The pros and cons of upfront payment and credit terms

24/01/2020

The decision as to whether or not to offer credit terms can be difficult.

The balance between protecting your business from the potential risks involved and providing an attractive proposition to win and subsequently retain customers is tricky.

Take a look at the range of pros and cons of both upfront payment and credit terms…

Upfront payment

Pros

• Money from customers is received before goods are released which protects your business from the risk of late payment or even bad debt.
• Less resource is required for credit management and potential debt recovery; although resource is needed upfront to ensure the payment is received before goods/services are released/delivered.

Cons

• Can only trade with businesses that are able/willing to pay upfront.
• Some businesses may be unprepared to pay for goods or services they haven’t yet received, especially where there is a lack of trading history with you.
• Customers will potentially be less loyal as they don’t have any official ‘agreement’ with you, particularly where competitors are able to offer them more perceived value by way of credit terms.

Credit Terms

Pros

• Can offer a competitive advantage when winning business.
• It sends good signals to buyers -your business appears stable, established and trustworthy, which can help when winning the trust of new customers considering which supplier to work with.
• More businesses are able to trade with you and those who do may be more inclined to repeat buy if they have an established line of credit, which can increase loyalty.
• Customers trading on credit terms usually spend more than those who are required to pay upfront.
• Customers might focus less on price if they are able to pay on terms as the extension of credit can add value in itself.
• Credit terms can assist your customers in managing their cash flow challenges.
• Offering credit is widely accepted as the norm and is therefore pretty much an expectation. In industries where it isn’t common place then it could arguably give you a competitive edge.

Cons

• A thorough credit management strategy/policy must be in place to ensure you are trading with credit worthy businesses, as well as procedures for satisfactory collection of monies owed. Managing this function in-house requires increased resources. It could be cost effective to explore outsourcing options.
• New start businesses might not have adequate history to provide peace of mind for you to trade with. However, any businesses that are deemed to present a high risk can easily be excluded and supplied to on ‘cash on delivery’ terms.
• Your cash flow may be impacted by having to wait for payment, even if customers do pay within terms. There is also the potential issue of non payment or late payment which can leave your business vulnerable, but credit insurance/debtor protection can help to mitigate these risks and funding is available to bridge any cash flow impact.
• Balancing customer relationships with a firm credit management stance can sometimes stretch relationships. Again, outsourcing collections may be a sound option for your business.
• You will have to be strict and review relationships regularly to identify your ‘valuable’ customers and those costing you more in management than their business is worth.
• It’s clear that the key to offering credit terms comes down to a variety of factors, including the industry you operate in, the value of your transactions and the type of customers you have. However, many businesses feel they have to trade on terms in order to remain competitive. We would welcome your thoughts, experiences and opinions on this matter.

For more on this topic take a look at our blog post the top 5 most-resented payment terms which looks at poor payment practices SMEs have had to deal with.