This idea of lending your clients money might not come up in your consciousness, especially when you’re not in the actual business of lending money. But if you think about it, if you supply a product or a service to the value of $1000, with a 14 day invoice, but your clients don’t pay you for 30 days, essentially you have loaned your debtor $1000 for 30 days. They have had extra time to spend your money, invest it here or buy stock there. All before complying with your Payment Terms.
It is a strange concept to get your head around, yes? The idea that you are lending your clients money, at 0% interest. Unless of course you have penalties for late payment, but many businesses don’t have that. Most will send out the invoice, and then wait to get paid. And then stress when their cash flow falters. The service or product supplier suffers while this invoice, this loan, remains unpaid.
And on the other side of this transaction, the customer may not feel the need to repay your invoice immediately because you never really pressure them. They also have their own costs, so they prioritise payments. $1000 to you? That could be used to pay the delivery drivers right now, and when this other order comes in, then they will pay you. So, they’re borrowing your $1000 to pay someone else. Interest free, remember?
What you need to have in place before you begin to trade is how much you’re willing to ‘lend’ and for how long. Setting a credit limit, with firm payment conditions, prior to trade will clearly advise your client what the limits are, and what they are beholden to pay back to you, and when.
This idea is good, but you do need some processes attached to it. You can’t just pluck numbers from the air. There needs to be a logic which both your staff and the customers understand. A credit check completed on each customer is incredibly important and more than reasonable considering the circumstances. This will highlight the credit worthiness of your customer and their ability to pay.
If your customer has a good credit history, the credit limit will tie in with their purchasing needs. It is usually 2.5 times their regular spend, to account for invoices owing, those not quite due and also for growth. For example, if you have a customer who is willing to purchase $5k worth of product per month, and you have 30 days from end of month payment terms, then a credit limit of $12 500 would be recommended.
However, if your client is only able to cover $5k worth of debt, then you may consider reducing your payment terms to 7 days, or alternatively, make it very clear that once that $5k limit is reached payment must be received prior to further supply.
Thinking about these things differently is what I can help you with. Rewording the situation from an unpaid invoice to you ‘lending’ your clients, your debtors, that amount of money interest free, shifts the perspective and your view on this whole process. And if it gets a bit tricky, that’s where I’d like to help you. We can look at your processes, your terms of sale, and make them more palatable to you and your clients.
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