Extending credit to customers allows them to purchase goods and services on credit and pay for them later on. Extending credit is often a win-win for both merchants and buyers. Customers have more purchasing power, and tend to buy more if they are not limited to cash that they have at the time of the sale.
We’ll help you develop a credit policy and explain how you can use invoice factoring and AR financing to support cash flow while you’re waiting for customers to pay your invoice. Companies like FundBox can finance you the value of your invoices upfront for only a 2.5 – 5% fee.
Why Should I Extend Credit to Customers?
As we discussed, extending credit to customers is a way to increase sales. It’s also more common and even expected in some industries like trucking and legal services, and less so in others. Extending credit is generally only practiced in B2B businesses, and businesses that sell to government clients.
Here are the key benefits of extending trade credit:
- Gain customer loyalty and a competitive edge – By letting customers pay you later for goods and services ordered today, you give your customers more control over their money and also show that you trust them. This keeps customers coming back, especially if your competitors don’t offer credit.
- Increase sales – When customers have a longer period of time to pay you back, they can purchase more goods and services from you. More buying power for your customers translates to more money in your pocket.
While extending credit to your customers has significant benefits, there are also certain things you should keep in mind when developing your credit policy.
Factors to Consider When Extending Credit
Every business has some customers who are more loyal and trustworthy than others. Fortunately, you are in control over who you offer credit to. It’s wise to check a client’s business credit report before deciding whether to extend credit to them.
Credit Terms Don’t Have to be One Size Fits All
If a customer has good credit and has historically paid their bills on time, chances are that they will pay you on time as well. However, if a customer has poor credit or a past history of delinquency, that should send up a red flag. When customers don’t pay their invoices, you may be forced to take the loss or initiate costly legal proceedings.
Also, while “NET 30” is the standard, that doesn’t always have to be the case. Your best customers might deserve 60-90 day terms, while new customers might start out with 30 day terms. Learn more about what these invoice terms mean.
You can also get more creative with how your payment terms are structured. Ryan Hulland, President and founder of flooring company Netfloor USA, told me a few things his business has tried for construction projects: collecting a percentage prior to completing work (a deposit), collecting payments as work is being completed (progress or milestone payments), or, for smaller projects, collecting full payment up front. “As a vendor,” Hulland told me, “you should be as flexible and accessible to your clients as possible, while continuing to protect your business and your employees to make sure you grow.”
Set Clear Terms & Have a Plan for Late Payments
When you have decided your credit policy, put it in writing and make sure clients review and sign off on it before purchasing a product or service from you.
The policy should specify the following:
- When payment will be due
- Interest that will be charged (if any)
- How and where to send payment
- When the payment will be considered delinquent
- What steps will be taken in the case of a delinquency
- Any late fees that will be charged
- Contact information for your billing department
If a customer is several weeks late or habitually late, and you are not able to make acceptable payment arrangements with them, you can report them to the business credit bureaus at no cost to you. As a last resort (due to the cost and time involved), you can also take them to court.
Use Invoice Tracking Software
When invoicing multiple customers, you need to stay organized. Invoicing software helps you send invoices to clients and track payment due dates. You can do things the old fashioned way and use pen and paper ledgers. However, software tools often have time saving features, such as auto billing for regular customers.
For a complete accounting solution that not only includes invoice tracking but a way to keep track of all income and expenses for your business, consider using QuickBooks. QuickBooks allows you to run an Accounts Receivable report so that you can keep track of invoices that are current, coming due and past due.
Using Invoice Factoring To Support Cash Flow While Awaiting Payment
Extending credit to customers can help your business grow in the long term, but cash flow gets a bit messy when there’s a time lag between purchase and payment. Invoice factoring is one way to plug the gaps in cash flow, by advancing you capital now in exchange for unpaid invoices.
You may have read or heard negative things about invoice factoring. Traditionally, invoice factors would contact a small business’ clients to verify invoices and act as a collection agency to late payers. Understandably, this discouraged a lot of small businesses from using invoice factoring. However, a new breed of invoice factors, exemplified by BlueVine and Fundbox, allow you to get invoice-based financing while retaining control over your client relationships.
How Invoice Factoring Works
Both BlueVine and Fundbox will help you free up the capital that’s currently tied up in your unpaid invoices. However, the way they work is pretty different, as are the types of businesses they are well suited for.
BlueVine: Best For Borrowing Over $100K and Businesses That Don’t Want Installment Payments
BlueVine is a good option for cash-strapped businesses that are awaiting payment on invoices. They will give you 85-90 % financing upfront, based on the value of your invoices. The rest, minus fees, is sent to you once the customer pays the invoice. You can get credit lines of up to $150,000 from BlueVine, with funding available in 1-3 business days.
