For many companies, the practice of offering trade credit to commercial clients is accepted as a necessary cost of doing business. Sellers typically provide credit by way of net terms—which, depending on the industry, may be called payment terms, dating terms, trade credit, business credit, or customer credit. This allows buyers to buy now and pay at a later date, often 30, 60, or 90 days (or in extreme cases up to a year) before payment is due.
It’s a smart system when it works. In fact, typically 43% of B2B transactions rely on trade credit for financing. If you’re such a business, it helps you stay competitive, maintain good relationships with your best customers, and increase loyalty and referrals.
However, it really only works well when your clients pay on time. Many don’t. One survey found that 93% of B2B companies have received a late payment at some time during the year. Other research shows that as your number of customers grows, typically your risk of receiving late payments also increases. Nearly 55% of those with 500-plus buyers reported receiving more than 25% of their payments late.
Late payments are just one of the burdens you face offering net terms. This “cost of doing business” actually has other hidden costs behind it. Read on to learn four major drawbacks of financing your own trade credit program.
1. Cash flow delays can starve growth
By offering trade credit, you may be setting yourself up for cash flow risks. Even under the optimum circumstances—when customers pay promptly at the end of their term—your company must still carry the operational debt of supplies, labor, and other overhead during that time. This risk is compounded when you face amplified costs for taking on new business, such as requiring you to hire expert staff, advanced equipment, or premium materials before you can even begin the new job.
Cash flow becomes even harder to manage when customers pay late. Fundbox research found that 64% of SMBs get paid late, and as a result, 23% can’t invest in new equipment or hire new employees, and 17% can’t build up inventory.3 That’s how delayed payments can make it difficult for B2B sellers to invest in strategic growth initiatives.
Such cash flow problems can also lead you to pay your own bills late, even to your suppliers upstream and potentially harming those critical relationships. A 2019 study by PYMNTS found that 27.5% of firms that receive more than 75% of their customers’ payments late also pay their suppliers late, and nearly 68% of companies receiving more than half of their payments late routinely face short-term funding issues.2
If enough of your customers pay late or default, you may be forced to look to outside sources to finance your own operations (such as credit cards), which adds to your costs. In this case you’re actually incurring debt just to pay for your customers’ convenience of paying on net terms.
2. Early payment discounts thin profits
Late payments aren’t the only risk to cash flow. You may also lose money if you use discounts to encourage customers to pay earlier than Net-30 or whatever your established terms are. While it’s nice to get paid “early”, if they take you up on your offer, you’re actually earning thinner margins.
For the sake of speeding cash flow, you’re leaving money on the table for your customers’ ability to enjoy trade credit. Even if the percentage is small, these incentives could add up to a substantial sum. PYMNTS’ research shows that the value of discounts in the U.S. would total $1.7 trillion annually if every firm offered the average rate of 4.1%.”
In addition to making revenue planning less accurate, you’re also complicating your accounting process by having to keep track of which accounts owe how much based on their particular discount scheme and when they pay.
3. You shouldn’t act like a finance company
By offering net terms, your company assumes the responsibilities of a de facto finance company. 60% of small businesses depend on trade credit (either formal or informal), making net terms the second most common form of small business financing (after traditional financial institutions).
Just because it’s so common doesn’t make trade credit any less demanding for your accounting department. First, they have to make the determination as to which customers are creditworthy enough to be offered net terms. This typically involves asking for credit applications, running credit checks, requesting financial information or tax documents, talking to references, performing other due diligence, and following up.
Assuming the application is approved, you must then negotiate and write up the credit policy (your invoicing terms and conditions). Usually this isn’t a simple boilerplate process. For example, “Net 30” often means different things to different people. Does it start on the date of service or delivery, when the invoice is issued, or when the invoice is received? Are you offering discount terms as incentives for early payment, and according to what schedule? Are you charging interest, and at what rate, and beginning when?
Even the credit application process potentially strains relationships with key customers, who sometimes expect personal favors. A large customer may try to use its purchasing power to pressure you to agree to more favorable terms, relax rules, or make exceptions.
Remember: if you don’t have dedicated resources for managing the administrative tasks of your net terms program, that means these very serious credit financing functions are being performed on a part-time basis, either by employees (who may lack any specialized training) or the business owner.
4. Sometimes customers just don’t pay
Of course the biggest risk of offering net terms is that you might do the work or deliver the goods but then never get paid. No matter how hard you try to vet your customers before offering trade credit, there is the chance you get unlucky.
Besides the agonizing discomfort you or your employees might face at confronting a late-paying—let alone defaulting—customer (perhaps one you have known personally for years), there are significant costs and other risks involved in handling such situations.
First, you’re rarely in any position to demand immediate payments. Disputes may involve mediation or even potential litigation costs. You also face the likelihood of customer churn.
Collections is also a highly-regulated process that, if done improperly without training, could expose your company to serious fines or legal penalties. The Fair Debt Collection Practices Act (FDCPA) provides limitations on what debt collectors can do when collecting certain types of debt. Some state laws also provide additional protections to borrowers.
If a customer can’t or doesn’t want to pay, you are often left with only two equally-bad choices: hiring a collection agency (and absorbing their fees too) or writing off the balance as bad debt. Debt collection costs time and money, so you may find it’s not worth it to spend too much time collecting debts.
To anticipate or avoid potential cash flow problems, it’s helpful to keep an eye on how well your customers honor the terms of your credit policy. One way to do this is to routinely review an aging of accounts receivable. Typically, the longer an invoice has gone unpaid, the greater the likelihood you’ll have a hard time collecting the full amount.5
Finally, as much as you may value particular customer relationships, you should ask yourself if you’re willing to consider dropping clients who fail to pay on time.
Is it still worth it to offer net terms?
Despite the complexities, there are many reasons why offering net terms may make great business sense for organizations of any size. First, it’s often hard for SMBs to get other kinds of traditional financing for the goods they may need from companies like yours. Trade credit gives such customers a way to buy from you—often with a higher order size—so they can sell over a longer time. Trade credit also helps you close deals and gain a competitive advantage. Plus, it builds customer relationships and loyalty.
You can help minimize the cash flow impact of offering net terms by considering a Fundbox business line of credit, which can allow you to draw cash based on the anticipated revenue from your customers’ outstanding invoices.
Payment Practices Barometer, (Atradius, September 28, 2016).
SMB Receivables Gap Playbook, (PYMNTS, November, 2019).
Fundbox Study Reveals Crippling Effects Of Late Or Unpaid Invoices, (PR Newswire, March 16, 2017).
Technology is Changing How You Pay Suppliers, (Retailing Insight, September 16, 2019).
Harold Averkamp, What is the meaning of aging?, (AccountingCoach.com, accessed March 3, 2020).
_Disclaimer: Fundbox and its affiliates do not provide financial, legal or accounting advice. This material 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._ⓒ 2020 Fundbox. All rights reserved.