For many small and mid-sized companies, offering net 30-day payment terms to customers creates a financial challenge. Many companies can’t afford to wait 30 to 60 days from the date of invoicing to get paid. They need funds to pay for their immediate business expenses.
Slow payments are not the only problem of providing credit terms. Offering credit terms to the wrong clients also exposes you to the risk of non-payments. This risk is major, especially for companies that are growing quickly or that don’t have adequate reserves.
Whenever possible, you want to offer payment terms to only your best clients. This offer benefits your clients and gives you a tactical advantage over competitors. However, you also need to avoid offering payment terms to clients who have a high risk of not paying. This article explains how to make this decision.
Why do large companies pay slowly?
First, let’s understand the reasons why companies ask for credit terms. The most important reason for slow payments is that paying in 30 to 60 days is to their advantage. By paying you slowly, they get the benefits of your products and services while deferring payment. This approach gives them better use of their own cash resources, at the expense of their vendor. Basically, your business is providing them with the equivalent of a short-term, interest-free loan.
Another reason why companies pay slowly is that they may have cash flow problems. Basically, they do not have enough money to pay your invoice – at least not quickly.
As you can imagine, providing 30- to 60-day term credit to companies that are financially solvent but slow payers can be good business. On the other hand, providing term credit to companies that have cash flow problems can be costly. Consequently, it’s important to know which clients should be offered term credit.
Can you afford to offer net 30-day terms?
Before offering 30-day payment terms to clients, examine your own company finances and determine if you can afford to do so. This important step helps you avoid problems.
Your company should have sufficient reserves to pay for company expenses while waiting for your customer to pay you. If you don’t have sufficient reserves, avoid offering credit terms until you have improved your financial position.
Do your clients qualify for credit terms?
The next step is to determine if your clients qualify for trade credit from your company. Basically, do they have good commercial credit and do they pay on time? Obviously, your objective is to offer payment terms only to clients who have good credit. Other clients should pay in advance.
The easiest way to determine if a client has good credit is to review their commercial credit report. A credit report can let you know if your prospective client has a good track record of paying their vendors. This track record is the best indicator of how soon they will pay you.
Most credit reports are fairly east to read and also feature a suggested credit line maximum. Credit reports are a valuable tool for companies who sell on terms. Two well-known credit report providers in Australia are are VEDa and Dun and Bradstreet.
Consider early payment discounts
If you are offering credit terms but are facing mild cash flow problems, consider providing clients with an early payment discount. Offer select clients a discount off their invoice if they pay you in 10 days or less. This incentive can help entice clients to pay sooner and can improve your cash position.
While early payment discounts can help cash flow, they are not predictable. Clients will pay early only when it’s to their advantage. Therefore, these discounts are only a short-term solution.
Debtor financing helps you offer payment terms and grow
A better alternative, especially if your company is growing quickly, is to use a debtor financing solution such as invoice discounting or invoice factoring. Both solutions enable you to finance slow-paying invoices from creditworthy commercial clients. You can get funded as soon as you raise invoices, which enables you to pay for business expenses.
Debtor financing is easier to obtain than bank solutions, such as overdrafts or lines of credit. Furthermore, the line is tied directly to your sales and can grow quickly as your turnover increases. This flexibility makes debtor financing an ideal alternative for companies whose biggest asset is a solid client base. To learn more, read “What is Debtor Financing?”
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