Payments to businesses within 30 days: what effects on Supply Chain Finance? 

Gabriele Pirami

date: February 26, 2024

Each year, in the European Union (EU), approximately 18 billion invoices are issued, at an average of over 500 invoices per second. This massive flow of commercial transactions brings along significant payment delays.  This has substantial impacts on companies, especially Small and Medium Enterprises (SMEs). As highlighted by the European Commission, 25% of business failures are attributable to the late payment of invoices and, on average, 50% of commercial transactions are paid late or remain unpaid. 

The disparity in bargaining power between suppliers and customers of different sizes creates a domino effect throughout all production chains, weakening the competitiveness of companies and increasing the risk of bankruptcy, leading to payment delays. 

This persistent problem has not been solved by current legislation, namely the Late Payment Directive of 2011, which is characterized by deficiencies in terms of prevention and deterrence measures, insufficient application and repair mechanisms, and legal ambiguities. Current legislation sets a 30-day limit for payments in commercial transactions, extendable to 60 days or more “if it is not seriously unfair to the creditor”. The absence of an effective maximum term and the ambiguity in the definition of “seriously unfair” often lead to payment extensions beyond 120 days, particularly penalizing smaller creditors. 

Thus, the European Commission has proposed to replace the current Directive with a Regulation. Unlike a Directive, a Regulation is directly enforceable and imposes the same provisions throughout the European Union, without requiring transposition into national law through a specific law. The new proposal maintains the maximum payment limit of 30 days, already provided by the Directive in force, but eliminates ambiguities and derogations without specific justifications. The debtor who delays payments will be required to make automatic payments of default interest, calculated at the reference rate set by the European Central Bank, increased by 8%, in addition to an extra compensation of 50 euros for the recovery costs incurred by the creditor. 

But when will the new rules come into force? According to the Commission, once approved by the European Parliament and the Council, they will become applicable one year after the entry into force of the Regulation, thus giving the interested parties the necessary time to adopt the required measures. This is of course dependant on the ability of the current European Parliament to pass such regulation before its mandate expires. With the term end for current members getting closer (elections are scheduled on June 6-9 of this year), the possibility that the proposed regulation will not be enacted by the current Parliament grows every day. Would the regulation not come in force by June this year, timing will necessarily stretch, and the composition and orientation of the newly elected European Parliament will determine whether such proposed regulation will be enacted at all. 

In any case, Member States will have to establish control authorities and promote alternative dispute resolution. The proposal aims to introduce fairness in commercial transactions, increasing the resilience of SMEs, with estimated benefits, according to the Commission, for at least 30% of them. 

The adoption of strict and uniform payment terms is designed to allow SMEs to enjoy a faster cash flow thanks to advanced collections. However, it is important to note that, in turn, these companies will be required to respect tighter payment deadlines towards their suppliers.  While SMEs could benefit from a faster cash flow thanks to advanced collections, they could also face challenges in meeting payment deadlines due to their well-known difficulties in accessing liquidity. 

Regarding the application of default interest (already provided for by current legislation), the common practice is to avoid its use, as suppliers hesitate to take legal action against customers with whom they want to maintain a positive commercial relationship. 

The effectiveness of this new legislation for SMEs will depend on their ability to promptly manage both collections and payments. It will be essential to balance the need for liquidity with the obligation to respect contractual terms to ensure a positive impact on both financial aspects of the companies involved. 

Many Member States support the EU Commission’s plan to improve payment practices by introducing consistent payment terms (such as 30 days), but concerns exist regarding potential interference with contractual freedom, inspection time for goods/services, and legal conflicts. They emphasize the importance of business contracts and worry about possible migration of contracts outside the EU.  

Moreover, a significant question arises: what could be the impacts of the entry into force of the new rules on Supply Chain Finance (SCF)? 

According to the Commission’s report, SCF is a valid approach, especially when companies are involved in extra-EU export transactions. These companies, bound to payments within 30 days for EU suppliers, inevitably find themselves facing differences in payment terms between their debts and commercial credits. In this situation, SCF therefore emerges as a valuable ally, as it “significantly limits the impact” – cites the Commission – of the introduction of a mandatory limit on payment terms. 

Instead, the risk that, in international transactions, companies located in countries outside the EU opt for longer payment terms towards EU companies is assessed as limited by the Commission. The latter emphasizes that numerous EU partner countries, including Canada, the United States, Turkey, and the United Kingdom, already apply regulations on late payments. However, it is necessary to emphasize that, for companies operating in countries outside the EU, where restrictions are not as stringent, this strategy could give them a competitive advantage. This would allow them to adopt more flexible payment terms while continuing to use SCF tools to optimize their working capital. 

In this scenario it is clear that, beyond extra-EU applications, the introduction of the new rules could limit the implementation and use of SCF solutions, due to a lower need to anticipate cash flows from outstanding invoices, thanks to greater liquidity resulting from more timely payments. Nevertheless, the evolution of the financial and regulatory landscape could still lead to the innovation of new SCF tools to meet the needs of companies in the context of faster payments. It will therefore be essential to devise and develop SCF solutions that allow buyers to extend payment terms while continuing to ensure timely payments to suppliers within 30 days. 

Gabriele Pirami

Researcher of Supply Chain Finance Observatory at Politecnico di Milano
PhD student on Supply Chain Finance
Researcher on Purchasing and Supply Management