This may be a bit too academic for this forum but I promise this will be the only "serious" discussion thread I post this year. I believe it meets the "outside the box" criteria so here goes....

I was shocked the other day while having a few beers and discussing business with some friends. There was a National Credit Manager, a Chief Financial Officer, a Marketing Director, a Sales Director and myself. All have 20+ years experience including in international corporations.

The subject of paying creditors and creditor terms came up. I said that the last big corporate I worked for had a policy of reducing the payment terms of both creditors and debtors. Get the money in and out fast. They even went so far as to tie bonusses into making reduction targets.

The guys I was with were all horrified. They all agreed that there was only one business payment strategy....short term for debtors and as long as possible for creditors.

I disagree. Here's why. What do you think ? Who is correct and why ? This is a simplistic example but want to consider only the payment term effect, not the macroenonomic entirety.

In an economy with "X" dollars circulating (let's say $100) and with a creditor/debtor term of 30 days the potential monetary value circulating is $100 per 30 days. If the payment terms were to be doubled to 60 days the potential monetary value circulating would drop to $50 per 30 days. If the payment terms were to be halved to 15 days then the potential monetary value which could circulate becomes $200 per 30 days.

The simple examples above are intended to illustrate that shortening payment terms increases the potential monetary value circulating and therefore increases the overall level of economic activity. Shorter terms effectively increase the amount of money in circulation thereby increasing purchasing power meaning more buyers, more sales, more revenue and more profit.

Increasing payment terms conversely decreases the monetary value circulating in the overall economy resulting in less buying power, less sales, less revenue and less profit.

Credit was invented to multiply the vale of money in circulation thereby increasing economic activity in the same manner as reducing payments terms does.

What really surprised me was that these guys who were supposed to be at the top of their game seemed to be blindly reciting a mantra (learned from where ?) for short debtors/long creditors without considering the argument for shorter terms on it's merits. As for me, I don't understand why these guys advocate a business method, the tendency of which is to reduce overall economic activity and create conditions which limit the ability of their business to increase revenue and profit.

If this is indicative of how the captains of industry think then I'm afraid capitalism has no future as nobody seems to be learning anything new. I'm still shocked at the "ask no questions, accept no dissent" attitude.

While I agree there are advantages in areas of cash flow in maintaing long terms for creditors. But I don't agree that maintaing cash balances and earning interest on them is more beneficial to a company than the increase in business that could be achieved by speeding the circulation of money, especially in times of low interest rates.

For the sake of discussion can we assume that the company maintains a small cash surplus in the bank and therefore has no operating debt.

Cash flow is king. Profitable businesses go bust every day because they aren't getting paid quickly enough and so have to borrow from the Bank to buy raw materials and pay wages etc. If the profit isn't at least covering the interest charged by the Bank, then it's adios.

The likes of supermarkets have the best cash flow business model of all IMO. For instance, take delivery of 100 crates of milk and sell them all today getting money in cash from the public. 30 days later (maybe more dependant on the contract), receive the invoice from the milk company and pay the following month. luverley jubberley

Credit was invented to multiply the vale of money in circulation thereby increasing economic activity in the same manner as reducing payments terms does.

What really surprised me was that these guys who were supposed to be at the top of their game seemed to be blindly reciting a mantra (learned from where ?) for short debtors/long creditors without considering the argument for shorter terms on it's merits. As for me, I don't understand why these guys advocate a business method, the tendency of which is to reduce overall economic activity and create conditions which limit the ability of their business to increase revenue and profit.

I was in a rush in the last post, so don't think i fully answered your question from MY viewpoint.

In my view having short debtors means you are getting paid quickly and long creditors means you aren't having to pay up quickly and so the money is staying in your bank for as long as possible. However, if you have a strategic partnership with either a customer or supplier, you wouldn't want them to go bust. So this would also need to be taken into account.

As for Credit. I don't really think it was invented to multiply the value of money in circulation, i think was invented purely to sell goods to people who couldn't afford to pay for them cash. HP or On The Hock as they were once known.

Black money in the building and maintenance industry in Australia is endemic.

I'd seriously doubt if most self employed tradesmen wouldn't give a lower quoted price for cash on a job.

The tax man is spending millions every year trying to work out what these guys income should be in relation to what they are spending for materials. (Which they're paying for in cash of course).

Cash flow is king. Profitable businesses go bust every day because they aren't getting paid quickly enough and so have to borrow from the Bank to buy raw materials and pay wages etc. If the profit isn't at least covering the interest charged by the Bank, then it's adios.

The likes of supermarkets have the best cash flow business model of all IMO. For instance, take delivery of 100 crates of milk and sell them all today getting money in cash from the public. 30 days later (maybe more dependant on the contract), receive the invoice from the milk company and pay the following month. luverley jubberley

Agreed that a profitable business with bad cash flow is at risk. But if it did go bust that would be bad management IMHO.

To look at the merits of each school of thinking let's assume the cash flow is sufficient to meet operating costs and there is no debt. My point is in such a scenario, and especially like what we have now with low interest rates, what value, if any, is there in drawing out your creditor payments other than to accumulate funds in the bank which in economic terms is dead money.

(Yes, the bank can lend that money which is accumulated by businesses but would it have as beneficial economic effect as circulating directly amongst businesses directly driving demand and sales revenue ? For each dollar the bank has to lend some has to be held in reserve and some is lent for speculation which has limited economic benefit, some is lost (though not in terms of overall money in the economy) and then there are the bank's operating costs so dollar for dollar I believe it's more effective for businesses to circulate money rather than banks).

I'l have to go away and think about this. However, I know as a small business it can be a real pain if you do business with some companies who have 'end of the month' payment terms. In practical terms this can mean not being paid for 6+ weeks, which for small businesses can mean short term cash flow problems as I cant tell my staff they'll be paid in a month or so, same with the rent etc.

So on that basis you would favour shorter creditor terms, meaning you would receive your money to pay your staff sooner, who would in turn then spend their money in the general economy creating demand. QED.

Exactly!

Although my problem is that I can't delay paying my staff or rent or bills at all. This is what makes it unfair waiting for payment from 'slow' paying customers...

Many senior execs in large companies tend to make decisions that are not really the most beneficial or practical for the company they work for simply because they are playing with money that does not belong to them.

Put simply, if a company has a cash surplus after all its R&D and promotional/advertising/selling costs, it should pay its creditors on receipt. Everybody like to get paid quickly and by doing this your company always gets pole position in areas such as favourable pricing, tight supply, rush orders, dodgy QC and the list goes on & on.

I know for a fact, when I am doing business, if I have to choose between two cutomers, the one paying cash will always get his stuff before the one wanting 90 days credit.