact profit margins. P&G created an alternative for suppliers to secure payment from global banks much earlier.
In this case, the SCF program allowed Fibria and other sellers to receive P&G receivables in 15 days or less (Esty et al., 2017). Therefore, when the supplier needed working capital, it could quickly borrow and meet its financial needs without using bank loans. On the downside, although SCF provided P&G receivables much faster, it did so at discounted rates. These charges can reduce Fibria’s ability to meet its obligations, as there may be no corresponding increase in revenues to offset additional costs incurred in order to receive its payments sooner.
The SCF Launch with the New Payment Terms
Typically, most corporations are interested in improving their working capital without burdening their credit lines. One widespread practice through which enterprises can achieve this is by reevaluating the payment contracts of their external partners. The approach may be less advantageous to all sellers involved, as they will have to wait longer to receive returns for goods or services that have already been delivered.
P&G’s payment extension suggests that firms, such as Fibria, may need to explore alternative funding sources to sustain their operations. Although holding on to cash and injecting it into the business might be suitable for the former, the strategy may be unsuitable because introducing a 75-day payment period for the latter can negatively impact their cash flows and even damage the ongoing partnership. These are some of the reasons that might help explain why, in April 2013, P&G simultaneously launched the SCF program, along with the new payment terms.
Concurrent implementation of these programs was a strategic move instigated to mitigate the suppliers’ response. When an organization changes a payment term and creates longer waiting periods to receive proceeds for fulfilled transactions, it may not get the buy-in from all sellers. As a buyer, P&G understood it needed to avoid creating supply chain risk to improve its cash flow.
As a result, it launched the SCF scheme to ensure its eligible suppliers are not negatively impacted by longer payment terms while maintaining a good relationship. This is because an extended period could have only benefited P&G by allowing it to have more working capital at the expense of Fibria and other partners, who could have been disadvantaged. Ultimately, they may have experienced a cash flow crisis on their part. However, SCF demonstrated P&G’s commitment to ensuring its suppliers have an option to receive their payment quickly, while also offsetting the potential adverse reaction it might have received from these sellers for changing the payment terms from 45 to 75 calendar days.
How the SCF Program Works, Its Benefits, and Competitiveness
SCF acts as a third party between P&G and its sellers. Once the invoice is fulfilled and 75 days have elapsed, the SCF banks, including Deutsche, Citigroup, and JPMorgan Chase, compensate all P&G receivables in full without imposing a discount on suppliers. However, suppose these sellers cannot wait for this period to pass to get paid; they can participate in the SCF program and request early payments. In this case, the disbursement can be made within 15 days or less; however, the amount received is usually reduced by 0.35% of the invoice’s face value (Esty et al., 2017).
This program enhances the buyer-supplier relationship by extending P&G’s payment period and, simultaneously, offering an option that enables Fibria and other external partners to request early payments. Consequently, this implies more liquidity for these suppliers and the buyer. Additionally, for a supplier like Fibria, the SCF financing rate appears competitive compared to other traditional financing options available in the market. The charge incurred by suppliers to secure P&G accounts receivable is less than the interest rates levied on loans offered by banks in the United States.
Whether SCF Is a Win-Win-Win Program
The SCF initiative offers considerable advantages to P&G, its suppliers, and the banks. In this case, the organization benefits from increasing its cash flow. Since the SCF program allows P&G to lengthen the payment period for its suppliers, it can hold a considerable amount of funds for longer, giving it the agility to allocate capital in effective growth opportunities, resulting in improved returns. Additionally, the SCF project strengthens the relationship between the organization and its external business partners, as they can receive timely payments, resulting in improved working relationships and increased collaboration.
The SCF program also offers numerous benefits to suppliers. Firstly, it offers quicker payments in 15 days instead of waiting for funds for 75 days (Esty et al., 2017). This allows these sellers to meet their supply chain needs effectively. Secondly, the SCF initiative allows external business partners to choose payment terms while maintaining a clean balance sheet.
Thirdly, through SCF, suppliers have diversified financial choices because the program presents a new source of cash, relieving the pressure of overdependence on traditional borrowing systems. Similarly, the SCF banks are also critical beneficiaries of the project. The initiative offers an opportunity for these institutions to expand their operations by linking them with P&G and its extensive supply chain. This business association generates significant revenue for the banks, enhancing their profitability and competitiveness in the market. Therefore, the SCF program is suitable for all stakeholders involved.
Recommendations Regarding Fibria’s Future Use of the SCF Program
Fibria can ensure its operations are not affected by new pavement terms if it rebids its SCF contract. In this case, the financing rates for the third parties are shown to be 0.35% of the total invoice amount, with the remaining balance due after 15 days or less. However, suppose the supplier had to borrow in U.S. dollars to finance its accounts receivable; it would incur rates of 2% to 3%, which are higher than those offered by the SCF financing option.
Reference
Esty, B., Mayfield, S. E., & Lane, D. (2017). Supply chain finance at Procter & Gamble. Harvard Business School, 1-16.