Conventional wisdom dictates that bad credit customers are just that, bad. After all, it’s nearly impossible to plan inventory purchases against customers who might be here today, gone tomorrow. Most companies shy away from customers who must prepay orders, or those customers with a less than stellar credit rating. However, there is another school of thought that espouses pursuing bad credit customers at all costs, especially in cases where cash flow is a going concern.
This doctrine dictates that in a cash strapped business world, where credit is hard to come by and delayed customer payments are the norm, companies should refocus their efforts on customers who’ll reduce their receivables financing costs and improve their cash position. So, given the reality of today's economy, should your company pivot and start looking for customer who must prepay orders?
Reducing Financing with Bad Credit Clients
The intention isn’t to imply that your company should try to build your market share on customers with uncertain futures, although there are arguments in favor of pursuing this course of action. No, in this case the idea is to offset the current financial climate with a proactive plan to pursue customers who aren’t able to secure credit. Why? Simply put, prepaying orders immediately reduces your company’s receivables financing costs and improves your gross profit on sales.
The key to making this strategy work is to get that money before buying materials, before creating an internal requisition to purchase parts and before any action is taken that might leave you holding raw materials in inventory. In essence, your customer must prepay before your internal operations begins releasing the requirement to fulfill the customer’s order. Now, you might be asking yourself why any customer would go forward with such an arrangement, or why such a strategy would work. Well, there are a couple of reasons and they are outlined below.
1. Prepaid Customers Represent Fast Sales: Bottom line, if you’re dealing with a customer who can’t secure credit, then they should be easy to sell to. After all, if they are not credit worthy, then they likely aren’t credit worthy for any company and are likely to be looking for support.
2. Prepaid Customers Lack a Negotiation Position: Prepaid customers should be relatively easy to sell to. Most of your larger competitors will tend to ignore them and that means they likely won’t have a strong negotiating position. However, be wary of smaller competitors employing the same strategy. They may also find these customers appealing during these credit crunches.
3. Prepaid Customers Reduce Receivable Financing: Perhaps the most important reason why now is the time to focus on prepaid customers is because they help to reduce your company’s receivable financing costs. Your company’s cost of capital is often tied up in inventory and receivables. Prepayment reduces your company’s cost of capital and increases your gross profit on sales.
Most companies shy away from customers with poor credit. However, even with interest rates as competitive as they are, companies are still seeing costs increase. This is due to the speed at which customers are paying their invoices and the amount of product they purchase. In a down economy, demand declines and receivables collection takes longer. Either way, a company's costs of capital are bound to increase.
In some cases, customers are closing their doors. Ultimately, it means companies today are holding inventory longer and take longer to collect on receivables. Both do nothing more than increase the company’s costs of financing. Refocusing your efforts on getting paid upfront may help to reduce these costs and improve your cash position. In the end, it comes down to identifying those opportunistic sales with those customers who have no choice but to prepay their orders.
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