This post is a continuation of my previous post on establishing good terms of payment, maintaining excellent cash flow, and avoiding risk are related. Read that post first if you want an example of how pay terms and cash flow are issues in your very home. Then come back here for an example in business.
OK, we’ve covered how selling your car to your good buddy Joe involves payments terms, increased (or decreased) cash flow, and risk management. Now let’s look at some business examples.
For businesses, cash flow is all about having money available. They want to remain solvent so they can pay off other businesses they owe money to (creditors) and make payroll each week. They also need money on hand for expenses that require immediate payment. If money is not available, production could be shut down.
For businesses, pay terms are expressed a number of different ways. Typically as “Net_____ ” The blank being filled in with a number. The number representing how many days you have to pay. Net 30 for example means whoever is paying has 30 days from time of invoice, or receipt of goods to pay. Longer pay terms Net45, Net50, Net 90 are good for the buyer. It allows two things:
1. Improvement of cash flow. You’ll have more money around since you don’t have to pay it for a while.
2. Mitigation of risk. Mitigation of risk? Yep. If you do NOT have to pay in advance for a product or service and something doesn’t go right, you are in a better position. You (they payer or buyer) have the goods or services performed but you are still holding the cash. It makes it easier for you, the payer / buyer, to negotiate a resolution if they haven’t paid. If you paid cash in advance (CIA) or paid upon receipt of goods (COD) and some is wrong, they already have your money. It could be hard to get the refund or extra work you require. Have you ever posted something on Ebay and had to give a PayPal refund? I wrote a post on that (click here). It is painful to do but in many ways you are in control since you have the loot already. Same deal with supplier who already has the cash. He’s in a position to negotiate.
Here’s an example of risk. You hire an electrical contractor to rewire your manufacturing plant. If you pay in advance (also called ‘cash in advance’ terms or ‘CIA’) and the electrical work does not meet your expectations by not following 3 point rule) the contractor already has your money and can make it difficult for you to resolve the problem. If you still have the money, you can negotiate a resolution easier. Why? Because the contractor ulitimately wants to get paid. You can hang onto that money and leverage that amount in order to get the job done right.
You’ve hurt your business cash flow (but improved the contractors) by paying him upfront. Say the job costs $30,000. If you negotiated the service agreement so that you do not have to pay him until 30 days after service or receipt of invoice (referred to as NET 30) terms you would still have the $30,000 available to you to pay creditors or emergency expenses.
If you want to get longer pay terms it is in your best interest to own or work for a company that can pay their bills on time and has an established payment history. Payment history can be checked using Dunn and Bradstreet reports (see my article on D&B here) as well has checking credit references which I discuss a bit in the D&B post. Check the post out and you’ll learn a bit on how this information is requested.
I hope that helps you to better understand why business payment terms and cash available are related. Having more money (cash) on hand means your company is more financially secure. The right credit pay terms can help this. You can also reduce risk with good pay terms and preserve cash flow.
Thanks for reading my post. If ever really get into a legal jam, and hire an attorney, make sure he or she does a great job for you. They always ask for money up front (CIA) but there are ways to get your money back from a lawyer. Click here to learn how.
Please Check Out Another One Of My Posts on Excertz
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