Why Merchants Should Be Cautious About Offering Net Terms

Author: Rieva Lesonsky | June 3, 2020

There’s been a lot of talk lately about how offering trade credit in the form of net terms adversely affects businesses in general and small B2Bs in particular. Right now in the U.S., according to research from PYMNTS, American small businesses have $900 billion in outstanding receivables.

How did this happen? A lack of good funding options is a big part of what led to this situation. In the past when buyers wanted to make purchases, merchants (sellers) were essentially forced to act as a bank. Sellers of goods and merchandise didn’t want to go down this path. They became lenders (extending trade credit, also known as net terms) so buyers could afford to purchase their products.

In today’s Net Terms Economy, in order to enable buyers to keep purchasing from them, sellers are enticing buyers with terms of 30, 60, 90 days or more. This means sellers are waiting months and months to get paid, leaving them without funds to reinvest in their own businesses.

In fact, 2019 research from PYMNTS and Fundbox shows that sellers say extending trade credit “constrains their abilities to make capital expenditures (29.4%), expand production (27.2%) and purchase inventory (26.6%).”

The Net Terms Economy is not inherently flawed—and it is common. About 43% of B2B transactions rely on trade credit. Indeed, it’s what keeps many businesses competitive, able to maintain solid relationships with their best clients, and increase customer loyalty.

Sounds good. And it is—when it works, meaning when buyers pay on time. How often does that happen? Not often. Research shows nearly all B2Bs (93%) have been paid late at some time during the year. 

Late payments are just one of the burdens sellers who offer net terms face. You can read more about the 4 Painful Truths of Offering Net Terms. At this point, the situation is so familiar to sellers, it’s easy to just shrug it off, thinking it’s the status quo and there’s nothing you can do about it. But something can be done. You can escape the vicious cycle. And you may need to—if you want to grow your business, reduce your costs of doing business and lessen the risks you face from buyers who never pay their invoices.  

Let’s look at how you can do this.

Cash Flow Issues Inhibit Growth

Sellers who extend net terms and aren’t paid for weeks or months can easily encounter cash flow problems. You’re likely familiar with how these issues can negatively impact your business prohibiting you from:

  • Hiring needed employees; paying competitive salaries/bonuses
  • Expanding to a new location
  • Creating new marketing campaigns
  • Investing in R&D
  • Opening new sales channels
  • Paying for production of your goods
  • Investing in new technologies
  • Reinvesting in your business in general

It’s much more difficult for businesses with cash flow problems to grow. Independent analysts found B2B sellers can, on average, increase revenues by approximately 25% to 35% if payments are received immediately and invested in strategic growth activities such as expanding production capacity, purchasing inventory in a timely manner, and/or investing in new product innovation.

Increased Cost of Doing Business

Business survival depends not just on revenue, but profitability, and profitability is often lost in hidden ways, like wasted human capital. In some small businesses, most employees wear many hats. They need to invest their time wisely and effectively in the activities that bring in sales while improving profit margins.

But it might be more difficult to do that when key company personnel have to act as bankers as well. Companies that extend net terms have to first spend time and money evaluating the creditworthiness of buyers who want credit. Then, if the buyers are late making payments, they have to chase down the money. This is a time suck, diverting time and attention from more profitable tasks and responsibilities. And if they decide to hire a collections agency, they’re not going to receive the full amount due them—plus they have to pay for the collection services.

Then there’s the lost opportunities because sellers don’t have the funds on hand to take advantage of being able to quickly purchase inventory, order more goods from their factories or qualify for early payment discounts from their suppliers.

An independent analysis shows the cost of managing a net terms program can add, on average, an estimated 8% to 10% to the total cost of business operations. So, if B2B companies can escape the Net Terms Economy, the cost of doing business could be reduced by up to 10%. 

The Risks of the Net Terms Economy

The issues we’ve already addressed—cash flow and higher costs of doing business—are the usual byproducts of participating in the Net Terms Economy. But, it not only costs you time and money—it’s fraught with risks.

Smaller B2Bs are competing every day with their larger counterparts, who often have deeper pockets enabling them to endure late (or no) payments. Bigger companies can offer longer terms, which smaller businesses mostly simply cannot match and stay in business.

A small business could be devastated if their buyers default altogether, something larger sellers can more easily withstand.

Plus, larger businesses may have departments and divisions with employees trained to evaluate creditworthiness or collect delayed payments. The salesperson who makes the sale in a smaller business typically cannot build a close relationship with a customer if they’re also pestering them for payment. For bigger businesses, in general, extending terms is less risky than it is for smaller B2Bs.

But, if small businesses don’t extend net terms, they risk losing clients altogether, since those clients can do business with the larger companies that sell the products they want and offer the terms they need.

According to 2020 independent analysis Frost & Sullivan, revenue losses from late payments, payment defaults, and customer churn range from approximately 6% to 8% for SMBs. And the probability of non-payments and late payments increases when net terms are given. To avoid these scenarios, B2B sellers often promote shorter-duration net terms, putting them at a disadvantage compared to their larger competitors. 

Solutions

While some businesses may find this tradeoff pretty bleak, striking a balance doesn’t have to be so costly. Businesses don’t have to rely on old-school credit solutions, like factoring, working capital loans and credit cards. A business line of credit from Fundbox can provide business owners with the financial breathing room to keep operations going despite, despite irregular or late payment on receivables.

Using a business line of credit, which can be based on incoming invoices, offers these possible advantages: 

  • Faster financing so businesses can get paid as soon as their work is completed. 
  • Continued ability to offer net terms. As noted earlier, if sellers don’t offer net terms, buyers will simply move on to a company that does. But sellers need to be able to handle the risk of offering terms to customers. 

If you want to focus on growing your business, devote your energies to doing what you do best, it may be time to free yourself from being a part time “banker” and explore a solution that takes the worry out of giving your buyers credit. In the end both your customers and your business will benefit.

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