Buy now and pay later—much, much later. Many freelancers and small businesses face this classic scenario daily. Late invoice payments can lead to cash flow constraints, hinder everyday operations, and even affect the expansion and success of your entire business. The good news is, there are some strategies you can use to reduce late payments and protect your business.
A common tactic, negotiating payment terms with your clients, can help create a strong incentive for them to pay invoices earlier—or at least on time. However, new research suggests that not all payment terms are created equal. Ironically, some clauses designed to encourage clients to pay may end up leading them to pay even later.
As a business owner, what are your options when trying to battle the curse of late client payments, and why is it so important?
Why negotiate payment terms with your clients
No one enjoys chasing invoices or playing financier to clients. It affects cash flow and hinders your business operations as you continue producing work with the expectation that the clients will pay you eventually. A recent report by PYMNTS in collaboration with Fundbox illuminated just how big a toll late payments are taking on American businesses.
The Trade Credit Dilemma Report surveyed over 1,000 businesses ranging in size and scale and found that the flow-on effect of late payments and trade credit is impeding the growth and success of U.S. companies.
The strain is especially acute for freelancers and small businesses, who have limited resources to chase invoices and not enough market clout to demand immediate payment. It can mean prioritizing the cash flow of your clients before that of your own business, and that’s not only risky, it’s unfair.
How late payments may be affecting your business growth
The PYMNTS report found that 27.5 percent of businesses who frequently received late payments from their clients often missed their own payment deadlines. This situation necessarily affects your relationship with your vendors and suppliers. Even worse, if your business incurs a late-charge fee or another unexpected penalty (for example), you’ll probably be the one responsible for those expenses.
On top of missing payment deadlines, nearly a third of businesses said that offering trade credit made their day-to-day operations more difficult. Making business decisions and budgeting is trickier combined with cash flow constraints, especially when you’re not sure when the funds will be in the bank. This is where late payments start taking a severe toll on the success of your business.
29.4 percent of businesses surveyed in the PYMNTS report said that late invoice payments hampered their ability to make capital expenditures, and 27.2 percent stated that it limited their product expansion. Add another 26.6 percent who noted that trade credit reduced their ability to purchase inventory, and you’ve got yourself a series of bad business practices that could be the difference between succeeding as a freelancer or being overtaken by competitors.
How can you encourage clients to pay invoices earlier? Let’s look at five strategies.
1. Offer extended payment terms
Some businesses are fighting late payments and cash flow uncertainty by offering their clients extended payment terms. This gives clients more time in which to pay back their invoices. It can also help businesses better manage their Accounts Payable. Extended payment terms tend to range from 60-, 90-, or 120-day timeframes, depending on the goals of your business and its capabilities.
At first glance, it may seem beneficial to offer extended payment terms to your clients. The longer timeframe to pay back invoices can incentivize more clients into doing business with you and lets you better manage when invoices are paid. Rather than letting clients dictate the timing of their late payments, you’re doing so yourself.
However, The Trade Credit Dilemma Report points to a cruel irony: businesses who offered extended payment terms were more likely to be paid later than those who demanded immediate payment or offered shorter timeframes. In fact, the longer the time frame offered to clients, the more likely that businesses would receive late payment.
The report found that firms requiring payment within 2-3 months were reimbursed late more often than those who stipulated a shorter time frame. On the other hand, 48.8 percent of businesses who didn’t offer extended payment terms reported that they were never paid late. On top of this, firms who offered extended payment terms to their clients were also found to be late in paying their suppliers, and more likely to experience cash flow crunches.
2. Experiment with early payment discounts
The other strategy used by some SMEs and freelancers to help incentivize clients into paying on time is offering an early payment discount. Not to be confused with paying in advance, early payment could mean paying within ten days instead of the usual 30-day payment cycle.
Initially, this might look like a good idea since it can entice clients to pay earlier to receive a discount on the total invoice amount. Wouldn’t most business owners want to save money by paying an invoice early? Funny enough, the answer is, No.
The PYMNTS report found that offering a discount to clients did little to help speed up payments. In fact, offering discounts even correlated with increased late payments. The research showed that the larger the discount offered, the more likely that payment would be made late. Businesses who offered clients a discount of 5.7 percent on average were 75 percent more likely to be paid late, while those issuing a discount of less than 3 percent on average were paid late less than 10 percent of the time.
Offering early payment discounts seems to increase the financial burden on freelancers and SMEs. Consider the situation you could create by offering discounts: Not only are you still being paid late and suffering cash flow issues in your business, but you also stand to lose money via discounts. According to the report, discounts given for early payments averaged 4 percent of a business’s total annual revenue. To put that in perspective, if you’re earning $80,000 per year, that’s $3,500 gone in discounts, leaving you with less money in the bank for inventory, supplies, and everything else you need to keep growing your business.
3. Consider charging late payment fees
Many businesses charge late fees for not paying bills on time, and why shouldn’t yours? Late payments can harm your business, and it shouldn’t be up to you to bear the financial burden of your clients. Charging a fee can help ease the effects of late payments on your business while also encouraging clients to pay invoices on time.
Particularly helpful for freelancers, late payment fees can help establish you as a professional with a business to run. This would have a particularly strong impact on clients who are repeat offenders, and those who place you at the bottom of their list of contractors to pay. Charging such a fee can remind clients that you value your work, and can encourage them to pay your invoice before others.
That said, late payment fees won’t necessarily work with every client. As we all know, some clients are more easy-going than others. Some clients may get annoyed by being charged a late fee, so it’s worth considering whether you have the energy to enforce this fee and potentially be embroiled in an argument with a particular client over it.
It’s also important to consider why a particular client hasn’t paid on time. If it’s a one-off late payment due to personal issues or unforeseen circumstances, it might pay to forgive and show some understanding, rather than charging a fee. And as always, make sure that the work delivered was up to standard and your client was completely satisfied before hitting them with a late payment fee.
4. Try instant payment discounts
A step up from early payment discounts is offering clients a discount for paying on-the-spot. With this “here today and gone tomorrow” impulse, clients could be incentivized into paying immediately to get the deal.
The difference between offering this kind of discount versus immediate payment is that you don’t offer it on every invoice. Instead, offering it rarely can be an excellent way to increase cash flow on a slow month or when you need some extra cash for investment or inventory purchases.
One-off discounts like this can also help boost customer retention while ensuring you don’t end up missing a percentage of your annual revenue on discounts. Perhaps more optimistically, this kind of discount could also help get customers in the habit of paying on time.
Fight for your right to be paid on time
If you’re suffering from cash flow issues plus the emotional burden of late invoice payments, it could be worth negotiating payment terms with your clients. It could be a case of different payment terms for various clients, or trying out a few of the options above to see what works best for your business, its goals, and your particular clients. If you run a B2B business, innovations in financial technology can help you shrug off the burden of playing banker for your clients, improving your cash flow and allowing you to grow faster.
Whatever you decide to do, make sure you’ve explained the terms with your clients beforehand and described expectations in your invoices. Careful planning and clarity on both sides can help you win the late-payments battle.
Note: This content has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for financial, legal or accounting advice. You should consult your own financial, legal or accounting advisors before engaging in any transaction.