In the last blog posting I cited three factors that a company considers in moving to open account payments. The last point, on the view of the market on moving to open account payments, is not so obvious a consideration until one understands that once a company pays on open account, it requires much lower lines of credit to sustain an important payment program. If the company is viewed as proactively managing the reduced credit, it can be rewarded by investors; however, if the move is forced on the company, its shares can take a big hit.
This was illustrated back on April 16, 2008, when stock price of Talbots fell 32 percent after it announced that two lenders, HSBC and Bank of America, would not renew lines of credit totaling USD 265 million. The credit lines were used to support import letter of credit payments to its suppliers. On the same day Talbots issued a press release commenting on the “financial arrangements” with its banks and suppliers. Portions of the release read as follows:
“As reported in the Form 8-K, the Company’s major vendors, which represent approximately 75% of Talbots offshore merchandise purchases, have agreed to “open account” terms with payment in 45 days. The revised terms extend the settlement period to 45 days from approximately 22 days on letter of credit purchases, which the Company expects will effectively add approximately $40 million to the Company’s 2008 operating cash flow.
Due to the revised payment terms with its major vendors, the Company believes that its financing needs with respect to the remaining smaller vendors, representing a minority of its purchases, have been substantially reduced and can be accommodated with a letter of credit line of approximately $50 million. In recent years the Company had letter of credit facilities aggregating approximately $300 million; however, by going to “open account” for the majority of merchandise purchases, the need for credit should significantly decrease. The Company believes that approximately $50 million will be sufficient to satisfy the financing needs in purchasing from its smaller vendors. Talbots is in discussion with several financial institutions to supply the $50 million letter of credit and expects resolution of these discussions in the next few weeks. “
Talbots most likely made the change in payment terms in response to earlier notice from its lenders that its lines of credit would not be renewed. But, what if a company were to proactively move to open account payments with extended terms? Talbots was able to improve its working capital, freeing up USD 40 million in cash flow. Even for a company not at risk of its lenders reducing their credit lines, if a company can renegotiate its payment terms to free up working capital it should do so.
In fact many companies have already done so. They are moving to open account payment terms and extending payment terms. But, many are still keen to retain lines of credit even if they are not fully utilized. Perhaps as a lesson learned from Talbots, some treasurers have been keen to retain lines of credit, or at least reduce the lines in small increments, in order to ensure that reducing letters of credit payments is not perceived by market analysts or shareholders as a symptom of underlying financial weakness. In the process of improving its working capital, management will not do its shareholders any favor if a reduction in credit lines is perceived as a weakness in the company’s financial position with a corresponding drop in share value. Thus, when moving to open account payments, companies are moving cautiously to ensure that the reasons for doing so are not misinterpreted, reducing shareholder value.
