When it makes sense to pay suppliers late

Sarah Kuta | Aug 02, 2021

Sections Finance Strategy

Collections Operations Management

Buy now; pay later—as consumers, we do this all the time with credit cards and payment plans. Companies do it, too, receiving goods and services from suppliers today and then paying for them at some later date.

This arrangement, known as trade credit, is one of the most important sources of short-term financing for businesses, amounting to trillions of dollars worldwide. Instead of paying all of their suppliers on time every month, companies often pay late, which helps them to manage cash and put pressure on suppliers to deliver high-quality goods and services on time. It also puts suppliers in the position of acting as de facto lenders.

Companies make calculated decisions about which suppliers to pay late and how long to delay payment, according to Chinese University of Hong Kong’s Jing Wu, National Chengchi University’s Hsiao-Hui Lee, and Chicago Booth’s John R. Birge. Their study identifies some of the factors that affect companies’ late payment decisions and behaviors. 

Wu, Lee, and Birge cite a 2018 survey by credit insurance provider Atradius as finding that 88 percent of companies in Western Europe had frequent late payments accounting for 42 percent of trade credit. Another credit provider, Euler Hermes, found in 2018 that global trade credits were overdue an average of 66 days, up 10 percent in a decade.

The researchers analyzed a data set from business insights company Dun & Bradstreet of invoices issued by and payments received from more than 7,000 American companies from 2004 to 2016. Businesses with greater market power made more late payments to ordinary suppliers but were likely to pay their important suppliers on time, they find. And while companies awaited payments from their own downstream customers, they often shifted those costs upstream to suppliers by delaying payment, regardless of the suppliers’ importance.

“Companies are strategic about these payment delays, using them for market power or to do this type of cost shifting,” Birge says. “Late payment is an important part of companies’ financial and operational decision-making.”

Other factors that affected the timing of companies’ payments included their access to financing, the speed at which they could borrow money, and inventory turnover rates, according to the research. Companies with good access to financing were more likely to pay on time, particularly with their important suppliers, the researchers find. And companies that could borrow money quickly tended to make more late payments. 

Though they had a greater need for making late payments to cover cash gaps, businesses with slow inventory turnover made fewer late payments, most likely because they were in a weak bargaining position with suppliers, the data suggest. Companies with prior contract breaches were likely to continue making late payments in the future, though they were less likely to do so with important suppliers.

Suppliers may want to proceed with caution if they’re planning to offer trade credit to companies with large market shares or long accounts-receivable delays, the research suggests.

When writing up contracts with some downstream companies, suppliers may want to build in explicit deadlines or higher late-payment penalties, for example. At the same time, if suppliers agree to work with powerful downstream companies, they should deliver high-quality goods and services on time to increase the likelihood of on-time payments, Birge says.

“You may want to tighten some of the terms for payment-delay penalties, but it also means you want to pay attention to your performance because they do have some market power,” he says.