Payment Terms: Use Them to Your Advantage

Is your business taking full advantage of payment terms offered by your customers? If not, it should be, because they’re about as close as it gets to the proverbial “free lunch.”

In many industries, suppliers offer customers the opportunity to pay invoices in 10, 15, or even 30 days; these are known as payment or trade terms. These terms are essentially an interest-free, short-term loan. Taking full advantage of trade terms can boost your company’s cash flow considerably as well as decrease your borrowing costs.

An example helps demonstrate the potential impact on cash flow: Suppose ABC Corp. averages $50,000 a month in payables (or $1,666 a day). Because it is a creditworthy company, its customers have granted it 30-day payment terms. The owner, however, likes to pay bills as soon as possible after he receives them, usually within 10 days.

But look at what would happen if he stretched out payment to the full 30 days instead. The company’s annual payables outlay would shrink by more than $33,000 (20 days saved x $1,666 = $33,333), adding more than $2,700 a month to its cash flow.

Before extending terms, most suppliers want to see proof that you pay your company’s bills on time, especially if you own a startup company with little credit history. To determine this, they may require you to fill out a credit application. It will ask for detailed information about your company’s background (such as how many years you’ve been in business, whether you have any outstanding loans, and the name and branch of your business bank) and structure (corporation, partnership, LLC, etc.), as well as your federal tax ID number and at least three trade references they can contact.

The supplier may also ask you to personally guarantee the credit, requesting a personal financial statement and personal bank account information. It will also request permission to obtain a personal credit report.

If the supplier is uncomfortable with the information revealed in your credit application or your ability to personally guarantee the credit, it may request a security interest in your products. This allows the supplier to repossess the products sold to you if you don’t meet the agreed upon payment terms. In this situation, you’ll have to decide whether receiving terms is worth the potential downsides of granting security interest to a supplier.

If not, keep in mind that you may be able to create DIY (do-it-yourself) payment terms by paying suppliers with a business credit card. Many businesses accept business-to-business payments by plastic these days, though they may assess a small service fee to cover their cost of accepting cards.

By paying off the balance in full each month on or before the due date, you turn a business credit card into your own personal interest-free, short-term loan. Be careful, though, if you decide to carry balances from month to month because the high interest rate may more than offset the cash flow benefits you enjoy from the payment terms. Also be sure to make payments on time every month because card issuers can increase your interest rate dramatically if you make even one late payment.

Don Sadler is a freelance writer and editor specializing in business and finance.