Payment Terms and Extending Credit

How far should you extend credit to a new or existing customer? Opinions vary. June 4, 2012

About a week ago I was contacted by a furniture company out of New England for some 12mm baltic birch drawer stock. The individual had seen on our website that we sell custom drawer side material and wanted to know what price we could sell him 10k linear feet for. This was custom heights, groove widths and placement and varied from 4" tall to 10". This had to be finished two sides and foiled on the top.

We offered him the 10k ft for just under $1/ft plus shipping (approximately $1800), prepaid. He tells me he likes the price but he doesn't pay anyone in advance and he only pays net 30. I tell him that I don't do credit, especially at that price but I refer him to another company that does custom drawer stock and they offer him the same material for $15k plus shipping with 50% down. The furniture company will take it but they don't pay anyway but net 30. The deal fell through and I suppose he is still shopping for terms.

I don't know for sure but it does not make sense to me, in today's economy, that a reputable company would be willing to pay almost twice the price just to get net 30 terms. Companies today that would behave that way making decisions scare me. I don't do credit with my purchases and I don't do credit on my sales, there is too much risk today. Does anyone have any thoughts or anecdotal stories on companies doing business that way?

Forum Responses
(Business and Management Forum)
From contributor H:
I'd say that if they weren’t going to pay for the product anyway (net 30) it wouldn't matter how much they agreed in cost. Receiving money on something like this after they have it would be tough.

From contributor G:
Net 30 turns into net 120. He has your product and you have nothing. You made the good call.

From contributor S:

Credit is for the companies you develop a relationship with, not first timers who try the "Do you know who I am ploy". Even after years of dealing with some firms, you can get stung throwing credit around like its candy. I once had a large company order some custom cabinets and tried the same “we don't give money up front and 30 day thing.” We said we wanted a third. His response was that he could send lots of work our way if we agree to his terms. I said that if he agreed to mine and paid on time, I would consider working for them again. We did a lot of work for them over the years, and they never missed a payment.

It is my belief that if they are trying for nothing down, and nothing for 30 days until after it is installed that they are putting themselves in a position to bail out, if they deem it necessary. A customer, no matter how big they are, should also have an interest in the job at hand. If it takes you two months to build and install, that is a long time to be waiting for money.

From contributor A:
I agree - stay clear. I don't think you should ever agree to a deal with red flags like that. I've had the same experience with builders. Immediately, they start beating you up on price and payments.

In an informal meeting, I told one that I break payments into third’s. His response – “we'll see what we can do on that.” I stopped trying so hard to work for him. I know it can't apply to everyone, but I love working directly with homeowners. They are so happy when you can deliver what you've promised. They're almost happy to pay.

From contributor C:
We deal with some very large companies and for most first time orders it's COD. After that we do a credit check and possibly offer terms. However, most companies will not pay COD indefinitely, so if you want that kind of work you will have to issue credit at some point, assuming they check out.

From the original questioner:
I can't help but agree with the assessments offered. As tough of an environment that it is today, I think it is despicable that any business would prey on others, perhaps at the cost of the victim going out of business. We all need to be wary, we have only been successful these last six years by avoiding these folks.

From contributor F:
If you looked into using a factor, who would buy the invoice? Find out from the factor what the recourse is against you if the customer doesn't pay. You would give up a percentage that you could just add to the cost and let someone else take the risk if the customer passes the factors credit check.

From the original questioner:
The factor is certainly a good idea if working with credit is a goal. 99.9% of my sales are to DIY homeowners and small contractors and all orders are prepaid. We have some large OEM and manufacturing customers as well and with the pricing that I offer they prepay.

From contributor S:
You did the right thing. If you’re not in a position to offer financing don't do it. If this is a deal breaker it sounds like they simply don't enough cash or credit available to pay you. They are likely waiting for final payment on whatever job they are working on. Some contractors and businesses work this way. One possible workaround when a client requires net 30 is to request that they ask their customer to pay you directly. If I were unwilling to offer financing I would go this route.

From contributor F:
My reason for using a factor here is to get them to take the credit risk, get you paid, and add the cost of the factor to the order assuming once the invoice is assigned to the factor he owns it. I wouldn't recommend using a factor on a regular basis unless that’s all there is. I don't know if they will let you cherry-pick what you give them but if they do it’s a way to make the sale with no risk.

From the original questioner:
I have used a factor before, many years back. At that time I was doing a lot of commercial work in the multi-unit housing market and sometimes I needed to turn those voices in fewer than 45-60 days. Management companies are notorious for turning net 30 into net 60-90. I think the factoring route is good if that is where your business is. I prefer to have all work prepaid and everyone is happy. So many people have so many perspectives on a situation and every idea is worth a mint, in the right situation.

From contributor R:
As a former business owner (in an industry having nothing to do with wood), I'd like to offer a perspective from the other side. We would refuse to deal with companies that required deposits or COD terms. Net 30 was fine, while net 15 was something we'd consider on a case-by-case basis.

