Cash or Credit Terms: What Should I Offer My Customers?

It’s tempting to demand upfront payment before goods or services are supplied – especially as credit gets tighter. The decision to offer customers cash vs. credit terms is difficult, especially for a startup.

If you want to attract new customers, it is tough if your terms require cash upfront. Moreover, when you eliminate lines of credit for existing customers, it could have a detrimental impact on your business relationships. These customers will likely switch to your competitors where they can get credit. Yet, if you offer too much credit to too many customers, you could experience cash flow problems.

Every business needs to find the right mix between cash and credit. It’s wise to start all new customers on a cash basis. Once a business relationship has been built, and they have a proven payment track record, you can introduce credit terms. In a formal arrangement, customers can buy goods or services now and pay for them later at a mutually agreed-upon date—typically 30, 45, 60, or 90 days in the future.

As a precaution, credit customers can also sign a personal guarantee. Get your lawyer to draft a standard document if you take this route.

The Dos and Don’ts of extending credit to customers

If you intend to extend credit to customers must start with a credit policy and keep the following tips in mind:

• Do carry out a credit check on any new customers. You can get a credit check done by the Irish Credit Bureau or by specialist companies like Vision-net.
• Do check trade references. Confirm how long their account has been open and what their payment history is like.
• Do establish your credit policy from day one. This could include “no credit over $2,000” or “no credit terms” unless you’ve been in business over three years.
• Don’t give out too much credit and don’t offer credit to every customer. You’ll need some cash customers to ensure money is coming in regularly.
• Do review your policy and, in cases, shorten the amount of time you’ll carry that credit. Imagine the difference to your cash flow if you cut the amount of credit from 90 to 60 days?
• Do ensure your accounts are fully up-to-date and that you have an aged debtors list on the last day of every month.
• Do use a credit application for new customers. Ensure the form is completed fully so that you can verify all the facts.
• Don’t ever extend credit informally – “That’s ok – you can pay me next time”. Stick rigidly to your policy.
• Do ask company owners to personally guarantee if their company can’t pay. If it’s a sole trader or partnership, they are already personally liable.
• Don’t be afraid to adjust credit limits to specific situations. Remember: these are not set in stone, so change them if they’re not working well.

The difference between profit and cash flow

It’s important to clarify that profit does not equal cash flow. Simply looking at your profit and loss statement does not give you a clear picture of your cash flow. Many other financial figures are necessary to complete your cash flow, from accounts receivable (debtors) to stock, accounts payable (suppliers), capital expenses (plant and machinery) and loan repayments.

Put simply, profit is sales (cash and invoiced) minus expenses. Collecting the money on that invoice is what creates cash.

Positive cash flow is needed in order to generate a profit. You need this cash to buy fresh stock, pay developers, etc. It’s the sale of the inventory or service that helps to generate a profit. If you don’t have the money to pay for the stock, you won’t end up making any profits.

How to improve your cash flow

In order to keep your small business on the straight and narrow, follow these top tips for managing cash flow:

1. Keep accurate and up-to-date management accounts (past) and cash flow projections (future).
2. Set targets with your cash flow projections. This is a good way to ensure it’s given attention it deserves.
3. Agree payment terms from day one. If you don’t know when a payment is overdue, how will you manage cash flow?
4. Often, it can be a case of who shouts the loudest gets heard. Make sure this is you! Issue invoices promptly and follow up immediately if payment is not received in accordance with your terms.
5. Make sure to perform due diligence on any new credit clients. Make sure they pay in cash for at least the first 3–6 months.
6. Get rid of old and obsolete stock wherever possible. Don’t tie up cash in high stock levels.
7. Carefully manage payables. Whenever you see expenses growing faster than sales, take out the magnifying glass to find out why.
8. Take full advantage of creditor payment terms. If a payment is due in 30 days, don’t pay in 15 days. Make payments online, on the last available day. That way you’re within your terms and will have the use of these funds for as long as possible.

Ultimately, make sure to focus on cash flow and not profit. This is a common error of many failed businesses. Avoid overtrading! Keep your banking relationships close. You never know when you might need that short-term loan.

John Russell is Managing Partner of Russell and Co, a prominent accountancy firm in Ireland and Founder of My Start Up. Both companies specialise in helping startups and small business. John is also a published author of Ready Stead Grow – The expert’s guide to starting and running a successful business.

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