Terms of engagement

As we have seen to devastating effect over the last 12 months, markets change and the economic environment can be very fluid, which in turn impacts cash flow. What might have been appropriate pre-coronavirus may not be appropriate today.

In this environment financial controllers have a role to play in not only keeping on top of invoicing and collections, but also ensuring terms and conditions are current and appropriate, as well as recommending other strategies such as offering discounts for early settlement, or trading longer terms for a larger order or contract.

During contract negotiations small businesses should seek a prompt payment commitment. At this stage it is also important to determine the escalation process in the event that a debt remains unpaid beyond the credit terms. This can be a challenging conversation but it is a vital function of the financial controller.

No going back

Larger companies rarely change the terms of a contract after it has been signed so if it looks too onerous and/or the profit margin is marginal, a small business should carefully consider whether it is an opportunity worth taking.

For existing customers they should regularly review both the terms they offer to their suppliers, and the terms they negotiate with their customers.

Payment terms are intrinsically linked to cash flow. Therefore, payment terms should be reviewed as often as a company reviews its cash flow. If a company is struggling for cash flow because their payment terms are too generous then the payment terms should be changed.

Equally if the company’s cash flow is strong and extending payment terms would give it a completive edge over it competitors, this could be worth looking at.

Realistic approach vital

Aside from exploring options such as invoice finance or factoring, tips for managing cash flow include regularly reviewing payment terms and possibly offering different terms to certain customers based on their payment history.

An accounting software provider once suggested that if small businesses wanted to be paid within 30 days they needed to set their payment terms to 13 days or less. However, setting terms with the assumption that they will not be met is entirely the wrong way of tackling payment issues.

In any case, reducing payment terms to 13 days or less is unlikely to be practical for a lot of businesses and may negatively affect customer relationships, potentially resulting in losing sales. You also need to consider that if the company doesn’t have a large number of suppliers it may only do a payment run every fortnight.

Use your data

A better approach would be to negotiate realistically from the outset, agree terms, and ensure those terms are adhered to through good credit management. Some accountants will review their clients’ payment terms to ensure they protect themselves as much as possible from bad debt.

Of course, one of the best options for optimising cash flow is to make commercial decisions based on up-to-date financial data – which is easily done by users of cloud-based accounting packages such as Big Red Cloud.