Are Customers Using Your Company as a Bank?
Don't Let Customers Abuse the Credit You've Extended Them
Business customers often use their credit lines with suppliers as a form of financing similar to a bank loan. Trade credit, provides several advantages and functions in ways that can mimic traditional banking services, such as a line of credit or revolving bank loan. By using supplier credit lines, businesses can maintain operational efficiency and flexibility. They can also better manage inventory purchases, cover unexpected expenses, or take advantage of bulk purchasing discounts without immediate cash outlays.
The Advantages Sellers Get from Offering Trade Credit
Offering trade credit, however, isn’t something businesses do for purely altruistic reasons. While trade credit carries some risks, it offers suppliers significant benefits in terms of growth, customer relations, and market positioning. Here are the key advantages suppliers can realize by extending trade credit to business customers:
Sales and Revenue Growth: Offering trade credit often leads to increased sales volume and revenue by enabling customers to make larger or more frequent purchases. Trade credit can also help suppliers broaden their customer base and potentially enter new markets by appealing to businesses with cash flow constraints.
Stronger Customer Relationships: Trade credit helps attract new customers and fosters loyalty among existing ones, building trust and long-term business relationships. By offering trade credit, suppliers can position themselves as valuable partners, potentially leading to deeper business relationships and preferred supplier status.
Competitive Edge: Offering favorable credit terms can differentiate a supplier from competitors, making them a more attractive choice for potential customers.
Long-term Profitability: While there may be short-term cash flow impacts, trade credit can lead to improved long-term profitability through higher margins and repeat business.
The Advantages Buyers Get from Supplier Credit Lines
As already indicated, the benefits of trade credit go both ways. Using supplier credit lines as a financial tool allows businesses to manage their finances strategically, similar to how they would use a bank's line of credit. It provides flexibility, supports growth, and helps maintain positive cash flow without the immediate need for external financing. Here’s how:
Cash Flow Management: Vendor credit allows businesses to defer payments for goods and services, which helps in conserving cash flow. By having suppliers extend payment terms (e.g., net 30 or net 60), businesses customers can manage their cash more effectively, especially during periods of low liquidity.
Interest-Free Financing: Unlike traditional bank loans, vendor credit typically does not carry interest if invoices are paid within the agreed terms. This makes trade credit a cost-effective financing option for business customers needing short-term capital without incurring interest expenses.
Mitigating Cash Flow Gaps: Businesses experiencing seasonal fluctuations or delays in accounts receivable often use supplier credit lines to bridge gaps in cash flow. This ensures continuity in operations without resorting to interest bearing loans or a bank line of credit.
In an increasingly competitive business landscape, the strategic use of trade credit is critical. It not only strengthens the financial health of individual businesses but also contributes to a more resilient and interconnected economic ecosystem. As such, both suppliers and business customers should view trade credit not just as a financial necessity, but as a strategic asset that can drive sustainable growth and success in the long run. That, however, requires that customers honor their commitments…
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How Business Customers Take Advantage of Supplier Credit
Business customers often leverage supplier credit in a variety of ways to optimize their cash flow and financial position at the expense of their suppliers. Here’s the six most common ways they do it and how you can push back:
Paying Beyond Terms: Some customers deliberately pay invoices after the agreed-upon due date, effectively extending their credit period without formal approval. Whether or not this is due to liquidity issues, this practice allows them to retain cash longer and possibly also reduce borrowing costs. This is the primary reason a strategic and comprehensive collection regimen is necessary.
Payment Timing Optimization: This is an aggressive ploy sophisticated customers often use to pay late without incurring push-back from their suppliers. Implementation involves holding off paying invoices longer and longer until the supplier initiates a collection call. Future payments are then scheduled just before a collection call can be expected, which is within the implied credit terms as opposed to contractual terms, thereby causing no damage to the customer’s relationship with their supplier. The simple solution for the creditor is to initiate collection calls sooner.
