Managing Cash Flow Around Different Payment Terms
Net 15 versus net 90: The amount of time that you give customers to pay for purchases could be hurting your business. Cash flow has been called the heartbeat of a business. Having cash on hand means you can buy inventory, pay staff and fund marketing campaigns that grow your company. One of the most important factors that determines cash flow is your accounts receivable payment terms. How quickly after a product purchase or service delivery do you expect your customers to pay? By paying attention to this one small detail, you can completely change your business’ cash flow situation and free up cash to invest in your most important business goals. Here’s a closer look at the range of options available to businesses – and how managing your payment terms can help you streamline your cash flow.
Understanding Payment Terms
Accounts receivable reflect sales that haven’t yet been collected as cash. If you sell products or services in exchange for a promise to pay in the future, you’ve extended credit to a customer. There’s a wide margin of what’s acceptable in business vis-à-vis payment terms. Invoices go out every day with terms ranging from due upon receipt to net 120, or in limited cases, even further.
Shorter payment terms get money in the door faster. Longer payment terms provide customers more flexibility and may help you win more business. Companies often grant generous payment terms in order to reward customers or attract new business. It’s essential to understand how your choices around payment terms are impacting your ability to operate and grow your company.
Analyzing What’s Happening in Your Business
There are two ways to look at payment terms: there’s the ideal structure you set up with clients and there’s what’s actually happening in your business. It’s one thing to set a policy of net 30 by default. Yet there are many factors to consider regarding what model is right for your business. Are your customers paying on time? Do your terms work with the terms your own vendors are setting (e.g. does your accounts receivable timeline allow you to have the cash on hand to pay for your own necessary purchases or services)? By analyzing what’s happening in your business now, you’ll be able to balance the need to provide a great customer experience with meeting your company’s financial objectives.
Determining What’s Right for Your Customers and Company
At the start of each New Year, business owners should take the time to evaluate their customer accounts, cash flow and payment terms to determine how things are working. In many cases, the current structure is fine and no changes are needed. In other cases, when cash has been a challenge or customers are abusing credit terms, it’s time for sweeping or selective changes. Specific criteria to evaluate include:
The Status of Customer Accounts: Look at the historical performance of each of your customer accounts. How much revenue are they generating? What payment terms have you extended to them? Does the customer honor those terms, or are they consistently late? Consider shortening payment terms for late payers and looking at penalties to encourage timely payments. Generous payment terms are earned through consistent business, paying on time and generally being a good customer. For slow-paying customers, cash on delivery is another alternative to terminating accounts.
Evaluate New Customer Account Structures: While it can be challenging to change the payment terms for business relationships that are already established, look at ways to better manage receivables from new customers. Conduct credit checks before determining the payment terms for a new account. Require new customers to provide a deposit on initial services or orders. Consider shortening payment terms on new accounts to help improve your company’s overall cash flow.
Understand Your Own Financial Needs: A critical element to determining what payment terms work for your business involves looking at your own cash flow needs. Evaluate your budget and determine monthly spending, as well as what cash you need on hand for emergencies. Consider what terms allow you to operate comfortably if a key account is delinquent in their payments.
Manage Your Internal Process: Regardless of the terms that you decide with customers, it’s helpful to have a clear internal policy regarding accounts. Issue all invoices promptly. Use a system to help you log payments and alert you when an account is becoming overdue. Follow up promptly, politely and proactively with customers until they pay. Don’t be afraid to regard generous payment terms as subject to change for chronic late payers, and use that as leverage during payment discussions.
Offer Incentives for Early Payments: While your standard payment terms may be 30 days, consider offering an incentive (such as a discount) for paying early. Many companies also find that accepting electronic payments reduces the burden on customers and enables them to receive cash quicker.
What credit terms are you using for your business to help manage cash flow? Let us know what’s working for you in the comments below or join the discussion on one of our social media channels.