What’s the best way to manage cash flow when dealing with long payment terms from clients?
Effective cash flow management can sometimes mean the success or failure of a business. Healthy cash flows means the business covers daily expenses such as payroll, equipment, rent, utilities, and inventory. Insufficient cash flow will cause disruptions resulting in missed payments and business operations.
By gaining a better control on cash-flow, especially those related to long term payments, businesses can make sound decisions about resource allocation and strategic initiatives. Positive cash flow provides the flexibility and resilience needed to navigate unexpected challenges and economic downturns, while negative cash flow can restrict growth and threaten the businesses sustainability.
Businesses operating on long payment terms require more stringent monitoring than short term payments. Long payment terms extend from 30 days to 90 days, and some businesses offer up to 120 days payment terms.
When clients are given longer terms, businesses experience delays in receiving payments, which can lead to cash flow gaps. These gaps pose challenges, especially for small businesses with limited cash reserves, as they may struggle to cover operating expenses during the waiting period. Without sufficient liquidity, managing day-to-day costs like payroll, rent, and inventory replenishment becomes more difficult, increasing financial stress.
Strategies for Managing Cash Flow for Long Payment Terms
Several businesses, especially small to medium ones find it challenging to manage cash flow for long payment terms. Delayed payments from clients puts a financial strain on the business, making it difficult to cover daily expenses.
However, there are simple yet effective strategies that businesses can implement to overcome these challenges.
1. Optimizing Supplier Payment Conditions
If the business owner finds cash flow constrained they can ask their suppliers for more time to make their payments. Longer payment terms gives the business extra breathing room to manage expenses while waiting for payments from its customers. However, it’s important to maintain a positive relationship with the suppliers. Be respectful and clear when communicating to avoid straining the partnership.
A healthy tip in building a good relationship and trust with suppliers is to make payments on the agreed time.
2. Offer Discounts for Early Payments
Encouraging clients to make early payments will improve a businesses’ cash flow. The business can counteract this by offering a minimal discount. For example, offering a 10% discount if payment is made within 30 days can motivate customers to pay faster.
In addition to boosting cash flow, this strategy can also strengthen relationships with customers. By rewarding them for prompt payments, the business owner creates goodwill, making them more likely to continue doing business with them in the future. Just make sure the discount is manageable and doesn’t cut into the organization’s profits.
3. Incorporating Technology to Manage Long Payment Terms
Embracing technology can greatly help in managing payment terms. By implementing online payment systems, businesses improves the payment process, making it more effective and efficient. These systems enable customers to pay easily, leading to faster cash flow and less reliance on manual processes that are slow and prone to errors.
4. Consider Flexible Payment Methods
In addition to traditional payment options, businesses can explore alternative and flexible payment methods to enhance cash flow. For example, offering a Cash on Delivery (C.O.D.) option allows customers to pay at the time of delivery. This approach reduces the chances of late payments or non-payment, ensuring that the business gets paid immediately.
Businesses must consider the positive and negative aspects of COD options. On one hand, it ensures the business receives payment on time, while on the other hand, it can limit sales as customers may not have sufficient cash to make payment on delivery of goods.
Relying on traditional payment methods like cheque payments create unnecessary delays because there are several manual steps required in processing cheques. Alternatively, offering quicker alternatives like bank transfers, UPI payments in India, Giro payments in Southeast Asia, and ACH payments in the U.S. can simplify transactions and encourage faster payment.
5. Receiving Deposits before Fulfilling the Order
To avoid a negative cash flow situation, particularly when related to long payment terms, businesses can request deposits for large orders. By asking customers to pay a percentage of the total cost upfront, approximately 25-50%, businesses can secure immediate cash flow to help cover production or service costs.
Upfront deposits not only reduces the financial burden while waiting for final payment but also demonstrates the customer’s commitment to the purchase.
For the business to implement this strategy, it must clearly communicate the deposit requirement in their pricing terms and include it in all contracts or invoices. This approach can significantly minimize the risk of cash flow gaps, ensuring that the business has the necessary funds to fulfill orders without financial strain.
