Why do payable days matter?
High-quality companies require a healthy supply chain. And a healthy supply chain requires suppliers getting paid within a reasonable time frame.Download PDF version
‘Payable Days’ is the number of days a company takes to pay its suppliers. Investors often learn in ‘Finance 101’ courses that the longer a company takes to pay its suppliers the stronger its bargaining power is with them. Consequently, this is considered as key evidence of a strong franchise.
We beg to differ.
Why is this important? Long payment cycles leave most suppliers with little choice but to borrow at high interest rates to meet cash flow needs or, eventually, dilute quality standards. Smaller and fragmented suppliers, such as farmers, are disproportionately affected by one-sided payment terms. Banks often treat such borrowers as high risk, compounding their cash flow problems.
A bankrupt, low quality or an unpredictable supply chain can do more harm to a company’s sustainability than the savings accrued in the short-term by squeezing it. Paying suppliers promptly and in reasonable time is not only the right thing to do but also the smart thing to do.
It is the right thing to do as there is a clear and quantifiable positive impact on the lives of many, particularly smaller suppliers who have been disenfranchised over decades. A more sensible approach impacts numerous Sustainable Development Goals (SDGs), including, but not limited to, no poverty, zero hunger, reduced inequality, decent work and sustainable communities. This is impact at scale.
It is also the smart thing to do because trust is built by treating suppliers well. A trusted supplier stays with you during good and bad times and will ensure quality. This positive circle of trust creates long-term entry barriers that are often underestimated by companies and investors.
‘We maintain a positive working capital by choice’, quips Marico’s Saugata Gupta.1 He goes on to explain that during times of low farm output, Marico has never felt a supply squeeze. The company attributes this potentially to the partnership they have slowly built with farmers over decades. Amongst the many positive interventions Marico makes with its farm supply chain is the philosophy of paying farmers quickly and paying them market prices. Marico clears all farmers’ dues within 7 days, with more than 50% receiving payment on the same day. Marico is one of India’s leading consumer staples companies.
‘It is diabolical that big businesses want 90-100 day credit terms from small suppliers’,2 says Don Braid, CEO of Mainfreight, New Zealand’s largest logistics services provider. He is right to be upset. Mainfreight pays its truck owners well and pays them within the first 20 days of the month. This has helped build a loyal base of truckers who value a stable long-term partnership with the company. This partnership has been crucial to their success and we believe is likely to continue to be in the foreseeable future.
The benefits of such a trust-based system is not only visible in the long term but equally it is a long-term mindset that patiently builds trust. Marico and Mainfreight are stewarded by founder-shareholders who have nurtured a strong culture that understands the importance of such stakeholder relationships. A key engagement across many of our investee companies over the years has been to improve and shorten payment cycles. We must, however, admit to not making satisfactory progress in this area.
Numbers or ESG metrics alone do not explain quality sufficiently. Numbers are a good starting point for conversations with management on various sustainability issues. Such discussions are key to our understanding of quality. Our qualitative approach has always sat comfortably with many of the fashionable ESG metrics that the investment world is obsessed with these days. We never have and never will compromise one for the other.
View our list of investment terms to help you understand the terminology within this document.
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