Maximize Your Business Profits: Unlock the Power of 3 Cash Flow Boosting Strategies - A Side-by-Side Comparison!
When companies sell goods or services to other companies or government organizations, they often have to wait for payment for a certain period of time, usually 30 to 60 days. This can create cash flow problems for the selling company, especially if they need the money right away to pay for other expenses.
To help alleviate this issue, some suppliers offer early payment discounts. This means that if the company pays the invoice within a specified timeframe, usually earlier than the normal payment due date, they will receive a discount on the total amount due. This discount is an incentive for the company to pay the invoice faster and helps the supplier improve their own cash flow.
However, early payment discounts have both advantages and disadvantages. On one hand, they can help a company improve their own cash flow. On the other hand, taking the discount may result in a higher overall cost for the company.
There are alternative solutions to the problem of slow payment, such as negotiating faster payment terms or finding other customers who are more prompt in payment. When considering an early payment discount, it is important to weigh the potential benefits and drawbacks, and compare the costs and potential savings to make an informed decision.
In this article, we discuss:
Why do you need early payment discounts?
When small businesses or growing companies sell their goods or services to bigger companies or the government, it can sometimes be hard for them. These bigger companies usually have agreements that say they can take 30 to 60 days to pay for what the small business has sold them. This means the small business has to wait a long time to get their money, which can cause problems if they need the money right away.
Even if a small business is doing well and making more sales, they still might have trouble getting the money they need to pay their own bills. This is because the money they get from sales doesn't come in fast enough to keep up with their expenses. It's like filling a bucket with water, but at the same time, someone is taking water out of the bucket. The bucket might get full, but it still ends up empty.
To solve this problem, people came up with a solution called early payment discounts. Early payment discounts are a special prize that companies can get if they pay their bills faster than usual. This helps the small business get their money faster and makes it easier for them to buy more things or pay their own bills.
How do early payment discounts work?
Early payment discounts are simple to arrange and can produce quick results. Their main goal is to close the gap between invoicing and collections. Clients are usually offered two options. They can pay the full amount on their usual terms or pay a discounted amount if they pay early. Offering a 2% discount for payment in 10 days is common. For example, if you provide a 2% discount and your usual terms are net 45 days, you would write "2%/10 - net 45" on the invoice. Other discount options include:
Each industry has its customary discounts and terms. However, they are negotiable. Consequently, negotiate the lowest possible discount for the quickest payment.
Who should get a discount?
It's like giving a prize to someone who has always been good at doing something, instead of giving it to someone who has a history of not doing it well. So, instead of offering the discount to clients who have trouble paying their bills on time, it's better to offer it to clients who have always paid their bills on time. You can check this by looking at your records and making sure the client has a good history of paying on time. This way, you can reduce the risk of them still not paying on time, even with the discount.
Advantages and disadvantages
Early payment discounts can be a good solution, but it's not the best for everyone. Just like when you make any money decision, you have to think about the good parts and the bad parts. The good part about discounts is that they work fast and you can see results soon after you start using them. This is really helpful for companies that need money right away. Offering discounts is also easy and most customers like the idea of paying early and getting a little bit off the amount they owe.
However, this option has some critical disadvantages. These include:
1. They are?optional
Your customers get to choose if they want to take the discount and when they want to pay. But, you don't know if they will actually pay early until they do it. This can be a bit tricky and uncertain. Sometimes, when things are tough, like during a recession, people might not pay their bills quickly even if they have the option to get a discount. This means that you could end up in the same trouble you were trying to avoid in the first place.
2. They are open to?abuse
Some clients might try to cheat the system by taking the discount but still not paying on time like they should. This can be a problem for you because then you have to try to get the money you're owed, and it can be hard.
3. They can be very expensive to?offer
Offering discounts can be expensive, especially if there are other ways to get the money you need that are less expensive. For example, if you offer a 2% discount to get paid 20 days earlier, that's like paying 36% more in a year. So it's important to think about if it's worth it.
Some small businesses think that they don't have any other choices and offering a 2% discount is better than nothing. They don't want to have money problems. But actually, there are other ways to get money that might be even better. We'll learn about some of these ways in the next section.
Alternatives to early payment discounts
In a perfect world, the best and cheapest way to solve money problems from slow payments would be to get a line of credit from a bank. But, it's hard to get one of these because banks only give them to bigger businesses. So, if you're a small business, there are other ways to get the money you need. Some good options are called factoring, sales ledger financing, and asset-based loans.
a) Factoring
Factoring is a way for companies to get money for their invoices. They give their invoices to a special company, called a factoring company, and the factoring company gives them some of the money right away. The rest of the money comes when the client pays the invoice. Getting money through factoring is easy, even for small businesses or new companies that can't get a loan from a bank. The cost of factoring can vary, but it's usually between 1.18% and 3.5% for every 30 days (prorated).
b) Sales ledger financing
Sales ledger financing is like factoring, but it's more like a special loan. It's for companies that have grown bigger than the factoring option and make at least $850,000 in sales each month. It's more strict than factoring but not as strict as other options. The cost is based on the interest rate, like most loans. They are usually priced using a prime rate + X% model.
