3.4 Management of Working Capital 41Size of the firm. Small suppliers are often dependent on a few big customers. In
many countries, big customers benefit from their strong bargaining position by
paying late. For commercial reasons, it may be difficult for a small supplier to
charge penalty interest for late payment from a big customer. Small firms must, in
practice, pay earlier because of their weaker bargaining position.
Nature of goods or services. In practice, the payment terms depend on the na-
ture of goods or services bought by the firm. For example, the firm pays in differ-
ent ways for necessary raw materials and supplies, finished goods that are deliv-
ered to the firm, or large machines and equipment that will be installed on site.
Where the goods are finished goods that must be delivered to the buyer, the
parties may agree on the date when the price is payable to the seller. As a buyer,
the firm can increase its external funding by agreeing on long payment terms. The
firm can try to combine long payment terms with no obligation to pay interest on
accounts payable. Under legal background rules, no interest is usually payable on
the credit before due date, unless the parties have agreed otherwise, but will usu-
ally be payable after the due date.^73 The contract may also provide for a reduction
of purchase price on early or punctual payment. Such clauses often encourage the
firm to pay earlier because a small price reduction for early payment can amount
to a high interest rate on a yearly basis. For example, the firm can qualify for a
discount perhaps as high as 5% of gross invoice value for prompt payment.
Where large machines and equipment are installed at the firm’s site, the starting
point is that the seller is unwilling to carry out any work unless the buyer (the
firm) pays first, and the firm is unwilling to pay anything unless the firm knows
that the agreed specifications will be met. In large transactions, the parties often
solve this problem through a combination of two things. First, the parties may
agree on a staggered payment schedule that follows the schedule of the seller’s
main obligations. Second, the parties agree that the seller will provide uncondi-
tional bank guarantees payable on first demand (demand guarantees, see Volume
II). There are several forms of demand guarantees which the seller may be called
upon to provide in favour of the buyer at particular stages of the sales transaction.
The most usual forms of demand guarantees are: bid bonds (tender guarantees);
performance guarantees (performance bonds, completion bonds); repayment guar-
antees (advance payment guarantees, interim payment guarantees); retention
bonds (payment bonds); and maintenance/warranty guarantees.
Community law. Because of their weak bargaining power, late payment is a
problem especially for small and medium-sized businesses.^74 Community institu-
tions have therefore adopted legislation to combat late payment in commercial
transactions. The Directive on combating late payment in commercial transactions
(Late Payment Directive) provides for interest in case of late payment,^75 clarifies
(^73) See CISG Article 78: “If a party fails to pay the price or any other sum that is in arrears,
the other party is entitled to interest on it, without prejudice to any claim for damages
recoverable under article 74.”
(^74) Recitals 7–9 of Directive 2000/35/EC (Late Payment Directive).
(^75) Article 3 of Directive 2000/35/EC (Late Payment Directive).