Can 15 days matter when it comes to getting paid? For a small business, you bet.
CAMBRIDGE, Mass., July 27, 2016—Groundbreaking new research from the MIT Sloan School of Management and The Harvard Business School shows that paying small business contractors faster can have a meaningful effect on their cash flows, facilitate hiring, and stimulate overall employment.Federal government procurement amounts to 4% of GDP in the US and includes $100 billion in goods and services purchased directly from small firms spanning virtually every county and industry in the US.
In the past, government contracts required payment one-to-two months following the approval of an invoice, implying that these small businesses were effectively lending to the government while simultaneously having to borrow from banks to finance their payroll and working capital.
New “QuickPay” rules announced in September 2011, accelerated payments to a subset of small business contractors in the US shrinking the payment period by 15 days—accelerating $64 billion in annual contract value. A similar “quick-pay” policy was put into effect in the EU in 2013.
On average, each accelerated dollar of payment led to an almost 10-cent increase in payroll, with two-thirds of the increase coming from new hires and the balance from increased earnings per worker. The direct effect of the policy was to increase annual payroll by $6 billion, and to create just over 75,000 jobs over the three years following the reform.
“We are very excited about this research because this is the first time an acceleration in cash collection has been shown to have an effect on hiring in the all-important sector of small businesses,” says Assistant Professor of Finance at the Sloan School, Jean-Noel Barrot. “This suggests that increasing the speed of payment to small businesses can effectively stimulate job creation.”
However the authors find the policy to only have an effect on aggregate employment in areas with high unemployment rates. Elsewhere the benefits of payment acceleration are very limited.
This research sheds new light on the economic importance of “trade credit” whereby being paid weeks after the sale of a good or a service firms effectively provide short-term corporate financing to their customers. Trade credit is a major source of financing for the US economy. It is three times as large as bank loans and fifteen times as large as commercial paper in the US.