The Other Credit Crisis
We've heard a lot about the problems with the credit market -- banks aren't lending or, worse yet, they're pulling lines of credit back from good customers. I'm of the mind to play the drinking game 'Do a shot every time you hear the phrase economic crisis,' except for that kidney stone a couple months back…
There's another credit market we haven't been talking about, a huge slush fund of credit that's impossible to track, and one that's growing daily.
Well, implied net terms. If we send out an invoice to a client, it says 'Due on Receipt' unless we've made other arrangements with the client. Traditionally, however, our clients have treated that as 'I'll pay in the next payment cycle, or in 30 days… or so.' As long as we all expect it, it's okay; everyone knows when the money will show up, and they can manage their cash flow accordingly.
Only now clients and vendors are playing long-term credit games. For some reason not paying vendors is different than taking out a loan from a bank and not paying it. Sitting on a payable for 30, 60 or even 90 days is just fine for many business people, and the reality is the only ones who get paid on time are companies with big sticks like the banks.
As a business owner I obviously have problems with people not paying the company. We're pretty good about managing our debt, but most established companies carry a line of credit or credit card debt. If we have to tap that line of credit to make payroll or other expenses our clients are using our line of credit indirectly.
Even with the interest charges built into every contract, it's hard to recoup that cost of carrying the debt. As a business owner, you want to maintain a good relationship with your clients, especially the ones that spend (and therefore borrow) a lot of money. So, you use the interest charges as a last resort to get them to pay attention, and then waive them as part of the 'thank you' for getting paid.
In the process, you discount the work or product you've already sold. It would be like knocking 20% off the invoice just because your client didn't meet the terms of your agreement. In other words, you punish your own company for the mistakes of others.
Now we're seeing a ripple effect where people aren't getting paid at all. If we have a client who slow pays us for an invoice, it causes us to slow pay the vendor we used for the project, which causes him to slow pay HIS vendors… You could be 6 degrees from the guy who didn't pay in the first place and still get screwed.
The game only works if the chain remains unbroken and everyone pays; as we get further and further out of sync from products delivered or services rendered, the chain is gets weaker.
The best solution is to have your clients secure credit directly before going into the project or delivering the product. The downside is that offering direct terms is often a deciding factor in choosing otherwise equal vendors.
Rather than making the obvious statement, maybe I'll just skip ahead to doing a shot.