Michael Reid: Don’t let customers see your business as a source of free credit

Michael Reid: Don’t let customers see your business as a source of free credit

Michael Reid

Licensed insolvency practitioner Michael Reid discusses the importance of effective cash flow management as the key to the success and survival of businesses, particularly in the current economic climate.

Every business owner’s mantra: “Cash is King”

As a licensed insolvency practitioner, one hears many reasons why a company is facing financial difficulties, e.g. change in legislation, competitive forces, interest rates, supply difficulties, employment issues and demand for the product/service offering.

However, once further enquiries are undertaken, the root cause is invariably and inextricably linked to the lack of cash to fund operating activities.

In the current economic climate, many traders find it very hard to simply increase prices, fearful of losing customers, but remain acutely aware that all operating costs are increasing. Thus, unless selling prices can be increased, or internal efficiencies introduced, the cash within the business will decline because the amounts required to be spent on suppliers, utilities etc., will increase, thereby creating a cashflow challenge.

Some people may be lucky enough to have sufficient personal cash to utilise some of it to support their business: the majority are not, but even if they were, they should be asking themselves if they are throwing good money after bad in terms of being able to recover it in due course.

Further, when a third-party lender is asked to provide a funding facility, the inevitable questions arise about how the existing cash is being utilised and hence, what plans are there to pay interest on the new level of debt and repay the capital.

Many smaller businesses find themselves being squeezed by large customers who take an increasingly long period to settle bills. Immoral, unfair and inappropriate perhaps, but that is the reality of commercial life when choosing to deal with such customers. That said, if a product or service has been provided, one would like to think that a customer will have grudging admiration for the person who insists upon settlement in accordance with the terms of trade, or stops supplying, rather than meekly accept further delays.

In any business relationship, it is important that the terms of trade are clearly documented/agreed at the outset of any contract. If the terms require to be updated for whatever reason, further documentation should be prepared, agreed and signed. If you cannot demonstrate what the other party has agreed to accept, it is far harder to try and impose conditions at a later date.

If you are seeking payment from a customer, it is also of vital importance to know that the product supplied or service delivered is as ordered and accepted by the customer. Many businesses will have encountered the situation of pursuing an overdue book debt and find that, for no good reason, the customer claims faulty workmanship and rejects liability: but only after the third payment reminder has been issued. A supplier needs to know that the product/service has been accepted at the point of delivery i.e. there is no reason why a complaint at a later date will stop cash being received from the customer on time.

In summary, if you do not have proper documentation in place that covers the life of each transaction and decline to press for payment for fear of damaging a customer relationship, your most precious resource i.e. cash, may well wither to nil.

When chasing book debts, a customer might sense a weakness and offer a lesser sum to settle more quickly. By way of a quick example, take a business that is trying to recover £1,000 from a customer who normally takes three months to pay, despite the terms of trade stipulating one month. The customer offers £800 at the end of the first month and you are desperate for cash. If your cost for whatever you have sold is £750, you will be giving away £200 of your margin – 80% – while perhaps saving a bit of interest because the overdraft has decreased earlier than normal. Not a good outcome for you.

A number of people in business contend that it feels awkward to face a customer and ask for payment. If that is the case, recognise the issue and consider using a debt collection agency, or engaging an invoice factor. Using a third party to contact your customer who will have no qualms about pressing for payment means that trade professionals are being used to your advantage, albeit at a cost.

If your current system is not fit for purpose or you don’t like how it operates generally, ask for a review and make changes. Do not be seen as a good source of free credit by your customers and if necessary, engage with your suppliers in terms of trying to match your cashflow income pattern with the terms of trade that you would like to apply to customers. Everyone is in the same situation and keen to help if they can.

If no action is taken, then whatever the reason given by a worried director for the financial difficulties at hand, the reality is likely to centre around the fact that they have taken their eye off the most precious asset within the business: positive cash flow.

Finally, do not allow your business to fail due to inaction and remember … a sale is no good until the money is in your bank account.

Michael Reid is partner at accounting firm MHA

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