“Well, how ya’ doin’ John?”
The jingle of the bell above your general store’s front door alerted you that the town’s most hardworking and successful farmer just walked in to buy this week’s necessities for his household.
“I’ll take a pound of flour, 2 cans of beans, a canister of coffee, and 3 candlesticks. Just need a few things this week, not much.”
“Sounds good, John. I’m assuming this will be on your tab?”
“Yes, sir. Harvest is next month. It’ll be nice to get that balance back down to zero. I’ll see ya next week.”
“Sounds good, John. Tell the Mrs. I said hello.”
We all want this type of relationship with our business customers: kind, friendly, personal, and trustworthy. It’s sad to admit that businesses could never operate on a “put-it-on-my-tab” credit system today… but I’m here to tell you that many businesses do operate this way without realizing it. And there is a good chance that you are doing it too. Extending a line of credit to your customers may be exposing your business to financial risk that could leave your shelves bare and your pockets cashless.
Now, you might be saying, “Wait, Geneve. I absolutely DO NOT have a tab for my customers or extend them a line of credit. That’s bonkers.” Do your clients pay 100% of their bill at the time of sale? If they don’t, they have a tab with your business. You are floating money to them – effectively extending a line of credit – for however long your payment terms are. The most common payment terms are 30 days.
It’s natural to want to trust each and every customer that comes through your door and I’m not here to tell you to become paranoid that your customers are out to swindle you for a bag of flour and some candles. But there are financial processes that you can put into place to protect yourself and your business from a serious cash flow problem caused by payment terms. Think of me as the bell above your business’ door, reminding you each time a customer walks through your door that you need to follow a well-thought out payment policy with that customer. Don’t have a payment policy in place? Ding ding! I can help with that. Have a payment policy but not sure if it’s doing its job in protecting your financial health? Ding ding! I can help with that too. Need help implementing procedures to support your policy? Ding ding! I think you get the idea… (I’m not sure if this analogy unintentionally makes me sound like a ding dong… 😆)
It would be an honor to use my financial expertise to guide you through creating policies and procedures to mitigate financial risk when it comes to collecting payments from customers. I’m ready to chat with you about your specific needs and put together a game plan for financial success. Schedule a meeting with me at your convenience. I might even bring a bell!
The Importance of Having A Payment Policy
Let’s say that your business brought in $500,000 in revenue last year. A new customer walks through your door (ding, ding!) who wants to purchase $100,000 of what you’re selling. After you pick your jaw up from off the floor, you eagerly walk through your sales process and a contract is signed within the hour. When it comes time to pay, they ask if you can bill them instead of paying on the spot. “Of course!” is the answer that flies out of your mouth before you’ve even given it some thought. You’re so excited about this huge sale that you are celebrating the rest of the week.
A month comes and goes, and you’ve not yet seen payment from this new customer even though you delivered almost immediately. Cash flow is now an issue, because you have vendors and employees to pay for filling this order with no cash to show for it. 45 days… and still no payment.
Worse case scenario: they never pay and you have to take out a loan to cover your costs and hope that you recover from this financial hit. The only chance you have of getting the money is by taking legal action or using a collection agency to hunt it down.
Best case scenario: they finally pay and you’ve learned a valuable lesson.
Pro tip: Don’t extend a line of credit to new customers without developing and implementing a payment policy that safeguards your business from bad actors.
Considerations For Setting Up A New Customer Payment Policy
It’s important that you have a payment policy to protect yourself as a business owner from a serious cash flow problem and short cash runway. If you don’t get paid, you can’t pay your bills – how long can you stay in business?
Here are a few considerations for setting up a new customer payment policy (ding, ding!) that will protect your business:
Should you accept credit card payments as part of your payment policy?
You may think, “I take credit card payments, so I don’t have to worry about not getting paid.” Don’t be so quick to think credit cards are your saving grace here. Yes, credit card payments are great because they essentially shift who is extending the line of credit from you to the credit card company…but it is an expensive payment system. Most credit cards charge 2-4% of the total purchase in fees. Going back to the example above when you scored a $100,000 order: if you allowed your customer to charge it to a card, and the credit card fee is 3%, that would cost you $3,000. That’s a lot of money!
Credit card payment systems can solve your cash crunch problem, but they also take a chunk out of your profitability. If you decide your payment policy includes a credit card option, be sure to build in the credit card fee to the price of your product or service or add a processing fee to every order to cover the cost.
Pro tip: If you don’t want to take credit card payments because of the fee and you don’t want to pass that cost on to the customer, you can also accept ACH electronic payments or check. But beware: in both cases, if you say it’s due in 30 days, it’s still extending credit.
Always vet your customers, just like banks vet loan applications.