There were two reasons for this. First, our accounting processes were not set up to handle creating a payment prior to receiving delivery. Our accounting department processed around $1MM per month in receivables, and keeping the back end streamlined (following regular processes) was key in keeping that area of overhead down. For us to do a COD meant that I had to get personally involved, and I was basically uninterested in diverting my attention from moving the business forward for the sake of keeping any one particular supplier happy.

Yes, we could have set up more efficient processes to handle this type of situation. But, over time things had evolved where we really didn't need to. When the occasional exception arose where one supplier wanted different treatment, it was usually worth it to us to find someone who could work in our parameters, even if the price was a bit higher.

The second reason was that a supplier requesting net 15 or, especially, COD terms raised red flags in terms of their ability to manage their cash flow. We wanted to deal with business that were going to be around for longer than the time it would take to cash our check, and if they couldn't manage 30 days, we didn't want to be in the position where we had fronted them some money and they couldn't last long enough to deliver. We expected that they had negotiated at least net 15 terms from their suppliers, and that their employees were also on (effectively) net 15 terms, so expecting net 30 terms for us shouldn't be a stretch for a well-managed business.

Before anyone asks, our average turnaround hovered between 15 and 20 days. I was notified of anything over 21 days, and I got personally involved in the rare case where something went over 25 days. If it did, there was always a good reason, usually being incomplete product delivery or defective product.

That was for our regular business activities. When we added locations, we acted as our own general contractor and built our own buildings. For construction activities, our terms were usually net 60 (though typical payment was 45 days), and even in boom years, we had no problems with trades accepting this.

From contributor O:
I had one of the local builders contact me about doing his cabinet work. I had dealt with him previously in my day job in contractor sales for a local lumberyard, and knew he was slow pay. I did an estimate on six plans for him, delivered them to his secretary, and later he called to meet him at his office. Everything looked great until I gave him the contract on the first project, which stated 50% Deposit/Balance on Install. He stated he didn't give deposits to anyone, period. I gathered up my drawings and estimates, thanked him for his interest, and headed to my truck. His secretary caught me before I got out of his parking lot, to come back in and pick up the check. Completed the job, and collected it, but he was still slow pay. It's always best for everyone to have some skin in the game.

From contributor B:
Having been burned one to many times by clients that make final payments difficult I only work off 50% down, 25% when things go to finish and the balance on delivery or install. This situation has nothing to do with having cash flow problems or proper accounting methods to survive for 30 days without being paid and everything to do with not wanting to get burned by a large company with the resources to try not to pay a smaller company or a homeowner that has cash flow issues. I don't need to get 50% down to do the work, I want it because of shady contractors and large companies that choose to delay payments because they have cash flow problems.

I did work for a local contractor and was informed by some friends that he can be hard to get payments from in a timely manner. He did the 50% down, then delayed the next payment right up to the project deadline then delayed the final payment for several months after completion. The next project we did together I had 75% down and 25% before final install in the contract and surprisingly he paid those in a timely manner because he wouldn't get paid until the work was installed. This one was happy to pay as long as you held him over a barrel and there are many like him out there that might never pay. Why take a chance, if a client has a problem with giving a down payment or deposit then you can bet they will have a problem with all the other payments as well.

From contributor I:
I am not in the business of providing financing. However I will offer net 30 for jobs under $500.00. I may offer more on a case by case basis but only if I have a good reason to do so. Unless I have a good reason to trust a new client I require a deposit with all new customers. Exceptions may be made with references, or businesses with an upstanding reputation. I simply do not have the accounting staff, legal budget, or time to take on the risks involved with providing large amounts of credit. If a client were to see "red" flags as a result it would certainly make me wonder if I would want to do business with them in the first place. If a corporate customer needed proof that my finances were sound that could be arranged.

From contributor O:
If someone wouldn't pay 10K up front but would pay 15K net 30 they aren't planning on paying, so financially stressed that they can't pay up front, or are extremely concerned about you running away with the cash.

I would ask them which one it is. If it's one or two you should run away, and if it's three perhaps you could work something out that would limit your credit exposure, maybe an escrow account. This might cost a bit to set up but would still be much less expensive. In general anyone that insists upon 30 day terms to the point where they would pay 50% more is either a crook or a very poor businessperson.

From contributor Y:
You absolutely made the right call. Don't feel like you missed an opportunity because you likely would not have been paid. I worked for a millwork company owner like this (however, he demanded a 50% deposit himself). He would not pay up front, or pay a deposit and would go elsewhere and pay more if he had to. He is now gone bankrupt and is broke. It's difficult to pass up a nice sale and I don't blame you for wondering. This is my opinion looking from the outside though.

From the original questioner:
Everyone is right from their own perspective. There may be legitimate reasons for paying twice as much for the same product, even though this does not make sense to me. These tough economic times demand that we take a careful look at our methods for doing business. Thanks to everyone for some valuable insight and viewpoints.