What’s the hidden cost of extended payment terms?

“My VP of sales has been cutting big deals lately that give customers a six-month grace period for paying invoices. His argument is that we’re better off waiting a while to get paid full price instead of giving buyers a discount for net 30 day terms. I get the logic of what he says, but somehow I know there’s a hidden tradeoff. What am I missing?”

Mike: The tradeoff is the cost of the working capital or loans you need to cover payroll and other overhead while wait to collect from slow-paying clients. If you have plenty of cash, waiting six months to collect on a full-price sale probably costs you about as much as giving a 5%-10% discount for immediate payment. Both are very expensive solutions when you work out an equivalent annual interest rate.

If you don’t have much cash, your sales guy’s logic doesn’t work at all. Sooner or later, you’ll have so much money tied up in receivables that you’ll have trouble meeting payroll and other expenses. Then you’ll probably have to give up a big chunk of equity to get the cash you need.

Michael Gonnerman IncThe ASK MIKE is a weekly column providing answers from finance and small business expert Michael Gonnerman. Mike has served as a trusted advisor to hundreds of technology CEO’s and investors as well as served on more than two dozen corporate boards.

 

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