Selling to commercial clients can be a challenge for small businesses and start-ups. Most commercial and government clients have contract terms allowing them to pay invoices in 30 to 60 days. These terms can create cash flow problems for companies that can’t afford to wait for payment.
These cash flow problems can also affect growing companies that may appear to be doing well financially. Sales may be growing, but collections lag behind expenses. Because of this delay, expenses grow while your cash reserves shrink – at least initially. For a more detailed explanation about this scenario, read “Cash Flow Problems Due to Growth“.
The solution: Early payment discount
One simple way to solve this problem and close the gap between collections and expenses is to offer clients an early payment discount. It’s common to offer a 1% or 2% discount on the total invoice amount if they pay it in full within ten days.
This discount is often noted on the invoice as one of the following:
- 1%/10 – net 30
- 1%/10 – net 60
- 2%/10 – net 30
- 2%/10 – net 60
While this solution can provide good results, it is not for everyone. As a matter of fact, offering quick-payment discounts can have some serious drawbacks.
One common problem is that clients can change their minds at any time. They could revert to paying you in 30 to 60 days without warning. Consequently, you could once again have the same cash flow problems you were trying to avoid.
What’s worse, some clients may take the discount but still continue to pay slowly. This outcome has a negative effect on both your profits and your cash flow.
This situation happens often, and it’s a difficult problem to solve. Obviously, you could call the client and attempt to collect – risking confrontation. In the end, you could also risk losing your client.
So, before you offer quick-payment discounts, ask yourself the following questions:
“Do I need the money?”
Payment discounts lower your profit margins. Basically, you are agreeing to lower profits in exchange for quick payments. As a result, offer discounts only if you have an immediate need for the money.
Small companies often offer discounts to get funds to pay for critical expenses such as:
- Vendor expenses
If you do not need the money and have an adequate cash reserve, consider allowing customers to pay on their normal terms.
“Do my profit margins allow for it?”
Even if you need the money, you must determine if your profit margins allow for the discount. Companies that have low profit margins should consider improving their cash flow differently. For example, if your company has profit margins of 10% and you give your client a 2% discount, you are giving up 20% of your profit. That amount is a significant percentage of profit.
Other solutions could include adding capital to the company, negotiating payment terms with vendors, and finding cheaper vendors.
“What do I do if clients refuse to pay quickly?”
As mentioned, one potential problem with this strategy is that your client could simply refuse to pay early. In this case, you need to find another way to improve your cash flow. If you have the resources, consider adding funds to your business.
If you do not have funds and need financing, consider using factoring. Factoring allows you to finance slow-paying invoices from creditworthy commercial clients. Instead of waiting 30 to 60 days to get paid, you get immediate funds from the factoring company. You can use these funds to pay expenses while your client pays on their usual schedule. You can learn more about factoring by reading this article.
How to proceed
If you decide to offer payment discounts, review your finances to ensure that you need the money and can afford to offer discounts. Don’t offer discounts to everyone. Instead, select clients who have good credit and who are likely to honor the agreement to pay early.
Lastly, consider adding the early payment discount as a clause in your contract. This approach offers you more protection if clients decide to take the discount but pay slowly.
Need more information?
Do you have cash flow problems? We are a leading invoice factoring company and can provide you with competitive financing terms. For more information, get an online quote or call us toll-free at (877) 300 3258.