In business we often extend credit to other businesses. When you extend credit the unpaid invoice is considered an “Accounts Receivable” i.e. someone who owes you money for a service or good that you provided. This is a common practice, and as long as your customers pay on time, in full, you should not have a problem. This article is to show the ways this practice can become a pitfall to your company if your customers do not adhere to the Accounts Receivable terms.
Most businesses use a “net 30”. This means that payment for the invoice is due in 30 days from the invoice date. When a business offers credit terms of “net 30” to another business, then in essence, one business is loaning another business that money (the invoice amount) for 30 days interest free. The converse side is that your business also has net 30 terms with your vendors. So you get 30 days to pay them from the time you make your purchase of goods to sell.
So in a perfect world, you purchase a good on net 30 terms from your vendor, then sell it to your customer net 30 the next day. If you pay your vendor on time, and your customer pays you on time, then you really only extended credit for 1 day.
So what happens on the 31st day if your customer does not pay you?
What is The Vortex?
Assuming you paid your vendor on time, you are now using your money to pay for a good or service that someone else has not paid for. When you opened your business did you intend on being a bank? I hope not.
When a customer is late in paying you, this costs you money. You have to keep your employees, operating expenses and vendors paid on time to maintain a good standing, and good credit. In order to pay all of these expenses on time it is crucial that your customers pay within set terms of payment. When your customer is late in paying you, then you have to pay expenses, you have to borrow money as in a credit card or a Line of Credit from you bank.
Credit Card Borrowing:
When you are paying expenses on a credit card this is borrowing money. If the credit card is not paid in full by the due date, then the interest kicks in and you are paying more for the goods and services you paid for using your credit card. So if you purchase a good for $1000.00 on your credit card and pay in full by the due date, the good cost you $1000.00. However, if you cannot pay the credit card on the due date and the credit card company adds 26.9% interest to the unpaid card, wham you now paid approximately $ 1021.00 for the same part. If I see a credit card balance on a company’s books this is a red flag that something is wrong, usually Accounts Receivable unpaid or overspending. Credit cards should be paid in full each month.
Line of Credit:
Many banks offer Lines of Credit for businesses. This is what I consider a great backup. Lines of credit should be obtained in the good times, when your credit is great and bills are paid. A line of credit can be obtained and never used. It is best to get the line of credit now, before you need it. It is much harder to obtain when you actually do need or want it.
That being said, I like the line of credit for expansion and for purchase of machinery. I do not like the use of a line of credit for paying payroll or everyday purchases of goods, services or general expenses. If you are using a credit line for any general expenses this is a red flag that something is wrong, usually it is unpaid Accounts Receivable or over spending. Remember the same principle applies with paying for goods on a line of credit as when you pay for them using a credit card, the only difference is that the interest on a line of credit begins the moment you use it. So if you are using a line to pay for a good, it automatically costs more than the original price as interest accrues from day one.
If you are lucky, you have a savings account that you can dip into to keep everyone paid. But this too costs money. Money you have saved is earning interest. So when you take from the savings account, you are no longer earning interest, thus losing money. Remember, when you use your saved money, you no longer have that cash for an unforeseen event, or possibly for an opportunity to grow.
What to do to stop the Vortex?
The Accounts Receivable Vortex must be stopped. You are not a bank. You are not in the business of loaning money. You are in business to make money. If you have Accounts Receivables that are past the thirty day terms, and you are using your saved money, or borrowing money to pay your bills, then you have a problem.
- First you must be diligent to go after the money that is owed and is past due. Talk to these people. Yes, call them and talk to them. Set up a payment schedule-take a credit card and set up an automatic payments weekly to pay the past due balance.
- Do not continue to service people/businesses that are past due. Draw the line in the sand. As crazy as it sounds you are better off financially to not work for someone who is not paying you timely. These businesses will literally suck they life out of your business. Make them pay any balance owed before more services are performed or good sold.
- Offer a 2% net 10 payment terms. This means if someone pays you in ten days they can take a 2% discount off the price of the good or service. Yes, it costs you 2%, but that is a far cry from the 26.9% you are paying your credit card company. On the same note-ask for 2% net ten from your vendors. If you can pay your own vendors and save 2% on the goods you sell, you are 2% to the good.
- Offer credit card acceptance. Yes this too will cost you money, usually 2-3% of the invoice, but you are funded in generally 1-3 business days. That is a win.
- Offer 6 month interest free payments. NO I do not want you to fund businesses and people for six months. There are a number of credit card companies that will allow you to offer interest free terms to your clients/customers. Hook yourself up to these offers! I would much rather your client be paying a credit card company over time then paying you late, or not at all.
- When offering credit to another company get a credit check on them. If it costs you $20.00 to find out they don’t pay their bills, it was a small price to pay to not get stuck for thousands of dollars of work. If the credit comes back bad-offer them COD (Cash on delivery). Or accept credit card payment in full.
- Charge and collect a finance charge on any account over 30 days. Be adamant about this, if you let a business slide on this you fall farther down the other businesses to be paid list. After all, they know you are a nice guy/gal you will let them slide.
- Turn over gross past due invoices to a collections agency. This will cost you a high percentage of what they collect, but getting something is better than getting nothing, and right now, you are getting nothing.
Look at Your Business:
I want you to look at your own accounts receivable list right now. Is anyone past due? If so, then look at your own bills, are they past due and or not paid in full by the due dates? Is your Line of Credit getting higher? Is your credit card not paid in full? These are all signs of a bigger problem. Usually the problem starts with unpaid Accounts Receivable.