10 ways to prevent customers getting a free ride

It can be tempting for start-ups to offer generous payment terms, as a means to attract new customers.

But until you collect the cash, all you have done is gifted away a product or service.

Building sales this way is hazardous as it’s hard to wean customers off these arrangements and they carry a substantial cost to the business.

A discount here, extension of terms there and over time the accumulative affect of all this can lead to cashflow problems.

Unless you’re a bank, you should avoid developing a habit of providing a line of credit to your customers. To truly grasp the flow on effect, you need to understand your business’ cash to cash cycle.

The cash to cash cycle is the time it takes for cash invested to be returned as paid sales. For a manufacturing business, the cycle starts when raw materials and inventory is purchased.

For a services business, it’s when salaries are paid. The cycle moves from production and inventory, through to sales and delivery and finally the billing and payment stage.

Long delays in the cycle means the business may need to obtain additional funds to pay the business’s short-term obligations. Unless the owner can contribute additional capital the business may need to borrow from the bank.

This may be difficult if the business and the owner has limited security or a limited capacity to repay. The banks also aren’t exactly rushing to lend to small businesses these days.

A better option is to work on achieving a shorter but sustainable cycle which makes cash available to pay the business’s commitments and repeat the cycle without funding.

Sales can then be repeated more frequently and this typically results in greater revenue, profits and cashflow.

The key is achieving a sustainable cycle though. Most small growing businesses can get caught up in focusing on revenue and revenue growth as a measure of success.

While this measure is important, it ignores the cashflow position of the business. Growing the business beyond its capacity to fund growth can lead to cashflow difficulty and if left unchecked, failure.

This makes it important to understand and maintain a balance between growth and having the cash on hand to fund it.

Factors that affect the rate of progress through the cycle include how quickly you issue your bills, your efficiency, productivity, inventory control, supplier terms, and of course your terms of trade and credit policy.