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Credit Mgrs - Maintain Those Terms

The article below, "Extending Payment Terms as a Recession Looms is Very Risky"

penned by John Selek offers some great advice about handling requests from your buyers to extend their typical/previously agreed upon payment terms, particularly as we head into a recession.

Along with his advice, I would add:

  • Your trade credit insurance policy may not allow an extension of time to pay (and continue to insure future shipments) without express permission from the carrier - use this as leverage

  • Be extra vigilant about cease shipment timelines - your policy may not insure shipments to past due buyers

  • Slow payment trends lead to higher account balances so now is a good time to audit your buyer limits. Request increases where needed.

Protect Your Cash Flow: Extending Payment Terms as a Recession Looms is Very Risky

By John Selek at Your Virtual Credit Manager

Payment Terms define when a customer is supposed to pay your invoice for the products and/or services you provided, at your expense, using your cash. The “norm” is 30 days from invoice date, but there are many exceptions. Many customers will try to extend your terms to 45 or 60 days or more. Outside the USA, and in the export business, payment terms are often 90 days or longer.

Extended payment terms delay your incoming cash flow. If more than a few customers have been granted extended terms, your cash flow can suffer substantial strain. The more extended terms you grant, the worse it will get.

To compensate, you may have to borrow funds, pay interest and submit to the lender’s conditions and covenants. In addition, it raises the risk of loss from customer bankruptcy and resulting non-payment. If a customer has 60 day payment terms, and pays 30 days late, you will have three months worth of sales at risk, versus two for the customer the pays a month slow on 30 day payment terms.

Should other customers learn of your granting extended payment terms to one of your customers, and they will, they will likely demand the same treatment, further increasing your investment in Accounts Receivable (AR) and straining your cash flow. Once granted, extended payment terms are very difficult to rescind. Extended Payment Terms in a Recession Extending payment terms as we head into a recession is especially risky. Consider these facts:

  1. Most of your customers’ ability to pay your invoices will decrease, increasing the amount of credit risk in your AR portfolio.

  2. The amount owed you will increase substantially as you grant customers another 15 to 60 days to pay. If a customer currently has Net 30 day terms and their purchases remain constant, they will owe you 50 to 200 percent more on the new due date than if you had maintained the Net 30 day terms. Factor in the additional delinquency that will increase during a recession, and your Accounts Receivable (AR) asset can easily increase by 75 to 250 percent. This serves to further increase your AR portfolio risk as the economy slips into recession.

  3. Much of the increase in your AR will correspond to a decrease in cash flow, which will require your company to rely more on its credit facilities, or lacking a line of credit, to get some sort of a business loan. The added interest burden is a further damper on cash flow.

  4. The bankruptcy of a few large customers who owe you a substantial amount of money due to extended terms, can push your firm into insolvency as well.

Meeting the Challenge How can you minimize the impact of extended payment terms? The first step is to resist them as best as you can.

  • Refuse in a professional manner. If high volume/high margin financially strong customers insist on extended terms, grant them for a limited period (e.g., for one specific order or for all orders during the next 90 to 180 days), then automatically revert to the prior, shorter payment terms. If the extended terms become permanent, increase the price your customer pays (when you can) to cover your cost of borrowing money to compensate for the lack of cash flow.

  • For financially weak, lower volume customers, hold your ground. That may mean leaving some sales on the table. For example if they want an extra 30 days for a $10,000 order, ask if they can handle a $5,000 order on standard terms. The key is to avoid extending more credit to weak customers. You can do that by keeping them on a shorter leash, both in terms of order size and length of terms.

Remember, large customers may threaten to discontinue ordering from you if they do not get extended terms, or just unilaterally impose them. Other than refusing their orders under the extended terms, there’s not much you can do, except put subsequent orders on credit hold and otherwise be aggressive with their collections How will you finance this 75 to 250 percent increase in AR? This depends on your cash flow and how much it is impacted by the extended terms you’ve granted. Ideally, you’ll be able to generate sufficient cash flow even with the extended payment terms and some belt-tightening on expenditures. When this is not possible, you’ll need external financing, such as bank loans. Another option is trade financing to enable you to sell these receivables and receive cash per the former, shorter payment terms (e.g., 30 days), or even earlier than that (3, 10, 15 days). There are many forms of financing now available for small and mid-sized businesses (SMBs) receivables and many are reasonably cost effective. This can be an especially effective way for managing credit for your smaller customers. Your financing partner can essentially serve as your credit function for this segment of your customer base, saving you the cost of credit investigations and then collections.

How will you protect this large investment from bad debt loss? For all customers who will receive extended terms and as a result owe you much larger amounts of AR, conduct a credit check to determine if the customer’s financial condition is deteriorating. Is their request driven by the realization that they cannot pay on time with the existing, shorter payment terms? This is a red flag and you should revisit ways to reduce your exposure to this company (lower credit limit, strict order holds, etc.). As a rule of thumb, you should be updating your credit assessment on your higher risk customers every six months.

Staying the Course Recessions squeeze companies in two ways. On the one hand they dampen sales. On the other, they tend to increase receivables. Combined, this is a formula for a cash flow crisis, which is the primary cause of business failures. To navigate a recession, the most critical thing you can do to ensure survival is to protect your cash flow.

Extended payment terms are to be avoided, but that is not always possible. Inevitably, you will be forced to accept extended payment terms, but if you follow the steps outlined above you should be able to minimize the negative impact on your company’s cash flow.

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