Apr 30, 2019
Last updated: May 18th, 2023
Allowing customers to pay on credit has a large number of advantages when managed efficiently. Most businesses pay on credit, which means you’ll likely attract more customers and experience growth if you offer payment on credit.
This industry standard is known as offering net terms.
Balancing the advantages of extending credit with the disadvantages is where proper management of the accounts receivable (AR) process comes into play. In short, the AR management process is sending out an invoice for merchandise or services rendered, waiting for some predefined number of days for payment, and finally receiving payment and recording it.
In this blog, we’ll look at a balanced view of the pros and cons of offering net-terms financing.
The advantages of offering net terms financing
Advantage #1: Customer growth
If a customer can delay payments versus paying immediately, it's most likely that will be the approach taken. For businesses, paying on credit is the norm. If you know the majority of businesses will seek our merchants who allow credit payments, you need a good reason not to offer credit.
The end result of offering credit is growth and finding new customers, which, of course, means more revenue growth. Further, keep in mind that paying on credit is just expected in certain industries. If your industry is one of them, not offering credit will be stacking the odds against you. Learn more about using a net terms platform to drive higher revenues.
Advantage #2: More diverse client base
More customers can mean more diverse customers. The more customers you have, the less dependence you’ll have on any one customer. A diverse customer base can also mean some shielding from cyclical events in specific industries, seasonality, and bankruptcies. For example, GoMaterials was able to expand into new markets after finding a way to offer payment terms in the USA.
Advantage #3: Customer loyalty
Paying on credit always works in the customer’s favor. You also have the option to customize your credit offering depending on the customer. Some buyers may get longer terms than others, depending on their history with you. This can create great customer loyalty.
Most customers will appreciate the fact that you’ve extended additional credit to them or even customized credit to work on the customer’s unique terms. Not every business does this, but those that do can see big benefits in customer loyalty and we hope that is you! For example, Tern Bikes was able to use Resolve to offer more credit to their customers, which ended up growing their revenues!
After looking at a number of advantages to offering payment on credit, let’s look at a few disadvantages to give us a well-rounded view of offering customer credit.
The disadvantages of offering net terms financing
Disadvantage #1: Strained cash flow
Extending credit can mean short-term pain for long-term gain. In exchange for forgoing immediate payment, you potentially increase your customer base and loyalty, all the while driving up revenues. That's great! However, your cash flow will see it quite differently.
Since immediate payments for merchandise or services is delayed, your cash flow drops. You don't get paid for 30 to 60 days. Your business needs to be able to cope with this decrease in cash flow. Without incurring additional cost, the business will need savings on which it can lean.
Without cash to cover payment on the net terms you've extended, you can end up in a precarious position as bills come due, but there isn’t any cash flow to cover them. Note, there are several ways to manage cash flow shortages. Resolve Pay is one of them. Resolve is a net terms and invoicing solution that gives companies the option to offer payment terms - while receiving an immediate cash advance of up to 90 percent.
Disadvantage #2: Late payments
Late payments can certainly happen without extending credit (ie, due upon receipt) but they are exaggerated through credit extension. What should have been 30 or 60 net terms can turn into 45 or 70.
If you’re expecting a 30-day net term but instead receive payment 15 days late from 10 - 15 percent of your customers, the company may find itself quickly having to renegotiate terms with suppliers and re-evaluate future projects.
Building in a bad debt allowance for late payments can help better manage your late payments and help you avoid the above scenario. How many days late should you expect payments to be and from what percentage of your customer base? A good place to find this answer is to check the averages in your industry.
Along with late payments come no payments. While rarer, some customers will default on their payment arrangement. Some will even go bankrupt. Again, building in a bad debt allowance for these rarer events will allow the company to absorb such shocks better. One way around this is to consider Resolve. Resolve is known for decreasing bad debts by nearly 100%. In fact, Elston Materials achieved a 0% loss rate after working with Resolve.
Disadvantage #3: More labor-intensive accounts receivable
By allowing clients to pay on credit, you’ve added another cog into the finance machinery. There are now more parts to juggle. Payments are coming in while others are outstanding on net terms. You have to know who is late and if a notice has been sent. Some clients are new and need to be vetted for creditworthiness. Some clients are paying early and should be rewarded with a small discount (per invoice terms).
The way to keep up with all of these moving parts is to define your accounts receivable process well ahead of time. A few important factors to consider are:
- Do all clients get the same net terms or will they vary by client size and creditworthiness?
- Will you offer ranges of net terms (i.e., 30, 60, 90)?
- Will a discount be offered for early payment? If so, how much and does it vary by days paid early?
- How are late payments handled?
- Do we extend more advantageous terms to loyal clients? At what point should this happen?
The pros and cons of net terms financing is ever growing
As you start thinking through how your AR process will look, the above list will grow. This is why many companies choose to offer net terms online. The more items you can add to the list, the more prepared you’ll be when something unexpected happens.
Extending customer credit can certainly work in your favor when done right. Knowing what the challenges are and building contingencies into your process can help ensure your cash flow remains robust and your customers are satisfied.
Learn more about optimizing your net terms management here.