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c) Asset-based lending
Asset-based financing is a different way to get money for your business when you need it. Instead of selling your invoices, like you do with factoring, you use other things your business owns, like your inventory or machines, as collateral to get a loan. The financing company will give you money and you pay it back with interest. This is a good option for bigger companies who have at least a million dollars and don't want to sell their invoices. This type of loan usually costs less than sales ledger financing. Most asset-based loans have a minimum size of $1,000,000 and can cover substantially higher amounts. Like sales ledger lines, they are priced using a prime + X% model.?
Cost comparison of all alternatives
Comparing the cost of discounts for early payment to different financing options can be tricky. There isn't a standard pricing for each solution, and the cash flow timeline can differ. You'll have to talk with the people offering these options and decide which one is best for you based on your specific needs. This chart shows an estimate of the cost for early payment discounts, factoring, sales ledger financing, and asset-based lending. Each line shows a rough idea of the starting cost for each option.
In general, financing is cheaper than paying early, but there's a catch. The cost of paying early is the same, no matter when the client pays. But the cost of financing gets higher the longer the client takes to pay. So when companies use financing instead of paying early, the client won't have a reason to pay early and will just pay on their usual schedule.
Are there advantages to using financing?
Using financing can be cheaper than providing discounts for early payments in some circumstances. However, this is not always the case. Consider these other advantages when making a decision.
1. Financing provides dependable cash?flow
The most important advantage is that financing provides dependable cash flow. You no longer wait for a client’s payment or hope they took the early payment discount. This certainty enables you to grow your business more effectively.
2. Some lines have a selective option
Many factoring lines have a “selective” option that allows you to choose which clients and invoices to finance. Selective options provide you with a detailed level of control over your financing costs, enabling you to minimize costs.
3. Financing gets cheaper as your business?grows
The pricing of financial lines is usually tied to your sales volume. The rate falls as your volume increases. Consequently, your per dollar cost decreases as your business grows.
What is your best?option?
If your company has trouble with money coming in sometimes but it's not a big issue, then it's a good idea to offer discounts for paying early. It's not too costly to offer discounts every now and then and it's very simple to put into practice.
For a company that has ongoing cash flow challenges from slow payment from clients, alternative solutions should be considered. Factoring is a good option for smaller companies, while larger companies with a monthly invoice minimum of $850,000 may benefit from sales ledger financing or asset-based financing.
Sales ledger financing may be a better option compared to asset-based financing, even if asset-based financing is less expensive. Sales ledger financing typically has more flexibility, fewer rules, and requires less investigation, which often makes it a more convenient option despite its slightly higher cost.
Lastly, if your company has serious financial problems, consider discussing your options with a CPA or finance specialist.
You just learned how to finance your invoices as well as how to get your invoice paid early by your customers. And now the next thing you need to do is to subscribe to the newsletter so that you can start learning about business, property and capital.
In monopoly (UK Version) it works out that Pentonville road, Angel of Islington & Uston, the light blue sites on the left give you 159% return and are the best in terms of arithmetical return but the dark green sites which are what people think that are better Oxford Street, Bronze Street, and Regent Street only give you 101% return so they are very bad. The next best sites are the orange ones which are Bow Street, Vine Street, and Malbrough Street. They give you 141% return but they are better than Pentonville Road, Uston & Angel of Islington because there is an increased incidence of landing on them.?You land on them more often and the reason for that is, there is a card in the chance that orders you to go to jail. And if you go to jail, you are past the blue sites and about to land on the orange ones. In addition to that, there is another card in chance, ordering you to advance to Pall Mall which does the same thing, it takes you past the blue sites and another one demanding to advance to Marly Bourne Station.
There’s also another one demanding you to go back three spaces, which in one position will land you on Vine Street. So there’s an overwhelming case for having the orange sites. Now, most people do not know that.??
Quote
"Life is movement and movement in my opinion is represented as a wheel. It may be a car wheel, bicycle wheel,?or even a semi-truck wheel. In the end, you choose the size, width,?and type of rubber. What’s even better, you also have a choice to fill it with more air than the recommended pressure (for some that’s un heard of), however, one thing is crystal clear; to live a full life and have choices you must be willing to transform into a wheel rather than being a spoke on that wheel."
Amer Alamer (aka. Lamar Sidwell) is?venture capitalist and an expert in structuring real estate and business transactions. He is active in the mergers and acquisitions space as well as property development. He has been awarded three Real Estate Development Awards 2019-2020 (Best Developer Europe, Best Fiver Star Developer Turkey, and Best International Developer) by UK members of parliament and 80 other prominent judges at Prince Waleed Bin Talal’s hotel, the Savoy Hotel in London. Amer Alamer also helps small to medium-sized enterprises scale and exit by using public vehicles. He is also the winner of the Gold Stevie Awards 2021 for best innovation in the Financial Industry Middle East.
He is an author of How To 144X Your Options In Life which teaches how to structure real estate and business transactions using options. As well as taking them public on a recognized stock exchange. He has been featured in Smart Investor Magazine with a 4-page story.
Disclaimer: This material provided in this article should be used for informational purposes only and in no way should be relied upon for legal or financial advice. Also, note that such material is not updated regularly and some of the information may not, therefore, be current. Please be sure to consult your own financial advisor and lawyer when making decisions regarding your financial or legal management.?
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