The #SupplierPay program grabbed a lot of headlines over the past two weeks – including here on the Construction Payment Blog (see: Obama’s SupplierPay Fails The Construction Industry). Just after 26 companies pledged to pay their suppliers faster, word came out of CFO.com that “by whatever measure you choose, big companies are taking longer and longer to pay their smaller vendors.”
The CFO.com article cites a report from the Georgia Tech Financial Analysis Lab, which found that corporate payables jumped from 35 days to 46 days between March 2009 and the present date.
This is a working capital win for big companies who benefit from pushing out their payables. As the CFO.com article even suggests, as a reality-check for the feasibility of the SupplierPay pledge, “larger companies could find themselves seriously short of free cash flow if they slash their days payable.”
The extended payment terms are an obvious loss for smaller organizations, however, as they are getting stretched on cash and must rely on expensive capital access options.
Are Supply Chain Payment Term Averages Meaningless for the Construction Industry?
Those CFOs and CFMs in the construction must look at these payment term studies with a bit of context.
The construction industry has an unique payment paradigm. An invoice may propose payment terms, but the timing of payment is really regulated by a ballet of practical and legal considerations. Practically, invoices must get passed up the chain, and then approved and paid, whereupon the money must travel all the way back down the chain. Legally, most states have prompt payment laws on the books already, which require fast payments down the chain.
So, what difference does it make that Proctor & Gamble is taking 45 days to pay small suppliers, instead of their typical 35 days?
On the one hand, the Proctor & Gamble activity is irrelevant to the construction industry. On the other hand, it’s an unavoidable representation of the business mindset of any company who has cash in hand…including those in construction.
The CFO.com article reporting that payables are increasing with big companies has a great two paragraph explanation of what this means to small organizations:
To put the 11-day increase in payables days over the last five years in context, Mulford poses the example of a larger company that purchases about $83,000 in inventory from a smaller company every 30 days. An increase in the number of payables days from 35 to 46 would enable the bigger company to hang on to about an extra $30,000 for the month.
On the other hand, if the larger company’s days payable were reduced back to 35 days, the smaller company would have access to that $30,000 in cash each month.
In the construction world, it’s crazy to think that those without cash-in-hand aren’t appreciative of their advantage. While the extension of payables isn’t an extension of payment terms in the traditional sense, general contractors, subcontractors, and everyone else in the payment chain gets cash and holds onto it as long as possible.
The problem is actually exasperated in the construction world because those at the bottom of the chain must wait for everyone above them to part ways with the cash flow advantage.
There’s Only One Solution for Construction Players: Security Rights To Prioritize Payment
Mechanics liens, bond claims, preliminary notices, and other instruments associated with security rights in the construction industry gets a bad reputation. In fact, the reputation is so soiled that most companies go around swearing they don’t use lien rights. If I had a nickel for every company who denies having anything to do with security rights….
Notwithstanding the denial and the often-seen sense that Lien is a 4 Letter Word, the use of mechanics lien rights and security rights is real, present, and popular in the construction industry. In fact, it’s necessary.
Those at the top of the chain spend big money on technology products to mitigate their lien exposure, and those at the bottom of the chain spend big money to preserve their lien rights. All the while, everyone spends an unbearable amount of time keeping track of it all.
When the cash comes out…those subcontractors and suppliers who use their security rights get paid fast, and get paid first. It’s proven.