Managing working capital and ensuring that you have access to cash when you need it is a critical part of being a business owner. However, according to Xero Small Business Insights, less than 50% of Australian small businesses were cash flow positive in February 2020.
A common reason for these cash flow challenges is that some clients expect extended payment terms or simply don’t pay their invoices on time. Although it’s nice to recognise income from credit sales on your profit and loss statement, the reality is that ‘cash is king’ and you need that cash on time to pay suppliers and employees, deliver goods and services, and invest in the growth of your business. If not managed properly, working capital tied up in unpaid invoices can become an albatross around the neck of your business.
So how do you ensure that those invoices are paid on time? From the moment you start your business, it’s imperative that you adopt best practice accounts receivable management principles. We’ve created a two-part blog series that outlines exactly how to effectively manage your accounts receivable and access cash.
Check customer creditworthiness
In the past, slow paying customers were often seen as being at high risk of non-payment. But, these days, accounts departments in larger businesses commonly choose to delay the payment of small business invoices as a way to hold on to the cash for their own benefit. However, while often overlooked by small business owners, the fact is that by agreeing to sell your product on credit, you’re lending your customers interest-free money. And, just as lending businesses and banks assess the creditworthiness of their borrowers before issuing a loan, small businesses should check the creditworthiness of their customers before commencing work too.
So, before you begin working with a new customer, do your research to assess risk. It’s best practice to buy a credit report for your customer from a provider such as Creditor Watch or Equifax. Additionally, we recommend asking around other suppliers in the industry to see what the business is like to work with. Although you can never know for sure, this information can often provide the peace of mind you need to sell your products on credit.
How to negotiate the best payment terms possible
Too often, small and even medium-sized businesses are so happy to have a new customer that they don’t negotiate payment terms as well as they should (if they negotiate at all). When you start your discussions, or send through your proposal, it’s important to not only be clear on the price of the goods and services, but also on the payment terms and conditions, including how you’ll handle late payments.
Many business owners mistakenly default to lengthy payment terms of 30-60 days to make it easier on their customers. But the negative financial, productivity and business costs to long payment terms should not be understated. It’s easy to be intimidated by large customers, especially when your business is cash-strapped, but small businesses should treat the payment terms as a key part of the negotiation. Your customers expect to have this discussion and, once they have decided to buy your product, they often have some flexibility on the payment terms.
So what are fair payment terms in 2021? With the ubiquity of online banking, you should expect your customers to attend to payment within a short timeline – for example somewhere between 7 and 30 days. This ensures that cash hits your business account more regularly and that you can pay your employees, invoices and other time-sensitive expenses before incurring any late fees yourself.
Offer early payment discounts
A common way to incentivise prompt payment by your customers is to offer a discount for early payment. An example of an early payment discount is “2/10, net 30” which means that a two per cent discount on the invoice amount is available if the customer pays within 10 days instead of the default 30 days. This two per cent discount for paying on the 10th day instead of the 30th day broadly equates to an annualised interest rate of 36 per cent, so it’s important to speak to your accountant or bookkeeper to understand the true cost of these arrangements.
If you’re concerned that your customers present a non-payment risk, or you don’t want to sell your products on credit, it’s worthwhile requesting either full or 50 per cent payment upfront before any work commences. This provides financial security, particularly in the case of new clients where there’s no trading history.
Milestone payments (the process of getting paid as each project goal is delivered) are also a great way to maintain cash flow and mitigate risk, especially if you’re working on a major project that could take months to deliver. However, it’s important to note that if you do choose to go down this route, and unlock cash at each milestone, to seek advice from your invoice finance provider as funding milestone payments can be difficult for some lenders depending on the arrangement.
Invoice on time
Once you have agreed to payment terms with your customer, it’s important to be disciplined in issuing invoices shortly after the goods or services are delivered (or before work commences if they’ve agreed to pay upfront). Your time is valuable, and it also sends a message to the client that you expect to be paid shortly. Tardiness in issuing invoices can send the message that your business isn’t in a hurry to receive the cash or that your business is relaxed about its payment terms. Customers may take advantage of this and will be more likely to draw out their internal payables process.
Additionally, you don’t want any discrepancies over the goods or services provided, so sending it straight away ensures that the client knows exactly what they’re paying for.
Provide all documentation
Finally, it’s important for small businesses to take the time to understand their customer’s accounts payable processes and provide the specific documentation needed. Every business is different, and the documentation you provide may also help protect your business in the case of a dispute over what was or wasn’t provided. Supporting documentation such as purchase orders, proof of delivery slips, or timesheets may be required and it’s your job to make it as easy as possible for your customer’s accounts payable team.
Apply for invoice finance
Despite your best efforts, some customers will inevitably pay after the invoice due date. Earlypay can offer your business a fair and flexible line of credit that lets you release cash from your customer invoices so you can better manage the ebbs and flows of your cash flow.
In part-two of this blog series, we’ll cover everything you need to know on best practice accounts receivable principles for payment plans, communication, record keeping and collections.
If your business could benefit from Earlypay's invoice financing facility, please sign-up at our website to receive a no-obligation offer or call our friendly team on 1300 760 205.