Tuesday 22 November 2011

Debenhams early payment of suppliers’ invoices - how to calculate a fair share settlement discount?

According to the Financial Times, Debenhams has been allegedly offering suppliers earlier payment in exchange for a discount on their invoices, a process adopted by some other big retailers. It appears that its supplier terms can be up to 120 days, although people close to the company say it also has suppliers on 30-day payment terms.
Successful negotiation of a fair-share discount off invoice is possible using the following process:
Say, annual Invoiced sales to the Customer = £9.5m
Customer now pays in 90 days
We want him to pay in 42 days
i.e. a 48-day reduction in payment period

Customer now pays       4.06 times per year i.e. 365/90              

We want him to pay       8.7 times per year i.e. 365/42                           

Amount he owes us when paying in 90 days
                                                = £9.5m/4.06 = £2.34m
Amount he owes us when paying in 42 days
                                                = £9.5m/ 8.7  = £1.1m
Therefore the cashflow saving = £2.34m - £1.1m
                                                = £1.24m

Say the cost of borrowing is 10% interest per year
Therefore the cost of borrowing £1.24m for a year
                                                         = £0.124m

Which is equivalent to 1.3% of sales
                                          i.e.  £0.124m/£9.5 x 100%
Therefore any extra discount above 1.3% is attractive to the customer (or should be….! )
This discount is the most you should offer for a 48-day reduction in payment period!
(To tailor the calculation to your company-customer relationship, simply substitute your figures for sales, current payment periods and desired payment periods)
Incidentally, why stop at 42 days credit, a credit period in which a lot could go wrong?
In fact given the current state of the Euro-manoeuvres, we could soon enter an environment where selling to customers for cash becomes the only safe option…..!

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