Examine Impact of Payment Terms on Cash Flow

Most companies operating in a business-to-business (B2B) sector will need to offer customers credit terms. If a company insisted on cash with orders, it would be hard to win customers in a competitive B2B market.

Whenever you sell goods or services on credit, though, there is an element of risk. Customers may pay invoices late, and, in some cases, customers may not pay at all. So, companies must manage that risk by implementing proper credit control and credit risk management procedures.

The first step towards managing credit risk is setting reasonable credit terms. But what payment terms that will be attractive to customers and acceptable to your business? Here are ten tips to help you determine credit terms for your customers.

1. Assess Customers on Their Merits

It’s important to realize that you do not have to offer all customers the same terms. Standard terms will be easier to administer, and they may be appropriate for most of your new customers. However, it would be advisable to assess each credit customer individually and adjust your standard terms where necessary to minimize the risk. Take the approach that customers are not automatically entitled to your standard terms. Instead, judge each new customer on their merits to see if they should get any credit at all.

2. Research Your Competitors

Your benchmark for setting credit terms is likely to be what your closest competitors offer. You might prefer to provide 5-day terms, but doing so will make you uncompetitive if your competitors grant 60 days’ credit. So, find out what terms your competitors give their customers before you set your own. You might need to make a few calls posing as a potential customer to obtain this information. Remember, though, your competitor’s terms are only a benchmark. There will be other factors to consider before you decide on your own credit policy.

3. Consider Your Vendor’s Terms

How far your terms differ from those of your suppliers will have an impact on your cash flow. If your vendors give you 30 days and you offer your customers 60 days, you will be funding your direct costs for 30 days. Likewise, if you provide a service, you will be paying salaries at the end of every month even if you have not yet been paid for the employee’s time. Carry out some what-if scenarios on your cash flow forecast to determine the impact of various sales credit terms. Bear in mind, though, if you offer 30 days’ credit, a large proportion of customers will exceed those terms. Many don’t pay invoices on the due date. They pay vendors at the end of the month following the due date.

4. Credit Check Every New Customer

It is good practice to run a credit check on every new customer. It would also be advisable to ask new customers to complete an account application form that asks for financial information and trade references. Credit checks with a credit bureau will provide you with an assessment of a company’s creditworthiness. Trade references will give you a further indication of the customer’s trustworthiness and financial state. You can use this information to determine an appropriate credit limit and the payment terms for each customer.

5. Calculate How Significant to the Business the Debt Will Be

The risk will be higher if a new customer’s debt will make up a significant percentage of your total receivables. So, while you will naturally want to welcome a major new customer, you might also want to be more cautious about the credit terms you offer them, and it would be advisable to be more diligent with your credit checking procedure. Big companies can get into financial difficulties just as easily as a small company can. So, it would be unwise to assume that a significant turnover automatically represents a reasonable credit risk. Consider the damage to your business that late or non-payment of a substantial customer’s invoices would cause before you offer them overly generous credit terms.

6. Factor in The Cost of Financing

When you are negotiating terms with customers, don’t forget that providing credit costs you money. If you have a positive cash position, you will be losing bank interest on outstanding invoices. If your business has borrowings, you will be paying more interest to fund your credit customers. The interest lost or gained may be relatively insignificant on small-ticket items. But for large accounts or high-value items, the cost of financing may be material. So, credit terms should be in the mix when you are negotiating pricing or discounts with customers. If a customer wants the best price, they don’t get the best terms, and vice versa.

Related Article: Ten Tips to Get Your Invoices Paid Faster

7. Early Settlement Discounts

Early settlement discounts are an effective way to encourage customers to pay invoices. However, the cost of cash settlement discounts can be pretty high. With a sizeable B2B credit account, a 2% early settlement discount could be a significant sum of money. So, if you do want to offer discounts for prompt payment, it would be best to assess the impact of doing so on your gross margins. If you want to speed up the payment of sales invoices, it might be cheaper to assign your invoices to a factoring company to get your hands on the cash faster.

8. Late Payment Penalties

You are entitled to charge late fees so long as your policy to do so is made clear to the customer at the time of purchase. And it is best to state clearly on all your invoices that late fees will be payable should the invoice be paid late. Late payment penalties will incentivize some companies to pay your invoices promptly. However, some businesses may ignore the penalties. You may need to get tough if you want your late fees paid, which is not always easy to do with a high-value customer.

9. Consider Other Payment Term Options

Credit terms do not always have to be simple 30, 60, or 90 days. For significant orders, for example, you could insist on a down payment. For long-term projects, you could ask for stage payments. For potentially high-risk customers, you could insist on holding a deposit against purchases.

10. Credit Terms are Not Set in Stone

Finally, customer credit terms are not set in stone. It is advisable to review existing customers’ creditworthiness and payment history regularly. Then, you can adjust customer credit terms accordingly. Suppose a previously reliable customer begins to miss due dates, for example. In that case, it could be a sign that they are struggling financially, so you need to minimize your risk. On the other hand, rewarding prompt payers with better terms might gain you more sales and referrals.

Related Article: How to Collect Overdue Sales Invoices Without Losing Your Customer

The Bottom Line

As you can see from the above, determining B2B credit terms is not an exact science. You must evaluate the credit risk of each customer, and you must factor in the impact that your payment terms will have on your cash flow. But at the same time, you must remain competitive. The best advice is to consider all the above when determining credit terms for customers, and keep your customer credit terms under constant review.

About Universal Funding

Universal Funding is a nationwide invoice factoring solutions leader, supporting growth-focused businesses with scalable factoring solutions. With its invoice factoring, payroll funding, and purchase order financing services, Universal Funding provides clients with the working capital needed to grow and support their businesses without taking on new debt. Ranked as one of the nation’s top invoice factoring companies, Universal Funding provides cash flow financing for businesses all across the United States.

 

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