ISSN 1940-204X

Corporate Policy toward Vendor Payments:

Ethical Considerations and Unintended Consequences
David Perkins, CMA, PhD T. Kyle Tippens, PhD
Professor of Accounting Associate Professor of Finance
College of Business Administration College of Business Administration
Abilene Christian University Abilene Christian University

IN THE C-SUITE
John Taylor propped his feet on his desk at the end of a satisfying day and was thinking about his
report for the upcoming meeting with the board of directors. As the chief financial officer (CFO) for
CiM Corporation for the last four years, he felt a sense of accomplishment about the firm’s current
financial position. The company’s strategic focus on quality had led to a steady growth in sales and
profitability. John felt especially good about the company’s liquidity.

One of his first directives as CFO had been to improve the turnover for both customer receivables and
inventory. Then, a couple of years ago, he came across an article describing how some larger companies
were able to use their market position to defer payments to vendors when they represented a significant
portion of a vendor’s volume. John had decided to implement a similar policy, intrigued by the fact that
deferring vendor payments could improve liquidity by shortening a company’s overall cash conversion
cycle (CCC), even though the buildup in payables resulted in a lower current and quick ratio.

Now that the new approach had been in place for two years, he was looking forward to presenting
the financial results to the board. He would get Karla Hester, his lead staff member in the finance
department, to work up the numbers.

MEANWHILE, IN THE FINANCE STAFF OFFICES

Karla Hester left her desk in the finance department on Friday afternoon more discouraged than she
had been in a long time. As she passed the office of CiM’s CFO, she almost stopped to say she was
quitting. Karla had just gotten off the phone with Sheila Roberts, the owner of a local medium-sized
supplier of one of CiM’s primary components. Sheila was almost in tears as she told Karla about the
cashflow problems she was having and how desperately she needed to receive CiM’s payment for
their latest invoice from two months ago. Karla listened patiently and offered her encouragement as
she apologized for the processing delays, and she told Sheila that the invoice would soon be approved,

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and payment would be on its way. She pretty much had her response memorized, since she’d had two
similar conversations earlier that month and four the month before.

It all started about two years ago when John decided to implement a more aggressive cash management
policy targeting the company’s CCC. The company’s financial ratios were capturing the impact of
this decision. Accounts receivable turnover had been improved by two days simply by eliminating
administrative delays in the customer billing process. Process improvements in the manufacturing
department had allowed the company to carry lower levels of inventory, reducing the days for inventory
turnover by almost 20% from 109.6 days to 90.4 days.

But the most dramatic change in the CCC was due to the company’s new policy toward vendor payments.
Under the old policy, CiM paid its vendors within 45 days unless a discount could be negotiated for earlier
payment. Most vendor invoices contained a 30-day due date. Although the 45-day payment was an irritant,
vendors put up with it due to the size of the CiM account and were sometimes motivated to offer a discount
for a faster payment. Under this policy, the payables turnover had averaged just under 36 days.
The new policy was implemented after John read an article about how some companies were delaying
vendor payments to such an extent that the days payables outstanding (DPO) more than offset the
combination of days receivables outstanding (DRO) and days inventory outstanding (DIO), resulting
in a negative CCC. Using other companies as a benchmark, John set the new goal for the DPO to be
85 days, 49 days longer than the current measure.

When John originally presented the new policy to Karla and the other members of the finance staff, he
described the approach as good for the company’s cash flow. By increasing the DPO, CiM can decrease
its CCC significantly and reduce the company’s net working capital to a more efficient level. Paying
vendors more slowly also preserves the company’s cash flow from operations; thus, CiM can use its
market power to lean on vendors to help fund the company’s growth. The change in practice could
allow CiM to adjust its capital structure, possibly reducing its long-term debt.

Little was said about the impact the new policy would have on vendors, although there were a few
jokes about “throwing the company’s weight around” and “letting the vendors know who’s boss.” John
mentioned that the impact on vendors would be minimal, since CiM had engaged a large financial
services company, DJX Financial, to provide working capital financing assistance to its vendors, if
desired. The vendors would pay a fee to DJX Financial for the service if they chose to use it.

John tasked his team with preparing some brief communication to the vendors about the new
relationship with DJX Financial, but there was no plan to renegotiate any agreements with vendors.
Instead, CiM would just pay its bills more slowly. This behavior was nothing new for CiM or the
industry in general: CiM had already been paying its bills a little late (45 days instead of 30), and it
was well-known in the industry that larger purchasers often squeezed their vendors by paying later
than expected. If CiM’s vendors faced cashflow problems, working with DJX Financial to improve
cashflow timing would be a simple solution.

