How to handle debtor days and payment terms

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One of the most critical factors that determine the health of your cash flow is your customer payment terms and debtor days.

Net 30 versus net 90: The amount of time you give customers to pay for purchases could hurt your business, more specifically, your cash flow.

How quickly after a product purchase or service delivery do you expect your customers to pay?

Having cash on hand means you can buy stock, pay staff and fund marketing campaigns that grow your company. 

Debtor days ratio

This shows how long, on average, your customers take to pay you. For example, your customers owe you £14,000 on a given date. Your annual turnover is £100,000. Multiply the amount owed by the days in the year, 365, and divide the result by the annual turnover, £100,000:

(£14,000 x 365)/£100,000 = 51 days. In other words, customers are taking on average 51 days to pay your invoices.

If you sell products or services in exchange for a promise to pay in the future, you’ve extended credit to a customer. Shorter payment terms get money in the door faster. 

Longer payment terms provide customers more flexibility and may help you win more business – but at the cost of slower cashflow for you.

But that’s not the whole story. Compare your published credit terms with what’s happening in your business. It’s not unusual to find a business offering 30 days to pay invoices, but customers taking 90 days or more!

Do your payment terms work with the terms your suppliers offer you?

Does your customer payments timeline allow you to have the cash on hand to pay for your necessary purchases or overheads? 

By analysing what’s happening in your business now, you’ll be able to balance the need to provide a great customer experience with meeting your company’s financial objectives.

Payment terms example

If your terms are 30 days, it’s a good business practice to insist on 30 days.

Most customers will respond favorably if you enforce your terms, and if a few want to take advantage of you, ask yourself if you need their business.

If this sounds daunting, ask yourself what the downside might be. Are you afraid of losing customers who are only loyal to you because of your sloppy credit control?

Are you happy running up bank loans and overdrafts, with the associated extra costs to your business, to give free finance to your slow-paying customers?

Start by enforcing prompt payment with new customers and charging interest on late payment or requiring payment on delivery for new accounts.

Over time new customers will replace the old, slow payers, and you’ll have a healthier cash flow.

9 ways to improve cash flow and debtor days

  1. Make your credit terms clear on contracts and invoices, and state the due date on invoices, so there’s no misunderstanding.
  2. Instigate a reminder system for unpaid invoices, starting 7 days before the due date, on the due date and then 7 days afterwards. Then, if they still haven’t paid, PHONE THEM, don’t just write or email again! Apps like Chaser can completely automate this process.
  3. Get a part-time credit controller – you may be too close to the customer to chase them dispassionately.
  4. Use early payment discounts as a last resort – they may be effective, but you need to build the cost into your prices.
  5. If you have to incur costs upfront, ask the customer for a deposit or part payment up front.
  6. Make it easy for customers to pay you – put your bank details on all invoices and consider offering card payments too. For example, if you use cloud accounting software such as Xero or QuickBooks, you can email your invoice with a card payment link so they can pay with a couple of mouse clicks. On the other hand, if you supply a regular service, why not ask for payment by direct debit using GoCardless?
  7. Use factoring or invoice discounting. Factoring involves selling your invoices to a bank or specialist finance company which takes on the administration and cost of recovering the invoice payments. With invoice discounting, you raise a loan from a finance company against the value of your invoices, but you keep the responsibility for collecting the debts. 
  8. Negotiate extended payment terms with your suppliers. Simply taking longer to pay may be considered unethical, and you may find that some suppliers refuse to supply you if you habitually take too long to pay. 
  9.  Improve your stock control. Faster stock turnover means that there will be a shorter interval between the time that you have to pay your suppliers and the time that your customers pay you for the same goods.

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