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Payment terms are overdue a re-think

May 14, 2014

Recent research reveals that companies in Europe wrote off €360bn last year in bad debt. That comes on top of continuing problems with late payment, which averages 47 days beyond the number of days set out in the contract.

A report in the Financial Times includes a ‘call for action’ – though quite what steps they envisage is not clear. I think a more fundamental question is to ask what contract and negotiation experts should be doing to improve the situation.

Getting paid is fundamental to contracting. Therefore thinking through how best to avoid non-payment is a critical activity – and the numbers cited in the Financial Times report suggest we are not doing a very good job. I would suggest that one issue is that payment terms, trade finance and practices have not adjusted to commercial shifts. Markets, the nature of contractual offerings, the companies we do business with – there have been substantial changes in recent years and thinking on payment principles and guarantees has not kept pace. A few examples may help.

We are all aware of the continuing transition from product sales to services and solutions. By design, suppliers have sought to differentiate their offerings in ways that add complexity and increase apparent customization. At the same time, a continuing drive for standardization and automation of internal processes has reduced the capability to manage exceptions. Taken together, we see an increase in invoicing errors, a growth in the frequency of claims and disputes. Customers see payment as a lever; they like to delay it as long as possible. Increasingly, they also feel the need to check every invoice. And since the financial crisis in 2008, large corporations have been using supplier money to build cash – they deliberately delay payment. Outsourcing of accounts payable appears to be further exaggerating the problem. Finally, recent, highly publicized accusations of supplier fraud further undermine trust and confidence.

Vehicles to protect payment are coming back into use – a resurgence of supplier credit mechanisms such as Letters of Credit, but also some new approaches such as the ICC-backed ‘BPO’. Certainly the contracts community needs to be aware of these. But I believe more is needed and that commercial groups must become better at evaluating payment risk. Measures to achieve this include the need to ask more questions (e.g. has the customer outsourced payables?); development of shared information systems with key customers to allow data accuracy and improved tracking and problem resolution; a greater focus on the customer view of risk and how to reduce it; perhaps improved audit or checking rights to boost confidence – maybe even a penalty clause related to % invoice inaccuracy.

Payment is the issue that lies at the heart of contracting. It is far too important to allow these latest statistics to be ignored. Through IACCM, we will establish a working group to develop a set of ‘best practice’ terms and practices; I hope some of the readers of this blog will volunteer to join us.

6 Comments
  1. mohammed_Al_Asadi permalink

    Payment terms are very essential part in the contracts and we have to chose the correct payment method for each contract according to its nature to ensure financial side specialy payment in due time.

  2. Chandrashekhar Thatte permalink

    I completely subscribe to your view/concern on late payment trend and the necessity of a re-think on payment terms.A clause under Special Conditions of Contract can be introduced in the Form of Securities -Payment Guarantee by Employer to be governed by and under the Law of the Land subject to uniform rules for demand guarantee as formalized/published by International/country Chamber of Commerce as the case may be.I would like to volunteer to join the working group to develop a set of “Best Practice Terms”

  3. Hi Tim: Your blog from 2014 on reviewing and validating contractor’s invoices is very relevant today. A few months ago, I discovered a duplicate charge for travel on a contractor’s invoice, that totaled $3,500. Albeit small amount, imagine if this error occurred each month unchallenged – that is a cost leakage of $42,000! This is one area of post-award contract management that I enjoy and I’m writing to advise that I’m keen to be part of IACCM’s research committee for establishing an SOP for invoice validation. Cheers, Alex

    • Alejandro
      Thank you for your comment. It is good to be reminded of this blog – though a little disheartening that 5 years on it remains so relevant!

      Unfortunately our working group never really gained traction, but behind the scenes we have continued work in this area. Examples include:

      – at government and policy level, contributing to activities on prompt payment, especially for small/medium business;
      – in some large corporations, generating growing appreciation of the costs associated with the invoicing and payment process (cost of errors, cost of review, cost of delay – and the fact that these costs apply to both parties). We are finding opportunities to improve linked to Robotic Process Automation ((RPA) initiatives and comprehensive analysis of root causes;
      – automation more generally can assist in fixing the issues. Software such as that from SirionLabs is exposing and addressing issues. It’s also an area where blockchain technologies are starting to help.

      Finally, this will be a key area in a new book that we are working on at present. So at long last, we will develop those best practices – and any ideas or input you have will be most welcome!

  4. Tim – I echo your point regarding the material costs associated with the invoicing and payment process. There is much to be done in this space – e.g. using information technology to reduce basic counting / invoice / review errors and we should also look at the root causes, both pre- and post-contract. We’ve found that about half of the risks that materialize post-contract have a root in activities completed well before the contract is signed; the other half though arise from actions between the parties during operation of the agreement. Simple things like effective contract mobilization (where you establish a quality governance cadence) and robust obligations tracking and jeopardy management (to deliver what you said you would) go a long way to reducing the risks and issues that manifest in bad debt.

  5. paulpbranch permalink

    Tim – I echo your point regarding the material costs associated with the invoicing and payment process. There is much to be done in this space – e.g. using information technology to reduce basic counting / invoice / review errors and we should also look at the root causes, both pre- and post-contract. We’ve found that about half of the risks that materialize post-contract have a root in activities completed before the contract is signed; the other half though arise from actions during operation of the agreement. Simple things like effective contract mobilization (where you establish effective change management) and robust obligations tracking and jeopardy management go a long way to reducing the risks and issues that manifest in bad debt.

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