Simply put, a cash gap is created when cash inflows don’t keep pace with, or stay ahead, of cash outflows. In an effort to prevent an adverse cash gap situation, many businesses will attempt to entice early payments from their customers by offering what is known as an early-pay discount. Conversely, many savvy customers will offer to pay early in exchange for a discount. Don’t get suckered into this machination. It’s nothing but a way to obtain favorable pricing by equating the cost of product with the cost of money.
There are two primary arguments against giving an early-pay discount:
The first reason is cost: Let’s say for example that your standard terms are Net 30 days. Your customer offers to pay you in 15 days for a 2% discount. Basically, they are offering to increase your cash flow by 15 days and you will pay them 2% for that 15 days. Even if they pay on time, that’s an APR of around 48% based on the average funds employed. Sure, the more money you have in hand, the less you need to borrow. However, at those rates, you might as well go to Bobby Bacala
The second reason is Compliance: The fact is that very few customers actually pay within the discount period. In fact, most companies cannot even process invoices fast enough. Nontheless, they take the discount. They have now eroded your margins, and by extension your bottom line, and you have gained little or no working capital in return. In addition, you now need to expend administrative costs attempting to collect the shortage or deciding to write it off.
Companies want their money, and getting paid timely is imperative to a healthy business. That said, the best way to encourage timely payment is to offer a good product at a competitive price to stable customers. Simple. Right? Not really but it’s better than trying to buy customer performance..
The best way to avoid a cash gap issue is to establish sound policies:
First: Don’t sell to companies that don’t pay. Establish a sound credit policy. When you sell on credit, you are giving that customer a company asset and trusting them to pay for it. Do your due diligence. Make sure that that they have the stability, ability and willingness to pay.
Second: Don’t give customers any reason not to pay: Billing errors, shipping errors, invoices mailed late or not at all, etc. are all invitations to your customers to delay payment. Make sure that your billing and shipping departments are double-checking their work.
Third: Establish payment terms that are consistent with your Accounts Payable requirements. If you pay your bills in 30 days, your terms should be 30 days.
Fourth: Establish a tenacious collection policy: Once you have established your terms, they must be enforced. Customers pay beyond terms for a myriad of reasons. It is essential that you educate your customers on your expectations and the consequences if they are not met. Close follow-up of receivables and some “Dialing for Dollars” when needed will, in most cases, keep the payments coming in on time. You should also talk with your banker about establishing lockboxes and electronic payment systems to minimize the float and mail delays.
Most companies need to borrow money from time to time in order to bridge the cash gap. However, you should never pay 48% for the loan…..or even 24% given today’s cheap money. If you have a working capital line of credit, use it wisely but use it first. If not, work with your banker to establish one at the best possible rate. Start at prime and go from there. There are also other ways to enhance working capital. If you absolutely must, use a credit card but don’t borrow money from your customers. It's a windfall for your customer but you can’t afford it.
There are two primary arguments against giving an early-pay discount:
The first reason is cost: Let’s say for example that your standard terms are Net 30 days. Your customer offers to pay you in 15 days for a 2% discount. Basically, they are offering to increase your cash flow by 15 days and you will pay them 2% for that 15 days. Even if they pay on time, that’s an APR of around 48% based on the average funds employed. Sure, the more money you have in hand, the less you need to borrow. However, at those rates, you might as well go to Bobby Bacala
The second reason is Compliance: The fact is that very few customers actually pay within the discount period. In fact, most companies cannot even process invoices fast enough. Nontheless, they take the discount. They have now eroded your margins, and by extension your bottom line, and you have gained little or no working capital in return. In addition, you now need to expend administrative costs attempting to collect the shortage or deciding to write it off.
Companies want their money, and getting paid timely is imperative to a healthy business. That said, the best way to encourage timely payment is to offer a good product at a competitive price to stable customers. Simple. Right? Not really but it’s better than trying to buy customer performance..
The best way to avoid a cash gap issue is to establish sound policies:
First: Don’t sell to companies that don’t pay. Establish a sound credit policy. When you sell on credit, you are giving that customer a company asset and trusting them to pay for it. Do your due diligence. Make sure that that they have the stability, ability and willingness to pay.
Second: Don’t give customers any reason not to pay: Billing errors, shipping errors, invoices mailed late or not at all, etc. are all invitations to your customers to delay payment. Make sure that your billing and shipping departments are double-checking their work.
Third: Establish payment terms that are consistent with your Accounts Payable requirements. If you pay your bills in 30 days, your terms should be 30 days.
Fourth: Establish a tenacious collection policy: Once you have established your terms, they must be enforced. Customers pay beyond terms for a myriad of reasons. It is essential that you educate your customers on your expectations and the consequences if they are not met. Close follow-up of receivables and some “Dialing for Dollars” when needed will, in most cases, keep the payments coming in on time. You should also talk with your banker about establishing lockboxes and electronic payment systems to minimize the float and mail delays.
Most companies need to borrow money from time to time in order to bridge the cash gap. However, you should never pay 48% for the loan…..or even 24% given today’s cheap money. If you have a working capital line of credit, use it wisely but use it first. If not, work with your banker to establish one at the best possible rate. Start at prime and go from there. There are also other ways to enhance working capital. If you absolutely must, use a credit card but don’t borrow money from your customers. It's a windfall for your customer but you can’t afford it.
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