Many companies practice offering trade credit to commercial clients. Sellers provide credit by the way of net terms which is also known as dating terms, trade credit, payment terms, business credit or customer credit. This allows buyers to buy now and pay later such as 30, 60 or 90 days before payment is due.
Most b2b transactions rely on trade credit for financing. It helps your business stay competitive, maintaining good relationships with customers, and increase loyalty and referrals.
It only works when your clients pay on time, but many do not. Late payments are just one of the burdens that you will face by offering net terms. In this article we will discuss the major drawbacks of financing your own trade credit program.
Cash flow delays can affect growth
You might be setting yourself up for cash flow risks by offering trade credit. Even when customers pay promptly, your company needs to carry the operational debt of supplies, labor, and overhead during that time. The risk is compounded when you face costs such as hiring staff, upgrading equipment or premium materials before you begin.
Cash flow becomes even harder to manage when customers pay late. Such cash flow problems can also lead you to pay your own bills late, even to your suppliers upstream and potentially harming those critical relationships.
If you find that many of your customers default or pay late, you might need to find a way to finance your operations which is going to add to your costs.
Early payment discounts affect profits
You can lose money too if you use discounts to encourage customers to pay earlier than net-30 or whatever your net terms are. It might seem nice to get paid early but you are actually thinning out your margins.
For the sake of speeding cash flow, you are leaving money on the table for your customers’ ability to enjoy trade credit. You are also making your accounting process complicated by having to keep track of which accounts owe how much based on their discount scheme and when they pay.
You shouldn’t act like a finance company
Over half of small businesses depend on trade credit making net terms one of the most common form of small business financing. If one’s application is approved, you need to negotiate and write up the credit policy. The terms “net 30” can mean different things to different people such as is their interest rate involved, are there discount terms for early payments and more.
Even the credit application process potentially strains relationships with key customers, who sometimes expect personal favors. A large customer may try to use its purchasing power to pressure you to agree to more favorable terms, relax rules, or make exceptions.
Sometimes customers do not pay
The biggest risk of offering net terms is that you might do the work and deliver the good but never get paid. There are major costs and risks involved in this type of situation.
First, you are rarely in any position to demand immediate payments. Disputes may involve mediation or even potential litigation costs. You also face the likelihood of customer churn.
If a customer cannot or does not want to pay, your two choices include hiring a collection agency or writing off the balance as bad debt. Debt collection costs time and money, so you may find it is not worth it to spend too much time collecting debts.
To anticipate or avoid potential cash flow problems, it is helpful to keep an eye on how well your customers honor the terms of your credit policy. Another thing to consider is ask yourself if you are willing to drop clients who fail to pay on time.