How to Support Longer Payment Terms, Without Losing Cash Flow

By Marc Price | July 19, 2022
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One of the most common concerns we hear from credit directors is the need to support their customers’ demand for longer payment terms.  There is a clear trend for longer payment terms across many industries, a trend which directly impacts sellers’ cash inflow.

It’s not hard to understand why buyers want longer to pay.  Every extra day of days payable outstanding (DPO) frees up working capital that can be put to use more profitably.  Buyers use their sellers’ lines of credit to enable growth and improve liquidity.

Payment terms can make-or-break a sale. Consequently, businesses need to balance the cash flow and risk impact of higher days sales outstanding (DSO) with the ability to reach more customers and sell more goods or services.

The Impact of Extended Payment Terms on Cash Flow

If you have had to extend payment terms to your customers, it’s likely you are already aware of the cash flow problems this can cause. If cash comes into the business later, liquidity is reduced and it becomes harder to meet liabilities. Cash flow management is crucial to effective business operations, allowing sufficient capital to invest in growth alongside day-to-day commitments to salaries, inventory and other overheads.

Late payments may already be testing your cash flow, so why would you allow longer payment terms to place even greater stress on cash flow management?

Encouraging Early Payments

In order to counter customers’ requests for extended payment terms, many businesses provide incentives for early payment, such as early payment discounts. In practice, negotiating payment terms needs to be done early in a customer relationship, as part of the sales process, which can favour longer payment terms over early payment discounts in order to preserve sales revenue.

Aside from incentivising early payments, businesses need to ensure invoices are generated and delivered quickly and accurately and the payment process is as pain-free as possible, or customers may be less inclined to make prompt payments. Consider sending electronic invoices which link directly to electronic payments online via debit or credit card to streamline the process and remove barriers to early payment.

If invoices are delivered electronically, open and click rates can be tracked and automatic follow-up communications sent ahead of the invoice due date, encouraging early payment.

Customers may require invoices to be delivered directly to their accounts payable invoicing portals to allow them to automate the payment process. In some cases, this can require accounts receivable teams to log in to multiple portals and copy-paste or type invoice details in manually – risking human error and payment delays. Thankfully, there are now ways to streamline invoice delivery to these portals, as you can find in this guide to streamlining invoice delivery to buyers’ AP portals.

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The Need for Longer Payment Terms

As businesses recover from the impact of the COVID-19 pandemic, and grapple with the supply chain crisis, financial leaders are inclined to prioritise liquidity to reduce the risk from future uncertainties. Small business owners are particularly sensitive to cash flow shocks and will take even longer than larger businesses to deprioritise liquidity.

As a result of this emphasis on liquidity, businesses may seek to increase DPO and benefit from the working capital this liberates. In some cases, this may be more than a customer’s attempt to improve liquidity, but perhaps a necessity if their place in a supply chain is experiencing payment delays or extended payment terms and they need to pass this on, as they wait for payers to settle their debts.

Length of credit may be as valuable as volume of credit to some customers, if they are experiencing cash flow challenges. So, while credit checks may suggest limited credit terms to mitigate risk in uncertain times, deals can be sweetened by allowing longer to pay the same amount.

Maintaining Cash Flow with Longer Payment Terms

Here is the crux of this article: how to meet customers’ demands for longer payment terms without suffering a hit to your cash inflow. There are two main ways this increase in the accounts receivable ledger can be converted into cash sooner, so let’s evaluate each in turn.

Factoring

Invoice factoring is a form of invoice finance, where the seller sells their invoices to a third party (called a factor), who then owns the customer invoice and can collect the invoice amount directly from the customer.

With customer payments going directly to the factoring company, it is immediately apparent to customers that the seller has employed an invoice factoring company to assist with the accounts receivable process. This can leave a negative impression, implying that the seller is either struggling with cash flow or needs to raise working capital.

Because invoice factoring liberates working capital from the accounts receivable ledger, this removes the cash flow impact of longer payment timeframes – the cash is available from the moment the invoices are sold.

However, a word of warning, factoring without a non-recourse agreement can leave you open to repaying the funds that were provided by the factor if your customers default on payments. You can find out more about the risks of invoice factoring in this article.

Managed Accounts Receivable

An alternative to factoring is managed accounts receivable (MAR); a technology-enabled managed service from Corcentric. MAR works as a white-glove extension of your business to generate, deliver and collect invoices. You can set the number of days you want your invoices to be paid on and Corcentric makes the payment to you on time, every time. So you can allow your customers 90 or 120-days terms, but you get paid on 15 days, providing far better cash flow.

MAR also simplifies cash application, as you are receiving just one payment from one business, with the guarantee that all invoices due on that date will be paid. No more three-way matching of multiple invoices, payments and purchase orders.

With MAR, you receive a guaranteed business outcome (a dramatic reduction in DSO) regardless of any customer insolvency or late payment. Bad debt simply ceases to exist, as Corcentric absorbs this risk as part of the service. You can find out more about how Corcentric MAR liberates working capital in this white paper.

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