Example: Let’s say you have a $10,000 invoice that is due in 30 days. If you are a first-time customer, BlueVine will advance you $8,500 up front. When the invoice comes due, your customer will pay BlueVine directly, and BlueVine will send $1,000 of the payment to you. The remaining $500 it will keep as its fee (potentially as low as $250, or 2.5%).
The nice thing about BlueVine is that there are no monthly payments to worry about once you’re approved for financing. You get a large advance upfront, which you can use to pay for operating expenses, working capital, or whatever else you might need it for. In addition, the funding you receive acts as a credit line. As your customers pay invoices, you get access to that money again to factor new invoices.
Even though your customers pay BlueVine directly, they won’t know you are factoring their invoices. BlueVine assigns an account number and payment address that are in your business’ name, so your customer can still make checks payable to you. BlueVine will never contact your clients, which is a big advantage over traditional invoice factoring. Also, you can choose to factor as many or as few invoices as you want — individual invoices must be at least $500 but there are no contracts as there sometimes are with traditional invoice factors.
BlueVine’s standard fee is between 2.5%- 5 % per month. So whether your customer pays their invoice in 10 days or 29 days, the fee is the same. Repeat clients, clients from certain industries such as trucking, and larger credit lines tend to qualify for lower fees.
Fundbox: Best For Borrowing Under $25K and Businesses That Want a Line of Credit
Fundbox is another good option for businesses with unpaid invoices. They provide up to $100,000 in financing based on the value of your invoices. Financing from Fundbox is structured like a line of credit with weekly payments.
Example: Let’s say you have a $10,000 invoice that will be due 90 days from now. Fundbox will loan you the full $10,000. Then, you have to pay back the $10K plus the fees charged by Fundbox over the next 12 or 24 weeks. The fees for a $10K invoice would be approximately $466 if you take 12 weeks to pay back the loan. If you took, say, only 6 weeks to pay it back, then your fee would be cut in half ($233). This makes Fundbox an economical option for invoices that are due in a short period of time.
While Fundbox will never contact your customers or wait for them to pay you back, customers are considered during the application/approval process. You receive 100 % financing upfront and you pay back the loan week over week. If you can’t afford to make the weekly loan payments, then BlueVine may be better suited to your business.
Fundbox loans also work like a line of credit. As you pay down what you borrow, that money becomes available to you again to factor additional invoices. The cost is approximately $50-70 in total fees for a $1000 invoice over 12 weeks. As mentioned above, you can save on fees by paying the loan off earlier.
Funding is available from Fundbox in 1-2 business days, but in order to qualify, you must use compatible invoicing software (Freshbooks, Clio, Wave, Harvest, QuickBooks, or Xero). Fundbox hooks up with your invoicing software, and you can then choose which invoices you want to submit for funding. There is a $100 minimum per invoice required and $1000 minimum per funding event. Fundbox also requires payment in full before requesting a new funding event for the same customers.
Will I Qualify for Invoice Factoring?
Invoice factoring is available to businesses that sell to other businesses or to government customers. It’s relatively easy to qualify. Here’s what you need:
- Invoices should be due in 90 days or less.
- Personal credit score above 530 increases odds of getting approved.
- Creditworthy customers who pay on time.
- For Fundbox, you must use compatible invoicing software.
- At least 3-6 months of invoicing history, so the lender can see your billing and payment patterns.
Invoice Factoring Cost
The cost of invoice factoring is approximately 2-5 % per month. When you convert this into an Annual Percentage Rate, it comes out to be about 30-60 % APR. While this seems sky high, it’s actually cheaper than several other business financing options out there, especially if you need financing on short notice. For instance, invoice financing is cheaper than short term loans and merchant cash advances.
In addition, you should keep in mind that the cost of your capital being tied up in the invoices is often more than the fees charged by the invoice factor. You can use the funding to acquire inventory, hire employees, expand, or do other things that will help your business grow. Without some way to free up the cash in your invoices, you have to put your business on hold until your customers pay up. Or worse, you can’t even offer credit, which can make you a less profitable company in the long run. Invoice factoring is a good solution for businesses that want to offer credit to customers but need help in stabilizing their cash flow.
For many small business sellers, extending credit to customers is essential to business growth. When developing a credit policy, set clear terms, track payment deadlines, and only extend credit to customers who you trust. Be sure to consider using invoice factoring to support your cash flow when you extend terms to customers.
Check out our How to Manage Accounts Receivable guide for tips on how to stay on top of the money that customers owe you.