Managing cash is important for any business, but what happens if customers need to extend their credit terms beyond those already agreed and what are the risks of doing so?
Offering credit terms to support sales is a normal and expected part of doing business in many sectors. However, there may be times when business owners come under pressure to extend credit terms beyond preagreed limits. Whilst this could happen for a number of reasons, how should they respond?
Managing Credit Extension Requests
Customers may ask to extend the terms of their credit agreement for a variety of reasons. For example, they may be looking to extend the length of time before making payment, or the amount of credit they can accumulate. In either case, this could be a sign that they are experiencing cashflow difficulties and business owners need to be aware of this risk. Therefore, understanding the reason for the customer’s request is crucial in order to balance the potential risks and rewards.
The main risk is non-payment; the larger the amount owed, or the length of term agreed, the greater risk the business is exposed to. However, working with a key customer can also bring benefits. For example, if the business agrees to increase credit terms, the customer may increase the volume of orders, which could in turn boost turnover and help the business to grow.
Balancing Credit Terms and Cashflow
Before making a decision, owners should consider what’s right for their business. Financial information, such as cashflow forecasts and aged debtor and creditor ledgers, can help to reveal whether the business can afford to negotiate increased credit agreements. Looking at the amount of time the business takes on average to collect payments, versus how long it takes to pay its creditors, can be a good indicator of whether the right balance in terms of risk and reward is being achieved.
If the business is making payments more quickly than it is collecting them, then it runs the risk of cashflow turning negative, therefore owners and directors should consider how this might be perceived externally. For example, banks and other investors may be more inclined to partner with a business that has good control of its cash.
Conclusion
There will always be positives and negatives and you should weigh up customer requests carefully before agreeing to any extended credit terms to make sure you aren’t caught out by poor cashflow management.
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