I've been in business 11 years but only recently have I paid really close attention to the importance of payment terms.
Let's say we onboard a new customer. At some point an agreement is made about credit terms - they want 30 days, we offer 14 days. We settle on 21 days. Meaning we ship a pallet, issue an invoice, and payment is due 21 days after the invoice date.
What's really happened here? We've basically agreed to be our customer's bank for 21 days, offering a 21 day unsecured loan.
And when the customer's sales grow, so does our exposure. The two are intertwined.
They might start slow and buy a pallet a month, say $5000.
After 6 months maybe they're buying a pallet a week. Now we're carrying $20,000 of debt, instead of $5000.
Offering credit terms is basically pay to play. If a client requests a $20,000 credit limit, essentially you're giving them a $20,000 loan that lasts indefinitely, until they're no longer your customer and have paid their debts.
Imagine having 50 of these customers - your exposure, or fee you've paid to do business, is now $1m.
This is obviously industry-specific. E.g. E-commerce stores don't have this issue. Almost all online transactions are pre-paid. If an ecomm company has generous credit terms with their suppliers, they are always ahead.
The upshot is that it's best to maximise credit terms with suppliers and minimise payment terms with customers. The difference is either a 'fee' or a 'bonus' at any point in time.
Let's say we onboard a new customer. At some point an agreement is made about credit terms - they want 30 days, we offer 14 days. We settle on 21 days. Meaning we ship a pallet, issue an invoice, and payment is due 21 days after the invoice date.
What's really happened here? We've basically agreed to be our customer's bank for 21 days, offering a 21 day unsecured loan.
And when the customer's sales grow, so does our exposure. The two are intertwined.
They might start slow and buy a pallet a month, say $5000.
After 6 months maybe they're buying a pallet a week. Now we're carrying $20,000 of debt, instead of $5000.
Offering credit terms is basically pay to play. If a client requests a $20,000 credit limit, essentially you're giving them a $20,000 loan that lasts indefinitely, until they're no longer your customer and have paid their debts.
Imagine having 50 of these customers - your exposure, or fee you've paid to do business, is now $1m.
This is obviously industry-specific. E.g. E-commerce stores don't have this issue. Almost all online transactions are pre-paid. If an ecomm company has generous credit terms with their suppliers, they are always ahead.
The upshot is that it's best to maximise credit terms with suppliers and minimise payment terms with customers. The difference is either a 'fee' or a 'bonus' at any point in time.