When the Customer Wants More…
Calculating the financial impact of increased payment terms
(A key issue analysis from Namnews December 2005 - details click here)
Copyright EMR-Namnews Ltd

Halfords’ recent alleged demands for increased payment terms from suppliers can be placed in negotiating perspective by assessing the financial impact on a supplier’s business, as a basis for a negotiated agreement...

Essentially, on the assumption that a supplier sells £150k ex VAT per annum to a customer, and makes a gross profit of 40%, i.e. ex factory price is 60% of price to customer, then a price reduction of 5%, a 2.5% increase in retrospective rebates, and a move to 120 days credit can be factored into financial performance as follows:

1. Price reduction of  5%, all costs remaining constant: How much extra has to be sold to restore the cash profit?
(click here for autocalculator of Margin Maintenance)

On sales to the customer of £150k, the supplier currently makes a gross profit of 40% i.e.£60k on ex factory cost of £90k.

Reducing prices by 5% means that sales to the customer are reduced to £142.5k, and assuming that ex factory cost remains at £90k, the new gross profit is £52.5k i.e.36.8% of sales.

Then, New Sales x 0.368 = £60k

Therefore, New Sales =  £60k/0.368   =  £162.86k, i.e. extra sales of 14.3% to restore cash margin

2. Increase of 2.5% in Retrospective rebates, i.e. say current 2.5% rebate on sales of £150k becomes 5%.
(click here for autocalculator of Margin Maintenance)

Effectively this means a price reduction of 2.5%, all costs remaining constant, as per item 1 above:

Reducing prices by 2.5% means that sales to the customer are reduced to £146.25k, and assuming that ex factory cost remains at £90k, the new gross profit is £56.25k i.e. 38.46% of sales.

Then New Sales x 0.3846 = £60k

Therefore New Sales =  £60k/0.3846 = £156k, i.e. a sales increase of 6.7% to restore cash margin.

3. Cost of giving the customer 120 days credit
(click here for autocalculator of Margin Maintenance)

Here the supplier is effectively giving the customer an interest free loan = 120 days sales

On sales of £150k to the customer, a 120-day customer pays the supplier 365/120 times per year, i.e. 3.04 times per year.

This means that the supplier is lending the customer £49.3k, interest free, permanently.

Say the cost of borrowing is 10%, then the supplier is effectively borrowing £49.3k @ 10% i.e. £4.93k to give it to the customer, interest free.

However, assuming a UK average credit to the trade of 30 days, then 120 days represents an additional 90 days credit.

Using the above calculation, this means that on 90 days @ 10% cost of money, the supplier is effectively giving the customer a discount of 2.5% on sales of £150k.

Reducing prices by 2.5% means that sales to the customer are reduced to £146.25k, and assuming that ex factory cost remains at £90k, the new gross profit is £56.25k i.e. 38.46% of sales.

Then New Sales x 0.3846 = £60k

Therefore New Sales =  £60k/0.3846 = £156k, i.e. a sales increase of 6.7% to restore cash margin.

Conclusion:

The above calculations spell out the cost and sales implications of extra demands from the customer. Ideally they should form the basis of a negotiated agreement whereby the supplier, knowing the costs of each concession, should try to assess and add value in terms of impact on the customers business, seeking equivalent value concessions in exchange, and making compliance a key condition.

More on this at KamTips and the negotiation roadmap, for Namnews subscribers

The above analysis is an extract from our New Workshop: Negotiation-audit for advanced level dealing (details click here)

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