6. Track Due Dates and Sales Forecast
Establishing a robust system for tracking due dates and sales forecasting is essential for maintaining healthy cash flow. Without regular analysis, whether it’s weekly, biweekly, or monthly, businesses may overlook critical warning signs of declining sales.
For instance, if most of the annual clients are expected to make payments in March, but the businesses supplier payments are due in February, they could face a cash flow gap. By predicting the sales and monitoring account receivables, businesses can clearly outline payments due, payments received, and when to expect incoming payment.
This proactive approach enables businesses to stay ahead of their liabilities and operational expenses, ensuring their collections outpace their payouts. By accurately tracking this data, business owners can effectively manage long payment term cash flow.
They can also utilize cloud-based systems to simplify this process, providing convenient tools for monitoring due dates and forecasting sales, effectively helping businesses maintain a positive cash flow.
The Impact of Technology on Managing Cash Flow for Long Payment Terms
Businesses not effectively using technology and AI to manage their cash flow will likely not be able to compete globally.
Two key areas where technology can significantly impact businesses cash flow are payment tracking and automation, as well as cash flow forecasting.
Payment Tracking and Automation
Payment tracking and automation systems can improve the efficiency of managing long payment terms. Automated invoicing solutions allow businesses to send invoices swiftly and accurately, reducing the risk of human error. Additionally, these systems include features like automatic reminders that notify customers when payments are due, thus encouraging timely payments.
AI based tools can identify patterns in customer payment behaviors, seasonal sales trends, and external factors affecting revenue, AI-driven tools can provide businesses with precise forecasts. This foresight allows companies to anticipate potential cash flow gaps and make improved decisions to reduce risks.
Cash Flow Forecasting
The primary purpose behind creating a cash flow forecast is to compare a businesses’ projections with actual performance. In cases of material divergences, firms can analyze whether the variance is due to poor projections that may require further tweaking or because the company follows poor cash management practices.
In the latter case, businesses can take corrective measures to improve its cash inflows by speeding up accounts receivable, cutting down on expenses, or even taking on a loan before the business takes a downward spiral.
It is a good practice to the businesses cash balances on a weekly or monthly basis to ensure there are no material variances between actual cash flows and forecasts.
Advanced software solutions can efficiently analyze historical sales data and payment trends to project future cash flows. Using this information, businesses can identify potential cash flow gaps ahead of time, allowing them to plan accordingly.
For instance, if a business knows that a significant portion of its revenue is arriving in March but that it has critical expenses due in February, it can take proactive measures to reduce the impact. This could involve negotiating extended payment terms with suppliers, securing a line of credit, or adjusting spending in the lead-up to the expected influx of cash.
Additionally, accurate cash flow forecasting assists businesses allocate resources more effectively. With clear visibility into expected cash inflows and outflows, companies can make strategic decisions about investments, hiring, and other operational needs.
Automated Invoice Processing
AI tools can update invoice processing by automatically generating and sending invoices based on customer agreements and order details. These systems can also use natural language processing (NLP) to read and understand invoices, ensuring they are accurate and compliant with payment terms. Automation reduces errors and accelerates the invoicing process, leading to quicker payments.
Risk Assessment and Credit Scoring
Before finalizing long term payments with customers its important business owners conduct a risk assessment and credit scoring. There are several systems available to assist businesses with this by analyzing various data points, including payment history, industry trends, and economic indicators.
Risk assessment can guide businesses in setting appropriate payment terms for each customer, reducing the likelihood of late payments, bad debts and correctly managing cash flow.
Outsourcing Bookkeeping and Payroll
Outsourcing tasks like bookkeeping and payroll means the business can manage their finances effectively, freeing up time to focus on improving cash flow strategies. Professional services can also provide insights into trends and offer solutions to improve liquidity.
OBS Financials’ bookkeeping services can assists businesses with managing accounts and cash flow effortlessly.
OBS Financials’ payroll services ensure timely employee payments, reducing payroll stress even during cash flow crunches.
