One of the nice things about retail sales is that you usually get paid immediately after making the sale. The customer pays in cash or with a credit card and the transaction concludes. Unfortunately, most commercial transactions are different. Corporate clients often demand credit terms – the option to pay an invoice in net 30- to net 60-day terms. Some companies go even further and ask for net 90-day terms.
This request can put you in an odd position, especially if you are a small business. Making a sale on credit terms to a client who has acceptable credit is often a good decision, provided your company has the cash flow to support it. On the other hand, selling on terms to a client who has bad credit can be a very bad decision.
Remember, the only thing worse than losing a sale is making the sale and not getting paid for it.
Why do large companies ask for credit terms?
You’ve probably noticed that most large companies automatically ask for credit terms as part of any contract negotiations. They are often inflexible on this matter – threatening to take their business elsewhere if you don’t agree. The reason they ask for terms is simple – it improves their cash flow. By using your product (or service) for 30 days without paying you, they are essentially getting interest-free financing from their suppliers. It’s a good deal if you can get it. And most large companies can get away with it. Unless your product/service is unique and essential, there is little you can do about this.
Offering credit can be a sales tool
Providing credit to commercial clients can be an important sales tool. It can help you close deals, especially if you can afford to give more generous terms than your competitors. Used wisely, credit can help you grow your company and take it to the next level.
However, giving credit can be a double-edged sword because you are taking on additional financial risks. Invoices from clients who don’t pay become bad debt, which drags your finances. And if you give credit to the wrong client on a large sale, the damage can be irreparable.
As a result, offer credit very carefully.
Who should get commercial credit?
You should offer net 30-day terms only to companies that can afford to pay you back. It’s that simple. Determining this creditworthiness may appear difficult, but it is often very straightforward. You can buy a commercial credit report on any company. Unlike securing consumer credit reports, you don’t need any special permissions to get a corporate credit report. You can get them from companies like Dun and Bradstreet, Experian, and Ansonia.
The logic behind these reports is simple. They gather the payment history on your client and provide you with a way to determine if your potential client will pay their bills on time. These reports are often based on the premise that your client will pay you just as they pay their other suppliers, and that if they paid on time in the past, they will continue to do so.
At times, making the right credit decision can be as much of an art as it is a science, especially when the information is conflicting. Thus, it’s impossible to be right 100% of the time. Remember that the objective is not to eliminate all risk, but, rather, to manage risk and make informed decisions.
As a rule of thumb, observe these rules:
- Look at the payment trends. Are they improving or deteriorating?
- Does the client pay slowly or on time?
- Does the client have delinquent accounts?
- Does your client work with many vendors that report credit?
The credit report offers a credit determination and suggests a credit line amount. Take this suggested line as an opinion, but look at the data and use your own judgment. To be on the safe side, be sure that the amount of credit that you offer falls in the mid-range of the client’s credit history. For example, if they have a highest credit line of $200,000 but an average credit line of $100,000, offer $100,000. Also, make sure that they have an established track record with multiple vendors.
By the way, if you are making a very large sale, consider buying reports from more than one credit bureau. Some companies may have proprietary information that is not available elsewhere and will help you get a full picture.
If in doubt, call your CPA. They should be able to help you make the right choice, and their advice is money well spent.
What if you can’t afford to offer terms?
One challenge that small companies often encounter is the fact that offering terms can create cash flow problems. If you don’t have sufficient reserves to cover your expenses while waiting for payment, you’ll certainly run into problems. These problems can affect your company when it’s growing and when you least expect it. Sometimes, all it takes is a few late payments to derail your finances.
One way to solve this problem is to get a business line of credit with your local bank. You can use the line of credit to cover expenses while you wait for payments. However, qualifying for bank financing can be hard, especially for new companies, small businesses, and self-employed individuals.
Another option to solve this problem is to use factoring financing. Factoring companies (like mine – Commercial Capital LLC) can help you by financing your slow-paying invoices. However, this solution works only if your clients have good commercial credit. Watch this video to learn more about factoring.
One last word of advice
If your company has never offered credit payment terms to clients, you should start slowly. Give yourself time to understand how your cash flow will work and be prepared to deal with possible cash shortages. Lastly, start building a cash reserve that you can tap if clients start paying slower than expected. The last thing you want is to get into trouble with your own suppliers/employees because you can’t pay them on time because of your own client’s slow payments.