Saturday, February 12, 2011

Negotiation - Thoughts on Negotiating Payment terms

In negotiating payment terms you negotiate:
·       The actual term for payment (such as net 45 days);
·       The event that authorizes payment (such as from the date of delivery or date of shipment);
·       The requirements for making any payment (such as the receipt of a correct and conforming invoice).

As Supplier’s have experienced unscrupulous customers who use delaying tactics to delay making the actual payment to get the benefits of the cash flow, most Suppliers want a firm commitment to pay that is tied to an easily tracked event and may want to charge interest for late payments. As you have the most leverage to get problems resolve before you make payment, always seek to negotiate the payment term to have the payment be made well after you have received and have the ability to test or inspect the item to ensure it works and meets the requirements. If you require longer terms to perform acceptance and test, you may consider a form of payment schedule where you continue to retain a substantial portion of the price until the required acceptances can be performed so you keep that leverage.

When dealing with work that routinely involves a payment schedule, Suppliers will always have the tendency to try to front end load the schedule so they both get free financing of the work but also to reduce the risk of what they may lose if they don’t complete the work. Always make sure that you pay them less than the value of the work they have performed so you have that difference and the natural lag in payments as leverage to get the work done. Always avoid having the obligation of payment from being separated from the Suppliers obligation to perform. For example, never tie a payment schedule to dates alone as the Supplier could be substantially behind in performing. Link payments to a clear deliverable or milestone that they have to meet to be paid.

Suppliers will want some protections against being abused on payments, especially for the issue of non-conforming invoices. When needed you can add the specific requirements for a conforming invoice to your contract so it’s clear what they need to provide.

On the issue of late payments, a lot depends on how the rest of your contract is structured. If you clearly have provisions in your contract where you can collect from them every time they don’t do what they committed to do you may need to grudgingly agree. If you don’t have damages they must pay if they don't perform, I would link the two together and offer them a deal. If they pay damages every time they fail to perform, you will pay them late payment charges every time you don't perform. 
If you give them leeway before they are subject to damages or costs, look for leeway in return regarding when late payment charges will be collected.. If you must agree to pay late payment interest charges always negotiate a rate that is close to their cost of money and never leave it open ended. If you leave it open, they can charge the maximum amount that is allowable by law in that jurisdiction and that could be substantial.

Aside from the administrative requirements of invoices required for payment the only other thing you may do is agree upon how frequently you may be billed and whether that may be done electronically or not. A Supplier relationship may have a huge number of transactions that if billed separately would create a blizzard of paperwork and overwhelm your accounts payable function. So most times you try to negotiate monthly consolidated billings or bi-weekly consolidated billings. As most companies do disbursements only once or twice a month, daily or weekly invoicing would really wind up being scheduled to be paid for one of those disbursement times and wouldn’t provide any advantage.

When Suppliers are concerned about collection, which can especially be the case with international sales, they might want what’s called a “Letter of Credit” or Bank Guarantee.  Letters of credit are issued by financial institutions and guarantee payment by the financial institution upon completion of the conditions that are stated in the Letter of Credit. The Supplier needs to provide proof that they have met the requirements of the letter of credit.  Commonly providing a copy of the “Bill of Lading” showing proof of delivery to a carrier would be common in Letter of Credit requirements.  Payment under a letter of credit does not need to be immediate, it can be set at a point in time in the future after the conditions have been met. While Letters of Credit may be good for the Supplier in making sure they get paid, they aren’t good for the Buyer. First they cost money to create and unless the Buyer has a credit line with the financial institution they would tie up the Buyer’s capital from the issuance of the Letter of Credit until delivery occurs and payment is made. Worse is the fact that you are paying for what you purchased before you are able to test or inspect the product. That places the risk of collection on the Buyer if its defective and the price should be refunded. It also gives the Buyer no leverage to get corrections made as they have been paid.  

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