Offering Credit.

It’s the same rules as when you lend money to friends!

Son, 

One of the ways to leverage in business, is to USE OTHER PEOPLE’s MONEY (as well as time and resources).  What is important is to see that other people will also want to leverage using your money.  At the level of small to medium business, this is called ‘offering CREDIT’ to a customer.  You give ‘terms’ that they can continually pay for your goods (or services) at a later time - usually 30, 60, 90, or 120 days.  

Equally, as you operate your company, you can seek from your suppliers ‘terms’ to pay for your goods purchased, or services used at a later time.  The same 30, 60, 90 days apply.

You CAN offer one-time credit (consignment) however, when you offer a ‘Line of CREDIT’ to a customer, especially a Distributor (as they buy a lot more at a time), you take money from your cashflow, and you add it to theirs.  This money will never return to your cashflow in practical reality.  The only time your ‘Line of Credit’ offered will close is;

  1. if the customer goes bankrupt and is unable to pay - in this case you lose your money

  2. if the customer goes feral and refuses to pay - in this case you can sue for your money

  3. If the customer stops buying your product, and you may recover your money, finally.

If either a) or b) happen, the total sum of money lost may be;

  1. equal to or greater than the profit from the current year (and challenge your viability)

  2. equal to or greater than the lifetime profit from the customer (depending your margins)

The power of NOT GIVING CREDIT is that it avoids the risk of these ugly scenarios. The downside is that you will not grow the company as quickly or as ‘big’ (assuming that none of the negative events happen, because if they do happen, your ‘big’ can be ‘bankrupt’).

The power of GIVING CREDIT is that you can fit the ‘SME’ business model of 30 or 60 days credit terms, and later, you can fit the ‘Corporate’ business model of 120 to 180 days terms.  ‘Fitting the model’  gives you access to mass distribution by national and multi-national companies like Bunnings in Australia, Home Depot in USA, and ALDI in Europe.   The downside is that when a recession comes, CASH IS KING - cashflow dries up, and everyone hangs on to whatever cash they can, and increase the pressure on those that owe them, to pay up.   At this time, your 30 day ‘debtors’ (in debt to you) will go to 60, and 90 days payment for goods they have already taken delivery of (i.e. YOU have paid for them).  This is the reason why, if you offer credit, you MUST stay vigilant - insisting that ‘the terms, are the terms of the credit agreement’.  If they cannot, STOP S–––UPPLY immediately.  You may lose the customer, but you will not lose 2 - 3 months of product.

A secret upside to offering credit as a ‘big’ manufacturer, is that it can be a ‘golden anchor’.  For that buyer to leave your factory for another factory (let’s say it quoted cheaper), they must first pay ALL THEY OWE - which could be 90 days of goods. The cost/effect of the 90 days of credit from the buyers cashflow maybe higher than the cost savings on the product.

Dad.