Glow light of petrochemical industry on sunset

Why chemical companies’ payment terms need attention now


Chemical companies can release significant operating cash by updating payments processes and policies, based on industry-leading practices.


Executive summary: 

    • Chemical companies have excess cash tied up in working capital that can be made available with a better approach to payment terms, according to an EY study.
    • The study provides insights into global chemical industry practices by region, industry subsector and product type. 
    • Companies have a valuable opportunity to use benchmarking data to tighten and standardize payment terms in negotiations with trade partners.

    Many chemical companies are lagging when it comes to leading payment practices and can greatly improve cash flow with a few smart moves, according to an EY benchmarking study² and an analysis of the industry.³

    Efficient conversion of working capital to operating cash can strengthen competitiveness and decision-making flexibility and increase shareholder value. Chemicals companies have a significant opportunity to improve cash performance, with an estimated US$176 billion in cash tied up in working capital, industry-wide, an analysis by the EY Working Capital team shows.⁴

    A payment terms benchmarking study, also developed by EY Working Capital to help companies gain visibility into industry norms at regional and business-unit levels, finds there are a variety of opportunities to use available benchmarking data as leverage when negotiating payment terms with trade partners.⁵

     

    There are different reasons chemical companies may be behind in this area. Many have decentralized procurement and sales functions, which contributes to a lack of a unified approach and uneven enforcement of policies. Also, in recent years, many chemical companies, facing weaker shareholder returns compared to other industries, have understandably focused attention on other cost takeout and revenue growth opportunities.

     

    Below, we outline actions chemical companies can take to determine if they are lagging in renegotiating payment terms and to improve their processes.

     

    Companies must first understand their own supplier and customer relationships and respective trade deal terms by benchmarking their payments positions against industry norms and leading practices.

     

    Payment terms vary based on factors such as trade settlement obligations, regulatory requirements and culture. By implementing a thoughtful payments strategy, organizations can adjust key levers to release cash tied up in operations. 

     

    Accounts payable

     

    Industry analysis⁶ shows that median days payable outstanding (DPO) for the global chemicals industry is 57 days, with 76 days and above considered to be optimal. Such a sizeable gap points to an opportunity for companies to release 19 days of working capital by improving DPO, which would generate approximately $50 million in cash per US$1 billion of revenue.⁷


    One way for CFOs and procurement and sales leaders to do this is by using available benchmarking data, such as the EY benchmarking study, to negotiate with vendors for longer payment terms, which vary based on region and level of product specialization as well as the comparative market strength of the supplier. The study finds:

    • Commodity chemicals are the product category with the shortest payment terms, with a global average of 42 days. 
    • Within commodity chemicals, major feedstocks, including ethylene and butane, had even shorter terms, averaging 24 days across regions.
    • Terms for specialized products tended to be longer, with specialty chemicals and industrial gases averaging 45 and 48 days, respectively.
    • From a regional standpoint, the study found that terms in North America tend to be the shortest, with major feedstocks in the region averaging 22 days. This compares to 25 days on average in Asia-Pacific (APAC) and 26 days in Europe, the Middle East and Africa (EMEA).


    Strategic considerations for accounts payable changes

    Proper planning and communication with suppliers prior to making changes to accounts payable processes are critical.

    It is important to consider industry benchmarks as well as factors that impact negotiations, including how intentional a company should be with a particular vendor as the approach is developed. Strategic considerations include:

    • A comprehensive negotiation methodology, including considerations and trade-offs with suppliers on price, volume and terms, to create the greatest value for the business
    • Alignment of procurement strategy and sourcing requirements to vendors to enable positive outcomes for both parties
    • Standardizing company-wide accounts payable processes that can extend the time to pay suppliers, such as using invoice receipt date instead of invoice date to initiate the payment-terms clock and conducting payment runs biweekly or even monthly instead of weekly
    • Supply chain finance and similar tools, along with payment incentives, which are useful enablers to obtain more advantageous payment terms and can provide the corresponding balance sheet benefit from improved DPO

    Accounts receivable

    Days sales outstanding (DSO) is a function of customer terms and payment behavior. EY analysis of industry data indicates the median DSO for the global chemicals industry is 60 days, with “best in class” companies at 44 days. Industry benchmarks indicate a 15-day improvement in DSO would release US$43 million in cash per US$1 billion in revenue.



    Companies can help drive a sustainable cash culture and greater business resiliency by aligning accounts receivable terms to industry standards.

    Customer terms, like supplier terms, also vary by business type and region. However, as with supplier terms, the EY study showed shorter payment terms offered to commodity chemicals and hydrocarbons customers and longer terms for specialty and branded chemicals. CFOs and leaders in procurement and sales can gain traction in client negotiations by understanding how their own incoming payment arrangements compare with industry norms. 


    Interestingly, variances are even more pronounced when analyzing customer payment terms for a business across a geographic region. On average, study participants had the longest terms by region in Latin America and the shortest terms in Asia-Pacific. Although the Asia-Pacific region has the shortest terms on average, it also shows the largest variation between hydrocarbons and additives and industrial and engineered chemicals of 32 days.



    Strategic considerations for accounts receivable changes

    • There are a variety of areas where companies can make structural, customer-term changes, including:
    • Taking a targeted approach by region and business unit
    • Obtaining a better understanding of why individualized payment terms are proliferating
    • Balancing multiple commercial considerations, including price, volume and margin

    Companies should consider adopting a “return on invested capital” metric to balance improvements in terms with improvements in price. One significant challenge is managing the growing number of unique payment terms, a situation that may indicate companies are offering too many exceptions and extreme customization of terms. This typically results from the lack of a standard terms policy and poor governance or approval processes that limit transactional efficiency.

    Sales leaders and others can use a standardized approach to improve terms negotiations without damaging customer relationships and revenue, reduce confusion in the sales cycle, and improve overall business relationships. Discount terms can destroy value if they are not carefully managed for their impact on cash flow against price, volume and buyer power. Also, having clearly defined payment term standards by region may help obtain buy-in from the company’s commercial organization to balance financial benefits and business growth.

    Balance of trade

    Chemical companies can improve their payments posture by taking a more deliberate approach to their buyer and seller relationships within the industry. In negotiations with other chemical companies, the organization must be careful that a gain on one side of the relationship doesn’t result in a concession on the other that reduces the overall benefit and introduces additional risk.

    To improve negotiating leverage, companies can implement a sustainable process to analyze the balance of trade to get a better understanding of these relationships. However, in some cases, total trade working capital for a company may be difficult to discern due to parent-child relationships or hard-to-track international arrangements where the details are obscure. Analysis may also be hampered by discrepancies in the way expenses are categorized or a lack of advanced analytical capabilities.

    By addressing these issues, companies can identify priority accounts, negotiating positions and risks related to balance of trade. Some chemicals companies have successfully implemented customer and data management programs to map balance-of-trade relationships so that value is maintained across purchase and sales negotiations. Although it may be challenging to implement, this approach can deliver significant value from improved working capital and trade benefits.

    Aaron Bocian, Emily Coughlin, Allie Untracht and Sam Powers of Ernst & Young LLP contributed to this article.

    Summary

    Chemicals companies have a valuable opportunity to use available benchmarking data to reinvigorate underperforming payments processes. A recent survey¹ reveals that many companies are operating with disadvantageous sales and purchasing terms that result in a costly tie-up of working capital. By making a few strategic corrections, and by basing trade negotiation strategies on insights into industry norms and leading practices, chemicals companies can release cash from working capital to improve competitiveness.



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