The majority of B2B businesses offer credit terms to their customers. While this can have major benefits to a business you should be mindful of the cost of providing credit.
Firstly, let’s look at some of the benefits.
Offering credit to customers enables you to stay competitive. If your competitors are offering credit terms, you must do the same. It also demonstrates to your customers that you trust them. This creates a positive business relationship and enhances customer loyalty. And when customers have longer to pay, they are able to focus more on what you have to offer and less on price.
However, providing credit to customers does have cost implications and you should be mindful of what those are. So now let’s look at the cost of providing credit.
Administration overheads
Assessing who you offer credit to and the level of that credit requires a good understanding of their credit standing. This typically incurs the cost of obtaining a business credit report along with other checks such as credit references.
The reality is that customers don’t always pay on time. Someone needs to keep unpaid invoices on their radar, send follow-up letters, make phone calls, do additional record keeping etc. The older the invoice, the greater the administrative costs.
There’s also a time cost associated with providing credit. For most small-business owners time is a precious commodity. Having to make credit decisions and manage your accounts receivable means spending less time running other aspects of your business.
Cash flow
When you provide credit to your customers, a portion of your cash flow will be tied up in your debtors. This may not only impact the ability to pay your bills, employees and suppliers but also the funding required for any future growth plans.
Since giving credit terms to customers affects your cash flow, you will need to calculate how much your accounts receivable will increase and how you will finance this increase.
Financing credit reduces your profit margin. Options such as a bank overdraft facility will incur fees and ongoing interest. Invoice factoring costs are around 2 to 5% of the total value of the factored invoices every month. Converted annually this equates to a rate of 30 to 60%.
Late payments
The time lag between when you provide goods and services and when payment is received not only affects cash flow but can be frustrating and a source of contention for B2B relationships.
Late payments can put significant financial pressure on a business, with cash flow being the leading cause of SME failure. Analysis by Dun & Bradstreet shows that just 38 per cent of business invoices are paid on time. 55 days is the average amount of days taken to settle outstanding invoices.
Bad debt
There is always a risk that you won’t get paid for goods and services that you provide on credit. Large sums of money owed at any given time makes you vulnerable to bad debt which can lead to costly legal fees, time and stress. In some cases, where it is commercially unviable to pursue collection, the debt will need to be written off.
While offering credit to customers may be necessary to remain competitive, it is prudent to consider the cost. Partnering with MPS gives you the freedom to build your business by placing your account receivable management into our experienced hands. Your cash flow is predictable with credit risk removed.
Contact MPS to see how we can help alleviate the cost of credit to your agency.
