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Dear Commercial Acuman...

Dear Commercial Acuman...
My agency has been invited to pitch for a piece of business, but the client wants payment terms of 90 days from end-of-month; should we accept this or refuse to pitch?

Payment terms are essentially a commercial matter between two businesses and form part of the overall commercial aspect of the relationship.

There are reasons both for and against accepting extended payment terms – as well as various potential mitigating factors.

It helps greatly if your business is not desperate for the income – if the rest of your business is performing well and you have happy, well-serviced, profitable clients, you can afford to be more dispassionate about the decision, and more bullish in your client negotiations.

As an agency, you pay your staff at end of month, your rent quarterly in advance and suppliers generally on 30 days, so extending your payment terms from 30 to 90 days costs you an extra £1,000 per £120k of fee income each month assuming a 5% net borrowing cost.

But the real cost of extended cashflow is more than just profitability – it can be your very survival. Remember that agencies go out of business because they run out of cash, and the cash runs out quicker than the profits.

The principled argument against:

My view is that, in our industry, any payment terms in excess of 30 days should include financial compensation for the additional delay in receiving payment; agencies are not in the business of bankrolling clients and it makes no sense for them to borrow money expensively in order to lend it to far larger clients who have more clout in negotiating their borrowings.

In this age of low interest rates and cash stockpiles, there is no logical reason for clients to request extended payment terms – except one; it increases agencies’ risk profiles and makes them more dependent on clients.

The practical argument in favour:

A desperate agency may well have to take extended payment terms on the chin, but why might a profitable and stable outfit want to incur the additional cost of extended terms? With good client and Scope of Work management, you may be able to make an acceptable margin even after allowing for the working capital costs.

Additionally, there may be strategic reasons why you want the client – a great creative opportunity, a margin or growth opportunity, a trophy client – but you will need to be very clear about your risk appetite when considering these; make sure you balance off a realistic assessment of the potential upsides against a sober view of the downsides. A client who takes a tough stance on payment terms is unlikely to be a soft touch in any other areas.

Remember that it is one thing to accept extended payment terms on your own fees, but you should also consider pass-through costs; media-buyers are particularly at risk here, but production can make up to 50% of a creative agency’s billings.

Mitigating strategies:

The best mitigating strategy for dealing with a request for extended payment terms is not to need the business.  This means having a diverse portfolio of profitable clients, well-utilised staff, good revenue and cash flow visibility plus good payment behaviour from clients.

As well as reviewing your client portfolio for sectors, growth potential, creative opportunities and profitability, you also need to consider payment terms and keep those on over 30 days to a low percentage.

When extended payment terms do rear their head, another option to consider is billing back the additional financing cost, either explicitly or by increasing your rate card. I have known instances, for example, of billing a client for the cost of increasing PI from an agency-standard £5m to a client-required £10m; and it’s not unthinkable to have more than one rate card – one for payment on 30 days, one for 60 and one for 90+.

Ultimately, it comes down to knowing your cost base, effective client management and a good negotiating strategy from a position of strength.

FD Tips for managing cashflow:

-          Start with 30 day terms as standard (as per the IPA’s industry-standard contracts)

-          Get your invoices out promptly

-          Review your aged accrued income

-          A full set of financial information includes a cash flow and balance sheet, as well as a P&L

-          Build a “payment behaviour” with your clients

Last updated 21/10/2015

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