Article 18 — When Working Capital Masks a Cost Structure Problem
The working capital program had been running for 18 months. Days sales outstanding had improved by 8 days. Inventory turn had increased. Payables were bein...
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The enterprise contract had taken 7 months to close.
The commercial team had done exceptional work. The contract value was significant, the relationship was strategically important, and the pricing had held through a difficult negotiation. In the celebration of the win, one element of the final agreement had passed without financial scrutiny. The customer had requested 90-day payment terms as a condition of signing, and the commercial team had accepted them to close the deal.
The CFO found out 3 months later when the first invoice aged past 60 days without payment and was flagged as overdue. The finance team pulled the contract. 90-day terms were clearly documented. The invoice was not overdue. It was on schedule. The business had committed to serving a $2M annual customer for 90 days before receiving the first dollar from them, and the working capital cost of that commitment had not been part of the closing conversation.
Customer payment terms are negotiated as commercial variables in the sales process. They are concessions offered to close deals, incentives to win competitive situations, and accommodations made for strategically important relationships. They are rarely examined as working capital commitments at the time they are agreed, even though their financial consequence is as real and as durable as any capital allocation decision the business makes.
When a business agrees to 90-day payment terms on a $2M annual contract, it is committing to fund approximately $500K of working capital to service that contract before receiving payment. That $500K is not a one-time commitment. It is a permanent working capital requirement that exists for as long as the contract is in place at those terms. The business must hold that capital in the operating cycle, either from its own cash or from its credit facility, at the cost of whatever rate applies to the capital it is using.
When terms are agreed across multiple contracts without working capital review, the cumulative capital commitment can be substantial. A sales team that has agreed to 60-day terms across a customer base that would have accepted 30-day terms has added months of working capital requirement to the business’s operating cycle without any financing decision being made. The capital requirement is real. It was created in the sales process rather than in the treasury function, and it is often invisible to the people managing the cash position because the terms were agreed before the finance team was involved.
Enterprise customers consistently request payment terms that are longer than the business’s standard terms as a condition of doing business. The enterprise procurement process is designed to optimize the enterprise’s own working capital, and extended supplier payment terms are one of the primary tools used to achieve that optimization. What is a working capital benefit for the enterprise is a working capital cost for the supplier.
The commercial pressure to accept enterprise terms is real. Enterprise contracts are large, strategically valuable, and competitively contested. Declining to accept the requested terms risks losing the contract to a competitor who will accept them. The commercial team’s incentive is to close the deal. The terms are a commercial concession that closes deals.
What is missing from that commercial logic is the working capital cost of the concession. A 30-day extension of payment terms on a $3M annual contract costs approximately $250K in annualized working capital at a 10% cost of capital. That cost is as real as a $250K price reduction, but it does not appear in the pricing model, the contract value, or the commercial team’s performance metrics.
“We calculated that the payment terms we had agreed with our top 10 enterprise accounts were collectively costing us $1.9M in working capital annually. Not one of those terms decisions had gone through a financial review. They had all been made in the sales process.”
Beyond the aggregate working capital cost, payment terms concentration creates a specific risk when long terms are concentrated in a small number of large accounts. When 3 customers representing 50% of revenue are all on 90-day terms, the business is funding nearly half its revenue for 3 months before collecting any cash from it. A delay in any one of those relationships, even a delay measured in days rather than weeks, creates a cash flow event.
The terms concentration risk compounds the revenue concentration risk discussed elsewhere in this series. Concentrated revenue from customers with long payment terms creates a cash flow vulnerability that is the product of both conditions simultaneously and is larger than either condition would produce alone.
How customer payment terms shape the cash flow requirements of an operating business is one of the most commercially sensitive and least financially examined dimensions of working capital management. The conversation between commercial teams and finance teams about terms is less common than it should be.
Governing customer payment terms as a working capital variable requires building financial review into the commercial process at the point where terms are negotiated rather than after the contract is signed. That review does not need to be complex. It needs to answer a single question: what is the working capital cost of these terms, and is that cost reflected in the pricing or offset by other commercial value?
“We introduced a simple terms cost calculator into the contract approval process. The commercial team was not required to reject long terms. They were required to know what those terms cost and to include that cost in the deal economics. The average terms length across new contracts dropped by 19 days in the first year.”
Terms governance also requires including payment terms in the regular working capital review, tracking the aggregate capital committed to the customer base through the terms structure, and identifying where terms extensions have been agreed that the business is not compensating for elsewhere in the commercial relationship. The businesses that do this find that the working capital cost of their terms structure is often larger than the cost reduction they have been pursuing through other working capital management initiatives, and that terms renegotiation or terms-conscious pricing is a more accessible improvement than the operational cycle changes they have been working on.
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