Managing Your Cash Flow

Should you provide payment terms to clients?
Marco Terry
October 1, 2013
RETAIL : MANAGEMENT

Editor’s note: This article is the first in a three-part series on the subject of protecting and managing cash flow. The series will address how to offer payment terms to commercial clients, how to prevent collections problems, and how to strengthen finances to prevent common cash-flow problems. Read part two of the series in the November 2013 issue of Glass Magazine.

For many subcontractors and general contractors, cash flow is always tight, especially if a project pays in progress stages with complex or lengthy approval requirements. As a result, most GCs and subs prefer to buy glass products on credit rather than pay cash up front. It’s common to ask vendors to provide 30- to 45-day payment terms.

Providing credit can be a doubleedged sword for a glass vendor. When done correctly, providing credit can help grow your client base and boost your revenues. However, it can just as easily drain your cash flow, create problems, and, potentially, put you out of business. For many glass companies, all it takes is a default from a big project account, or a couple of delayed payments, to create serious financial problems.

Can you afford to wait?

The decision to offer payment terms to a client is actually two-fold, and the first question to ask yourself is if your company can afford to wait 30 days to 60 days to get paid. Keep in mind that you still need to pay your own suppliers, employees, and other expenses while waiting for your customers to pay.

There are two ways to determine if you can afford to wait for payment. The right way is to build a cashflow statement and factor in any projected revenues and expenses into the future. If your cash flow becomes negative, you have a problem, and offering credit will be risky.

A less precise but easier way is to simply look at your bank accounts and determine if your cash reserves are sufficient to handle expenses while waiting 30 days to 60 days to get paid. If they aren’t, then don’t offer credit.

Running out of cash is a serious matter. At best, you might be forced to delay payments to key suppliers and employees, affecting your corporate credit and your company’s morale. At worst, you could go out of business.

Give credit where credit is due

Just because you can afford to give credit doesn’t mean that you should give it to anyone who asks for it, without first doing some research. You should offer terms only to clients that will pay you back on time. This point brings us to the next question: how do you know who deserves commercial credit?

As a rule of thumb, a client usually treats you as well as they treat other vendors. If they pay other vendors on time, they will likely pay you on time. It’s that simple.

Determining creditworthiness

The easiest way to determine the creditworthiness of a commercial client or general contractor is to get a commercial credit report from a credit bureau. These reports track how well a company pays its vendors.

As opposed to consumer credit reports, which require approvals, anyone can get a commercial credit report. Two well-known credit bureaus are Dun and Bradstreet, www.dnb.com, and Experian Commercial, www. smartbusinessreports.com. Depending on the level of detail, their reports can cost from $50 to a few hundred dollars.

Although credit reports are easy to read and understand, making a credit decision isn’t always that easy. Fortunately, however, most reports provide a summary and a credit recommendation. While this information is useful, to make a more informed decision you should consider:

  • Days beyond terms: how late are their payments to other vendors?
  • Payment trends: are their payment habits improving or deteriorating?
  • Highest, average, and lowest credit: how much credit are they getting?

This analysis is where credit decisions become more of an art than a science. You need to look at these factors, determine your comfort level, and make a decision.

Here are some guidelines:

  • Paying a little late is not a big problem as long payment is made in fewer than 15 days beyond terms.
  • A declining payment trend is always a problem. A slowing of payments is often an indicator of financial distress.
  • To be safe, extend to them only the average amount of credit that other vendors provide.

Always look at the number of vendors providing information for the report, because the accuracy of the credit score is directly related to the number of vendors that report their data.

Construction industry issues

Most credit reports for companies in the construction industry are far from perfect. These companies are more likely to have judgments and other negative indicators in their file. These negative indicators are not necessarily a problem if you are working with a very large company, as most large companies—especially in construction— get sued during the course of business. However, numerous lawsuits against a small or mid-sized company could represent a serious problem. You need to make your own call as to what you consider acceptable risk.

How to handle a large project

Using a single credit report can work well for small to mid-sized projects. However, if you have to quote a large project, consider using reports from multiple credit bureaus for two reasons: First, each credit bureau has a proprietary scoring mechanism, and getting another opinion is always important. Second, and most importantly, credit bureaus don’t always have a complete credit picture of a company. Combining reports provides you with a more comprehensive view, enabling you to make a more informed credit decision.

The author is managing director of Commercial Capital LLC, a leading provider of working capital to companies in the glass industry. Contact him at 877/300-3258.