You’ve heard it before, “Sure, we'll pay you in seven days.” Too often those words…
Are You Your Clients’ Banker?
Do you realise that every time you provide credit to your clients and customers, you are effectively being their banker?
You provide credit when you allow your clients or customers to buy goods and services from you and pay at a later date.
It’s not unusual in many types of business to provide credit whereas in other industries the rule is you pay at the time. Think of retail outlets, online shopping, motor mechanics and hairdressers. In each of these situations, we happily hand over cash or a credit card and effectively pay for our purchases on the spot.
These businesses are working smart, not only do they get the money at the time, but they are saving hours of time maintaining accounting records and paying for the admin required to record and chase up payments. And to top it off, they never have to worry about whether they will be paid or not because if you don’t have the ability to pay at the time, you can’t buy.
Bigger corporations have credit application processes, often require financial statements or a credit agency report in addition to directors’ guarantees to ensure they have the information in place to commence legal proceedings in the event of non-payment.
Other businesses provide credit without undertaking any checks let alone getting an application form completed with basic information and the signature of the client or customer that confirms their agreement with your trading terms.
Which begs the question, what are your trading terms?
Do you have any and are they in written form and provided to every client or customer? Your terms would include basic requirements of how long you allow for payment (e.g. 7 days, 14 days or 30 days) and what your procedures are in the event of non-payment (e.g. application of interest, cessation of services, commencement of debt collection or legal action). To make sure that your trading terms will withstand a legal battle if required, do seek legal advice.
Whilst an application for credit and trading terms are imperative in the event that you do allow your clients or customers to pay later, the better option from a cash flow perspective, is to consider whether you can’t imitate the retailers and require payment at the time of purchase, or whether up-front payments can be required before service commences.
If you have a number of clients or customers who aren’t paying within your trading terms, or have large amounts outstanding, I suggest calculating your debtor days.
Debtor days or Accounts Receivable days.
This is the average period of time that it takes for your clients or customers to pay their invoices that they owe to you.
The way to calculate it is as follows:
Total Trade Debtors or Accounts Receivable divided by your annual total revenue and then multiplied by 365 days.
For example, if your Trade Debtors are $85,450 and your annual total revenue is $568,900 then your Debtor days would be:
$85,450/$568,900 x 365 = 55 days.
Irrespective of your trading terms, 55 days is not a good number, and if your trading terms are 14 days or 7 days, this is dangerous. Ideally, if you offer 30-day terms, your Debtor days should be around 30 days. Similarly, if your trading terms are 7 days, your Debtor days should be around 7 days, but they rarely are.
What is not uncommon is for the Debtor days to be 1½ times the trading terms.
For example, if your trading terms are 30 days, it isn’t unreasonable to expect your Debtors days to be 45 days. Anything more than this is not good, anything less is not so bad.
If you don’t know what your Debtor days are, do the calculation today, and see how good or bad it is.
Then start working on improving the figure by putting more time and energy into chasing up the outstanding invoices and considering how you can charge new clients or customers differently so that you get paid up-front or at the time of the sale.
“The opinions expressed by Smallville Contributors are their own, not those of www.smallville.com.au"
SHARE THIS ARTICLE WITH LIKE MINDED SMALL BUSINESS PEOPLE