The working capital trap: when extending payment terms destroys more value than it creates

Extending payment terms from Net 30 to Net 60 generates a predictable balance-sheet improvement. Free cash flow rises. DPO metrics improve. Finance celebrates. And somewhere in the supply chain, a supplier with thin margins and no access to cheap credit begins to degrade. The working capital you freed up was a loan you took from your supply base at zero percent interest. The cost of that loan shows up later, in ways your ERP does not track.

The assumption that longer payment terms are always better for the buyer is wrong. Academic research on trade payables and firm performance produces conflicting results. The relationship is not monotonic. From a supply chain perspective, single-firm working capital optimization creates financial stress elsewhere in the chain. When that stress reaches a critical point, the cost flows back in the form of supplier failure, quality degradation, higher prices on renewal, and supply disruption. These costs do not appear on a DPO dashboard.

Working capital optimization is a supply chain problem, not a firm-level metric

A study published in the European Journal of Operational Research designed a supply chain perspective on working capital optimization and reached a conclusion that contradicts standard corporate finance logic. Single-firm optimization damages overall supply chain performance and resilience. When one large buyer extends payables without modeling the financial fragility of tier-1 and tier-2 suppliers, the chain absorbs costs that do not appear on the buyer's balance sheet until something breaks.

The same body of research found that when suppliers are in financial distress, loyal buyers benefit from paying suppliers earlier. Shorter trade payable terms can allow firms to realize significant cost savings through early payment discounts. The intuition that "longer DPO equals better working capital" fails exactly when suppliers are most vulnerable. A supplier priced at Net 60 that could offer a 2% discount at Net 10 is effectively offering a 36.5% annualized return on early payment. Most treasury departments would call that the best risk-free yield in the portfolio. Instead, procurement is often measured on extending terms in the opposite direction.

"It has been shown that when suppliers are in financial distress, loyal buyers can benefit from paying suppliers earlier. Shorter trade payable terms can also allow firms to realize significant cost savings through early payment discounts."
— International Journal of Production Research, 2024

Reverse factoring: the hidden leverage most CPOs do not see

Reverse factoring is marketed as a win-win. The buyer extends payment terms. The supplier gets early payment at the buyer's credit rating. The financier earns a spread. Everyone benefits. This narrative held until it did not.

High-profile collapses exposed what happens when reverse factoring becomes disguised debt. Carillion, Abengoa, and Greensill each had substantial reverse factoring liabilities that were reported as trade payables rather than financial debt. When the programs unraveled, investors and suppliers discovered leverage they had never been shown on a balance sheet. The absence of clear accounting guidance has allowed firms to classify factored payables as trade payables even when the terms suggest debt-like obligations.

A 2025 study in Accounting Forum examined financial reporting disclosure practices for reverse factoring programs across jurisdictions and found that differences in enforcement and auditing requirements significantly influence whether firms disclose these programs at all. Most prior research focused on operational benefits while underplaying financial reporting and investor-risk implications. The practical result: CPOs may be extending terms through reverse factoring programs whose aggregate liability they have never seen in a single report.

The single-solution problem: why one-size reverse factoring underperforms

A study in the European Management Journal found that buyer firms typically implement only reverse factoring with their suppliers in an undifferentiated manner. This single-solution approach is inefficient. It prevents the adoption of better-fit financing tools like dynamic discounting or inventory finance, resulting in limited supply chain finance utilization and reduced benefits for the extended supply chain.

Research from the same body of work, published in the European Journal of Operational Research, found something even more counterintuitive: when the market size is sufficiently large, traditional trade credit generates higher total supply chain profit than reverse factoring. The default assumption that reverse factoring is always the superior tool is wrong. Context matters. So does supplier bargaining power. For small and medium-sized enterprises, the benefits of reverse factoring depend heavily on bargaining power and buy-back terms. In some settings, suppliers would prefer no reverse factoring at all because the surplus is captured entirely by the large buyer.

Supply chain finance can improve resilience when done right

The evidence is not uniformly negative. Panel data from 2017 to 2023, analyzed in a 2025 International Review of Economics & Finance study, found that supply chain finance mechanisms can significantly improve supply chain resilience. Early adopters of blockchain-enabled platforms decreased payment delays by 47% and enhanced supplier survival rates by 32% during the supply shocks of 2020 to 2022.

The distinction is not between using supply chain finance and avoiding it. It is between using it as a static, undifferentiated extension of payment terms versus using it as a dynamic, supplier-specific tool calibrated to actual financial conditions. Programs built on static assumptions become unattractive or harmful for one side when market conditions change. Research from the Journal of Risk and Financial Management found that changes in interest rates, credit ratings, or news alerts turn former win-win arrangements into win-lose situations for suppliers, contingent on the business cycle.

What this means in practice

• Stop measuring working capital success by DPO alone. The academic evidence is clear: the relationship between trade payables and financial performance is not monotonic. Add supplier financial health metrics to your working capital dashboard.
• Audit your reverse factoring exposure. If your organization uses reverse factoring, verify that aggregate payables appear transparently in financial reporting. Ask your treasury team whether factored payables are classified as trade payables or financial debt. The distinction matters for both your suppliers and your own risk profile.
• Match the financing tool to the supplier, not the program. The research shows that undifferentiated reverse factoring underperforms. Some suppliers need dynamic discounting. Some need trade credit. Some are fine at Net 60. Treat working capital as a category strategy, not a finance KPI.
• Model the annualized return on early payment. A supplier offering 2% at Net 10 versus Net 30 is offering a ~36% annualized return. If your organization's cost of capital is below that, you are leaving money on the table by not paying early — regardless of what the DPO target says.