Is your business profitable on paper, but tight on cash? If so, you might want to take a look at the payment terms and conditions you have established with your customers and suppliers.
If you pay suppliers faster than your customers pay you, cash outlays get ahead of cash coming into the business from sales. It is easy for payment terms and conditions to lose their alignment, because they tend to be created one at a time. Sales people promise financing or delayed payment with an eye on getting the deal and beating the competition. Meanwhile, purchases tend to be negotiated on unit price, but typically do not include terms for delivery, minimum order quantities, payment or penalties for delayed payment.
Negotiating payment terms and conditions is a balancing act that takes into consideration the economic needs of your customers, your suppliers and your own business. Terms are influenced by such factors as the size of the purchase, the time it takes to produce the product and the amount of inventory and commitment a supplier makes. So your payment terms will likely be unique to your business or industry. These four steps will help you keep your small business cash flow in check:
1. Match days to pay between customers and suppliers.
Ambiguity costs money, so make sure your payment terms are clear on every bill. When drawing up invoices, keep in mind the following:
- Shorter is better for the payment terms you extend to your customers. Consider negotiating partial-progress payments or down payments for larger jobs or orders.
- Send out invoices as soon as you book the business.
- Avoid paying restocking fees. Negotiate discounts if suppliers demand fast payment. Try to buy in bulk, but pay over time when materials are delivered.
- Try to get suppliers to provide you products on consignment if your customer base, retail space, or access to markets is attractive to them.
2. Make discounts and penalties work for you.
Discounts and incentives can help you improve your cash flow in two ways. First, accelerating payments to suppliers may allow you to reap significant early payment discounts. Second, offering your own customers incentives for paying a bill before it’s due may allow you to collect cash faster and put it to work for your business.
When working with customers, consider the following to optimize your cash flow:
- Provide incentives for fast payment via Internet, electronic or debit card payment, or scheduled electronic payments using online bill payment or Automated Clearing House (ACH) transactions. Ask your accountant to assess your cost of capital and teach you how much a 30-day delay in payment costs your business in terms of cash and profit generating potential.
- Clearly state your payment terms on all bills, including when you begin to charge interest and strictly adhere to these terms. Send month-end statements including any interest or late fees to urge payment.
When working with suppliers, consider the following to optimize your cash flow:
- Negotiate harder on discounts and penalties.
- Do your homework and be diligent about complying with terms. Paying suppliers online helps you to control and schedule when you pay, to ensure you meet your payment terms and supplier discounts, and avoid penalties.
- Fast pay discounts can significantly lower your cash expenses with suppliers if you have enough cash on hand. Paying with credit cards gives you the flexibility to negotiate different terms that may be more favorable to you.
- Avoid late payments with scheduled recurring payments with regular suppliers.
3. Balance financing terms.
Sometimes seller financing for your customers is necessary to generate sales. This is particularly true in a challenging economy where credit is tight. If you do offer sales financing for your small business, keep the following tips in mind:
- Use informed caution when offering credit. Segment existing customers based on payment history. Take advantage of credit scoring services for new customers.
- For credit sales, increase the sales prices to cover your financing costs. Offer a lower price for cash deals to provide incentives to customers to pay immediately.
- Know the true cash cost of your bad debts. Bad debt expenses slow cash flow by delaying payment, and reduce your cash flow with revenue write-offs.
- Try to get your suppliers to offer you indirect financing by getting them to hold inventory on their premises without payment until it is delivered or by offering you longer payment terms on projects that will take you a long time to complete.
4. Negotiate what delivery means.
The terms of sale determine the timing of delivery or transfer of the product and the timing of payment. Since time is money, the faster you define a sale, the faster you bill and collect. Here are two tips for keeping your delivery terms in line:
- Time is Money. Understand your delivery costs in terms of time and costs before you negotiate price and terms. For example, it may be faster to call a shipper and deliver the goods to your customer’s location than wait for them to pick it up. On the other hand, make sure you understand your total landed cost of goods while factoring in all of the taxes, duties, fees and shipping costs associated with delivering products to their final destination before accepting terms.
- Navigating a Global Marketplace. For complex international transactions, ask your banker about a letter of credit, a legal instrument administered by the bank as an objective third party. It can protect both buyers and sellers from non-payment, non-compliance and default.