The Datings Game

The Datings GameIn the current troubled economic environment, firms throughout the supply chain are making hard decisions about their relationships with other members of the chain. Many of the decisions have significant financial implications. 

One of the most important considerations is the degree to which suppliers offer their distributor partners cash discounts and datings on the merchandise purchased. In a tight-credit/lowered-profit world, every supplier should review their terms of sale. To do otherwise would be to violate a fiduciary responsibility. 

However, even modest changes in the terms of sale can have an extremely negative impact on the financial results of distributors—both in cash flow and profitability. Everybody in the supply chain needs to understand how these revised terms work through the distributor organization. 

This article examines the datings/cash discount issue from two different perspectives: 

  • Impact on Financial Performance – Most suppliers, and even many distributors themselves, are not fully aware of the extent to which small changes in the cash discounts and datings offered impact results. This section will examine how such changes impact the firm.
  • Working with Suppliers – There must be specific programs in place to make sure the entire channel is working together for the best possible financial results for all concerned.
Impact of Cutting Inbound Terms and Cash Discount Rates on the Firm's Overall Financial Results

  

Impact on Financial Performance
The link between changes in supplier terms and overall financial results is outlined in Exhibit 1. The first column presents results for the typical GAWDA member based upon the latest PROFIT Report. As can be seen in the exhibit, the typical firm generates sales of $20,000,000 and produces a pre-tax profit of 5.0% of sales or $1,000,000. The firm pays its bills in 30 days and receives a 2.0% cash discount on purchases.

GAWDA members historically have produced reasonable, but unspectacular, profits. They also have operated on a very modest cash position. This is because their assets are tied up in inventory and accounts receivable, not cash.

The second column of numbers assumes that the payment period is cut in half, from 30 days to 15 days. The impact, shown at the very bottom of the column, is to cut accounts payable in half, from $925,000 to only $462,500. The effect on profit is relatively modest as the firm must pay interest on the reduction in accounts payable. Assuming a 6.0% interest rate, profit only falls by $27,750. 

The real impact is on the firm’s cash position. With less accounts payable, the firm has less cash. The result is to drive the firm’s cash position down to $212,500. Obviously, the firm would have to use its line of credit to overcome this situation, something easier said than done today. 

The third column of numbers looks at the loss of the cash discount. Here the relationship is exactly the opposite of what it was for a reduction in datings. Namely, profit is reduced dramatically, but the firm’s cash position is unchanged.

Getting Squeezed on Terms of Sale
 Distributors in most lines of trade continue to produce adequate profits despite the marked slowdown in the economy. However, as always, even small changes in sales, margin, expenses and the like can dramatically change results. In a number of lines of trade, suppliers are considering changes to the payment terms they offer to distributors. The potential changes are centered in two areas: shortening the payment terms and reducing or eliminating the cash discount offered. The Profit Planning Group has prepared an Excel template to help distributors understand how such changes would change their firm’s performance. It should be a useful starting point in discussions with suppliers. The template may be accessed here. Make changes in both datings and cash discount arrangements and see what happens. 

For ease of calculation, any changes in inventory levels are ignored and purchases are assumed to be equal to Cost of Goods Sold. With a loss of 2.0% of purchases, profit plummets from $1,000,000 to $776,000, a decline of 22.4%. 

The final column of numbers simply takes the analysis to its logical conclusion and considers both changes at the same time. Both the firm’s cash position and its profit level are moved into an untenable position. 

GAWDA members historically have produced reasonable, but unspectacular, profits. They also have operated on a very modest cash position. This is because their assets are tied up in inventory and accounts receivable, not cash. 

Distributors need to work very hard to maintain their cash position and their profitability. Even small changes can erode results very quickly. At the same time, suppliers must satisfy their own financial requirements. Clearly, a channel-wide view of the situation is needed. 

Working with Suppliers
Any potential change in supplier terms will almost certainly be met with the same response. Both sides will scream and yell and pronounce that life is unfair. After that, three specific actions are suggested. 

Supplier Education – Suppliers are often accused of not caring about distributor profitability. In almost all instances, such suggestions are unwarranted. What is true, though, is that the vast majority of suppliers do not understand distributor profitability. As a result, many well-intentioned programs may be poorly designed. 

If suppliers do not understand distributor financial results, it is at least partially the fault of distributors themselves. A very open and honest discussion as to how changes in terms and discount plans affect financial results is needed. An agreement is probably closer than everybody thinks.

Suppliers willing to work with distributors with regard to their financial position need to be rewarded for doing so. It is called loyalty.

Commitment to Suppliers – If terms and discounts are going to be provided by suppliers, then those terms and discounts must be honored by distributors. Terms of 30 days does not mean 35; it doesn’t even mean 31. 

In addition, suppliers that are willing to work with distributors with regard to their financial position need to be rewarded for doing so. It is called loyalty. 

Helping Suppliers with Their Financial Challenges – Just as supplier decisions can impact distributors in negative ways, distributors have the same potential to impact suppliers. Placing fewer, larger orders helps suppliers tremendously, just as does eliminating emergency orders, controlling errors, using electronic data interchange and a plethora of other factors. Being a good customer never hurts in financial discussions. 

Tensions between suppliers and distributors have always existed and always will. However, if both sides approach the present situation with a desire to understand and help the other side improve, such tensions can be diminished. 

Moving Forward
Changes in either datings or cash discounts is not a minor issue for GAWDA members. It is very close to life or death. It is absolutely essential that firms work with their suppliers in an effort to reach an accord that satisfies the financial needs of every channel member. 

Gases and Welding Distributors Association
Al Bates Meet the Author
Albert D. Bates, Ph.D. is founder and president of Profit Planning Group, a distribution research firm headquartered in Boulder, Colorado, and on the Web at www.profitplanninggroup.com.