"We're in the process of renewing contracts with our distributors early this new year. Most of them, in light of higher distribution costs, are requesting adjustments in the distributor contract like additional discounts and extended credit terms. Given a flat sales forecast for our products this year, we need to look at other ways we can help our loyal distributors beyond just these. Do you have any suggestion for us, especially for our sales team?" - Chris Brews

As mentioned, there are a hundred and one ways to help your distributors improve their financial health beyond giving sales discounts and extended credit terms. One of them is to examine how distributors effectively manage their working capital. We learned that net working capital is primarily derived through this formula: Merchandise inventory + Accounts Receivable - Accounts Payable. Again, there are other current assets which should be included here, like cash, but in the context of our discussion, we will only focus on the three main variables which are: inventory, receivable, and payable.

The following examples will show how you could help your distributors manage their working capital using this formula. I converted values into number of weeks for a simpler illustration.

Example 1. Distributor keeps inventories good for 8 weeks, trade receivables at 6 weeks, and pays you in 4 weeks agreed credit term. Thus, the distributor needs to finance an equivalent of 10 weeks working capital due to excess inventories and inability to collect on time. Notice that when you overload your distributor and collection takes longer than expected, they have an immediate adverse impact on his cash flow. When overstocked, they will eventually expect you to help them deplete excess inventories through sell-out promotions which mostly are at your expense. A good distributor manager ensures that his distributor only keeps the right inventory level at all times while focusing on increasing sales turnover. One good industry practice is to set an agreed inventory level per stock-keeping unit (SKU) with your distributor based on historical sales off-take, frequency of ordering, and delivery lead time. This practice helps distributors maximize their return on assets.

Example 2. Distributor keeps inventory at 2 weeks cover, accounts receivables at 2 weeks, and pays you at 4 weeks average. In this case, distributor has zero net working capital requirement because you're essentially paying for the 4 weeks cover of his inventory and receivables. Here, there's a need for you to check if customers are given enough stocks because with a very tight inventory and credit policies, a stock-out situation is not very far. Check if customers are given competitive credit limits and terms by your distributor. Oftentimes, in the distributor's pursuit to keep a minimum to zero net working capital, customer service and supports are compromised. Find a way to quantify lost sales and profit opportunities of your distributor due to stock issues and very strict credit terms. Interview key customers to get information and insight.
Example 3.Distributorkeeps an average inventory level of 2 weeks, trade receivables at 2 weeks, and delays payment to you by 2 weeks instead of 4 weeks agreed credit term. A negative 2 weeks net working capital means you’re the one financing their inventories and trade receivables and still not getting paid on time. It's a pity if you're in this situation with your distributor because while stock-outs are happening and customers are complaining of strict credit terms, you're not being paid on time and your distributor is not hitting the sales targets.
However, let me qualify. A negative net working capital can happen as part of the agreements and not necessarily as a result of a very enterprising distributor managed by a salesman sleeping on the job. When I was starting my distribution company for packaged consumer goods, I had some suppliers on this arrangement but with very specific conditions. They required me to provide them exclusive salesmen, higher distribution levels, and better visibility for their products in trade channels. As we grew sales over time, the extended credit term was gradually reduced until such point that my business could safely afford to finance our jointly agreed growth objectives. I thought this was a smart idea from them. Their financial support (i.e. extended credit term rather than more discounts) was contingent upon the achievement of a specific output critical to the business within a specific time frame.

Emilio Macasaet III is the Chief Distribution Strategist of Mansmith and Fielders, Inc.  For more information, email info@mansmith.net, call (+63-2) 584-5858 / 412-0034 or text (+63) 918-81-168-88.