In that first meeting to discuss the new policy, there was also little discussion about any possible
impact on the staff who had to implement it. A few talking points were given to the staff to use in

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their discussions with vendors. If a vendor called to ask about the delay in payments, the staff were
encouraged to emphasize the positive new relationship with DJX Financial. ?

But the initial response by vendors a few weeks after the new policy was implemented was not
encouraging. Instead of thanking CiM’s staff for the information about DJX Financial, many vendors
expressed outrage with CiM’s new policy. Months after the new policy was implemented, some
vendors had become so disillusioned that they considered severing their relationship with CiM. A
handful had done so, causing some supply chain and quality problems for CiM as new suppliers had
to be hastily identified and approved.

Two of Karla’s colleagues quit a few months ago, stating stress and a negative work environment as
reasons for leaving. With each passing month, Karla was beginning to empathize with them more.
While CiM’s CFO had been enthusiastic about the financing solution offered to the vendors through
DJX Financial, the vendors themselves were not very appreciative.
Some of the smallest vendors had trouble getting approved for credit from DJX Financial, and the ones
who were granted credit were surprised at how expensive the funding would be. This was problematic
because in order to win CiM’s business in the first place, many vendors had already provided their
absolute lowest price proposals. They had little wiggle room left to pay for unanticipated financing
costs. Beyond the financials, many vendors were angry about the principle of the new policy: in their
minds, the policy ran contrary to the agreements they had signed in good faith with CiM. How could
CiM unilaterally violate their agreements and push the financial consequences onto the vendors?

Karla knew that payment terms with vendors were sometimes stretched in practice, but the significance
of the recent delays were causing her to feel anxious and guilty because her company was not keeping
its “word.” As an employee of CiM, she wanted to be a good team player and felt the policy on vendor
payments reflected poorly on her as well as her company. Over the weekend, Karla thought about her
future and her career. Overall, she enjoyed her job, and she thought CiM offered good opportunities
for advancement.

But the company’s approach to managing payables was creating a ripple effect throughout the company,
which was even felt within the local community. At times, when Karla met local business owners who
had been affected by CiM’s new payment policy, the encounters were strained. In addition, some
of the quality issues CiM had dealt with due to vendor turnover were starting to generate negative
feedback from customers.

At a recent meeting of the local chapter of IMA (Institute of Management Accountants), a guest
speaker had discussed what the IMA’s Statement of Ethical Professional Practice had to say about
organizational conflict and culture. Karla had seen John, the CFO, at the meeting and discovered John
was also a certified management accountant (CMA). Karla, however, wondered if John knew, or even
cared, about the personal and organizational ramifications of the new policy.

Monday morning, Karla’s dilemma was intensified. John asked her to put together a summary of
selected ratios related to the company’s CCC over the last three years and report on the success of the
new vendor payment policy. The financial statement information available to Karla is presented next
along with the liquidity ratios that she calculated for her presentation.

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The following references may be helpful in analyzing this case:

Cagle, C.S., Campbell, S.N., and Jones, K.T., “Analyzing Liquidity Using the Cash Conversion
Cycle,” Journal of Accountancy, May 2013, pp. 44-48.

Perkins, D. and Tippens, K., “Hidden Dangers of Vendor Payments–Is It Simply a Financial
Decision?,” Strategic Finance, May 2016, pp. 48-53.

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 CiM Corp.
Balance Sheet
Year 1 Year 2 Year 3
Cash $ 70 $ 93 $ 63
ST Investments 102 230 345
Accounts Receivable 467 520 590
Inventory 1,003 988 1,105
Prepaids 31 28 36
Total Current Assets 1,673 1,859 2,139
P,P, & E (net) 5,462 6,334 6,930
Total Assets $ 7,135 $ 8,193 $ 9,069

Accounts Payable 328 699 1,031

Other Current Liabilities 442 476 525
Total Current Liabilities 770 1,175 1,556
LTD 1,388 1,382 1,295
Common Stock 4,006 4,006 4,006
Retained Earnings 971 1,630 2,212
Total Liabilities and Equity $ 7,135 $ 8,193 $ 9,069

CiM Corp.
Income Statement
Year 1 Year 2 Year 3
Sales $ 5,770 $ 6,626 $ 7,795
Cost of Goods Sold (3,340) (3,784) (4,462)
Operating Expenses (1,766) (2,063) (2,318)
Net Income $ 664 $ 779 $ 1,015

Liquidity Ratios: Year 1 Year 2 Year 3

Quick Ratio 0.83 0.72 0.64

Current Ratio 2.17 1.58 1.37
# Receivables Turns 12.36 12.74 13.21
# Inventory Turns 3.33 3.83 4.04
# Payables Turns 10.18 5.41 4.33
DRO 29.54 28.64 27.63
DIO 109.61 95.30 90.39
DPO 35.84 67.42 84.34
CCC 103.3 56.5 33.7

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