Did you know that large companies ask for financial statements and vendor referrals before allowing new customers to have 30 days for payment?
For new customers walking through your door (ding, ding!), protect your business by acting like a bank. Ask to see their financial statements to determine the health of the company and if they can pay their bills. If they are losing money, you likely don’t want to float them money since your risk for not getting paid is higher. Of course, they can always say no to providing these statements, but it will never hurt you to ask.
You should also ask for a list of vendor referrals whom you can call to ask about their payment experience with the customer. It’s important to acknowledge that there is bias in this data – customers likely won’t give you referrals that will give them a bad report. But it’s still good practice to make the calls.
Small businesses typically don’t do this because they lack the staff or expertise to follow through. That’s where a financial expert comes into play to assist you with your financial policies and procedures. That ringing, reminder bell that goes off everytime a customer walks through the door might seem unnecessary, but it’s the best way to ensure you are consistently and accurately protecting your business and cash flow.
Pro tip: If you want to implement this financial evaluation process and you have the staff to execute it, don’t have the salesperson do it. They need to be aware of the policy, but let the salesperson be the good guy and the administration team be the bad guy. Your salesperson needs to maintain a good relationship with the customer. Digging into their financial history and potentially saying no to the payment terms they desire isn’t a “good guy” job.
Should you establish staggered payment terms and deposits into your payment policy?
Your first step should always be to request payment up front. This is the safest and best option for your business. Once you receive payment, then deliver the product – easy peasy.
Depending on the service or product, you also have the option to accept a deposit in advance of filling the order.
Let’s go back to our $100,000 order mentioned above:
- When your new customer signs the contact (yes, there should be a contract!) request full up-front payment.
- If that doesn’t fly, negotiate down the percentage. For example, request a 90% deposit, with the rest due within 3 days of receipt.
- You can continue negotiating down this percentage, if needed, but your payment policy should state the absolute lowest you are willing to go based on a financial cost analysis.
A financial cost analysis analyzes all of your data to determine exactly how much it costs you to deliver your product or service. For example, if your costs are 55% of your sales price, then I highly recommend you not go lower than that for the up-front payment. If you do go lower and the customer doesn’t pay anything more than the deposit, you would be losing money. You won’t even recuperate your costs! If you receive a deposit of 55% which covers your costs and they decide to skip out on paying the rest, you would lose profit, but at least it covers your out-of-pocket costs.
Pro tip: Try to get as much money up front as possible.
How do proven, trusted customers fit into your customer payment policy?
You don’t necessarily need to treat your longtime customers the same as a new customer. If you have a good history with them, you can grandfather them into your new policy without going through the steps of “vetting” and requiring full payment up front. Your risk is much lower in these cases, because you have actual experience with their payment reliability. Use your knowledge and wisdom and do what you feel is right. After all, we all want that personal, general store experience, don’t we?
You may be wondering at what point a “new” customer turns into a “trusted” customer so that you can say yes if they ask to pay in 30 days. Your financial payment policy should outline how many payments received on time are required before you extend credit. 3 payments? 12 payments? This will partially depend on how often they buy from you.
You should also consider how much credit you want to extend. If a loyal customer wants to wait 30 days to pay $100,000, you may be completely comfortable with that. But if a customer is on the line between new and loyal, perhaps you believe they are only good for $50,000 in credit. Credit card companies set limits on the cards they issue and then increase the limit over time as you’ve proven yourself trustworthy to pay. You should do the same with your business.
Executing Your Payment Policy
Payment policies should also include an aggressive collection policy. Make sure you have a written process for monitoring aging receivables (cash coming in!) and taking action to ensure nothing goes beyond 90 days. It’s always easier to collect your receivables when they are only a few days overdue instead of when they are 90+ days overdue.
You can learn more about how to set up a strong collections policy in the Tools For Effective Cash Flow Management section of Is Cash Flow Keeping You From Rolling In The Dough?.
Pro tip: You can set up QuickBooks Online to send automatic payment reminders on your behalf – automated and simple! But this shouldn’t replace all reminders… it’s easy for your customers to ignore an email but harder to ignore the phone ringing every other day asking about payment.
Partner With A Payment Policy Expert
Extending a line of credit to new customers should be a conscious decision, not a default one. Your business could quickly go from financially healthy to “mayday, mayday, we’re going down!” if you aren’t getting paid. Don’t allow your lack of a payment policy to be a catalyst for your business to enter crisis mode. Partner with a financial expert who can set up a policy that is right for your business. I’m happy to serve as the bell above your business’ door, reminding you each time a customer walks through your door (ding, ding!) that you need to follow a well-thought out payment policy. Let’s draft, implement, and execute it together for the health of your business. Contact me today for a free consultation.
