In its new directive on late payments, the Internal Market Committee (IMC) wants a maximum payment term of 30 days to be mandatory on all transactions, whether between public sector operators and private companies or between private firms (i.e. business to business).

The recommendations allow some leeway: in both cases the credit period could be extended to 60 days. In the case of B2B transactions, the extended period would have to be stipulated in the contract and could be further extended provided that it does not cause unjustified financial harm to either party. For public sector bodies the rules are stricter: there must be an exceptional reason to delay payment beyond 30 days, while 60 days is the absolute limit.

There are recommendations too for interest payments and compensation in the event of late payment.

The directive and its proposed amendments are no doubt well intentioned. But the question is, ‘Will they truly help cash strapped SMEs, and larger companies?’

The concept of maximum payment terms most definitely has merit, particularly when it comes to public bodies. The latest Atradius Payment Practices Barometer (available to download from http://www.atradius.com) shows that, in several European countries – notably the Netherlands – public sector bodies were judged by the businesses surveyed to be the worst payers.

Looking further, there are potentially other benefits as well:
» Increased incentives for cross-border trade, particularly with buyers in countries that typically use longer invoice terms.
» Fewer misunderstandings about international payment terms in Europe.
» Better receivables predictability can increase efficiency of payables, improve supply chain management and maximise manufacturing run efficiency.
» More disciplined purchasing from buyers.
» More efficient procedures for collecting payment on overdue invoices.
» And contrary to what one might expect, the legislation leaves room for flexibility in setting terms of payment.

However, legislating a maximum credit period of any number of days doesn’t necessarily guarantee timely payment. This element of the transaction still needs to be effectively managed by the supplier. We have to keep in mind that the party struggling to maintain its cash flow is just as likely to be the buyer as it is to be the supplier. In this case, there remains the possibility of a late payment occurring no matter what the payment term.

The length of the credit period is not itself a determinant of healthy cash flow. If the agreement does not put financial stress on either party and the supplier is confident of receiving payment by the due date, cash flow can be managed through intelligent credit management and a trusted portfolio of customers.

And, whether it is the supplier’s or the buyer’s cash flow that the EU directive seeks to protect, a short credit period may in some circumstances exacerbate the situation. In his article ‘The recession conundrum’, Rob Sherman expresses the following piece of absolute common sense: ‘Even the most meticulous accounts receivables efforts are ineffective if your customer simply does not have the financial means to repay their debt. So rather than fight a fruitless war, progressive finance departments are instead offering innovative solutions to their customers.’

The EU directive appears to have considered this by including flexibility for B2B transactions. What needs to be made clear is that late payment and agreed credit period are indeed two separate issues, and the parties to the sale must weigh up the best way for them to achieve a mutually successful transaction.

In his account, Sherman hits upon the salient point that perhaps one needs to read between the lines of the directive to grasp that trade credit isn’t simply a term of payment – it’s an expression of trust and a means of engendering good, long term and successful business relationships. And, in a competitive market, retaining good customers should be a top priority of any business.