Requesting Extended Terms: Customers sometimes request longer payment terms with suppliers, such as moving from net 30 to net 60 or 90 days. While this can improve the customer's working capital, it puts pressure on the suppliers' cash flow and may lead to increased prices to compensate for the extended payment window. Unless pricing is part of the negotiation, extended terms should only be granted as a customer accommodation for a limited period of time.
Making Partial Payments: Customers sometimes pay less than the full invoice amount, ostensibly due to cash flow problems. This practice can create cash flow issues for suppliers and require additional administrative work to collect the balance due. Customers willing to pay, but who are regularly unable to do so in full by the due date, should be charged late fees or put on a formal payment plan that includes interest charges.
Taking Undeserved Deductions: Some customers may claim discounts or deductions they are not entitled to, such as applying early payment discounts after the deadline or claiming promotional discounts that don't apply. Upwards of 90 percent of payment deductions incurred by suppliers are justified, and because of the administrative cost of resolution, some companies automatically write-off deductions below a specified threshold. As with payment timing optimization, some customers will exploit their suppliers’ write-off policy and regularly pay short. The solution involves monitoring your customers’ short payment behaviors and periodically auditing those with high deduction volumes to ensure there is not abuse.
Using Credit Cards to Pay on or beyond the Due Date: Customers increasingly opt to pay with credit cards on the invoice due date, effectively extending their payment period by an additional 30 days or more. While this provides customers with extra float and cashback on their credit card accounts, it results in processing fees for suppliers—not a fair exchange. Because of the processing costs, credit card payments should only be accepted by suppliers at the point of sale or within a short grace period (typically the 10-15 days offered for an early payment discount) for the full invoice amount, or as a last resort in an effort to settle very delinquent invoices, in which case open trade credit terms should be revoked for future purchases.
The various strategies employed by business customers to abuse supplier credit highlights the delicate balance between optimizing cash flow and maintaining healthy supplier relationships. While these tactics can provide short-term financial benefits to customers, they often come at the expense of suppliers' financial stability and operational efficiency.
The Importance of Monitoring Payment Trends
It's crucial for suppliers to be aware of these practices and implement robust credit management policies to protect their interests while still offering the flexibility that trade credit provides. A bulwark for those policies is visibility into your customer’s behaviors. Here are three metrics to watch:
Average Days to Pay: How your customers have paid you in the past is the best predictor of how they will pay you in the future. Unless you track average days to pay—the number of days from invoice creation and transmittal to receipt of payment—you will be working in the dark.
Customer Payment Trend Line: Once you know a customers average days to pay, you will want to learn how that is trending. Rather than average all a customer’s payments, it is more effective to track the moving average for a customer’s last ten payments. This way it is easier to identify changes in each customers’ payment pattern.
Standard Deviation in Average Days to Pay: A customer’s payment trend will typically move incrementally in one direction or another, until they run out of cash, and average days to pay skyrockets. Before that happens, customer payments usually begin to fluctuate—some slow, others faster—depending on cash availability. When this happens, the standard deviation will increase even if the average stays relatively stable. Monitoring the standard deviation of your customers’ running average days to pay provides early warning of customers with serious liquidity problems.
Final Thoughts . . .
Trade credit is a powerful financial instrument that creates a symbiotic relationship between suppliers and business customers. By extending credit, suppliers not only boost their sales and revenue but also cultivate lasting customer relationships, gain a competitive edge, and position themselves for long-term market success. Simultaneously, business customers benefit from enhanced cash flow management, interest-free short-term financing, and the ability to navigate financial challenges more effectively.
This mutually beneficial arrangement transcends simple transactions, fostering strategic partnerships and driving economic growth. As businesses continue to seek flexible financial solutions, trade credit stands out as a vital tool that aligns the interests of both parties. It enables suppliers to expand their market presence while empowering customers to optimize their operations and seize growth opportunities. Ultimately, the most sustainable approach is one that fosters mutual benefit and transparency, ensuring that both customers and suppliers can thrive in their business relationships.