Avoid Cash Squeezes With Smart Payment Policies
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You can foster a profitable cash flow for your firm by starting each production order off on the right track. Implement a three-step payment plan. Negotiate terms and conditions that require payments when you want them. Profitable cash flow will occur when you establish and execute timely cash-flow concepts into every order.
Many firms totally overlook the critical factors of:
- Identifying a billiable event--other than delivery.
- Setting payment due dates.
- Establishing penalties for late payment.
The result: great sales but not cash.
Be prepared to consider these steps before accepting an order. You need a negotiation plan. It should be prepared and followed with the same care you use to document your production process. Time invested in obtaining favorable cash-flow terms and conditions can mean added profit and higher returns on your investment. Never forget the fact that your cash flow will never get any better than what is defined in the negotiation process. Take steps to get the best available payment terms.
The first step is to bill before delivery. There are three ways you can issue an invoice before you ship the final product:
1. One way is milestone billing. This is fairly common where heavy up-front investment is required for a new product or job. In this case, the completion of a certain event or milestone (placing a subcontract, passing a critical design review, or receiving a large amount of material), is given a billing value. This authorizes you to issue an invoice when the event occurs--often long before completion of deliverable item.
2. A second way is to establish progress billings. This is fairly common in the defense and aerospace industries. Progress billings allow you to invoice costs, as incurred, on a routine bimonthly or monthly basis. This way your customer finances your inventory. The advantage is that while a job is in process your investment is reduced. In effect, you recover your costs before you deliver anything. (In this case, your customer does have a lien against the inventory.)
3. A third way is to utilize sub-line-item. This is fairly common in the construction industry. This billing term recognizes the times when an entire item cannot be completed, but the main elements of it are. Examples of sub-items are: the foundation, plumbing, frame and roof of a home. The advantage here is that as each major sub-elements is completed, an invoice can be issued, thus speeding cash flow.
The second step, setting payment due dates, is important because it defines when you will be paid. Why take an order if you don't make an effort to assure payment? Bear in mind that extending credit to customers has a real cost to you. Be sure your contract (and price) provides for that cost. Poor credit risks should be sold c.o.d. Discounts can be offered but tied to the shipment date, customer acceptance date, your invoice date, or a calendar date. The point is, once the payment date is established in your contract (purchase order, etc.) you have a legally enforceable document.
The third step, establishing penalties for late payment, will help you get timely payments. What happens today if a customer pays you 30 days late? Do you collect interest, or are you just happy to get paid? If your terms and conditions require a penalty for late payment, you improve your chances for timely payment--and based on contract terms, you have legal remedies available to use to collect interest from delinquent accounts.
You can negotiate profitable cash flow to save collection time and effort. You must place extra emphasis on payment provisions if you want to keep the profit you earned on the production line as your own!
This article was excerpted from The Small Business Encyclopedia.