5 Reasons To Make Buying ‘On Account’ Your New Best Friend

According to the Federal Reserve’s 2016 Small Business Credit Survey: Report on Employer Firms61% of the small businesses surveyed faced financial challenges last year. The most common reason for the financial challenge was expansion followed by making debt payments and purchasing inventory. It also said that 11% of the loans given to small businesses were for the extension of trade credit. In fact, many businesses use the trade credit offered by suppliers as a way to fund expansion and buy inventory without going into debt. In this way, trade credit addresses the three largest financial challenges faced by small businesses. 

What is Buying ‘On Account’?

What does buying on account, on credit, on receipt of invoice or by installment mean? They are all examples of deferred payment plans. Any payment plan that gives you full rights and ownership of the product before exchanging cash is a deferred payment plan. For the efficient organization a deferred payment plan is like manna from heaven.

You can apply for a loan from the bank to purchase the inventory for $10,000 or you can find a vendor willing to sell the inventory on credit. There is no difference. Well there is one big difference. Deferred payment plans often come with little or no interest on the deferred amount. Some plans pay you for making timely payments. Occasionally, high risk or start-up companies may even be willing to sell you product with full recourse. In other words, you make your best effort to sell their product and whatever you don't sell can be sold back to the supplier. 

From a business perspective, payments made on account are working capital injections. They are the cure for any company with short-term financing challenges and yet most business owners view accounts payable as a process burden. In many ways, your ability to negotiate terms with suppliers is more important than the sale.

The Seller And The Buyer

Who buys has need of two eyes, But one's enough to sell the stuff. - Anonymous

Business owners and CEO's must wear two hats. At times they play the role of seller and other times they are the buyer. Some organizations prioritize the role of the seller, but both sides of the equation must be good at their job to be profitable.

On one side of the equation sits the seller of goods on account. In a sea of sellers he differentiates himself with the extension of credit. Allowing customers to buy products or services on credit increases his customer base and the amount that customers are willing to spend. While invoicing and credit extension have increased his customer base, it has also deferred cash payment, which increases receivables and lengthens the cash conversion cycle. It also expands working capital. These deferred cash payments make the seller appear rich in net income, but his cash flow is locked up until the buyer pays him. 

This is one side of the equation. It is the second part of the equation that is often overlooked and neglected. 

On the other side of the equation sits the buyer of goods on account. The buyer has the power to make purchases on credit. Ideally, the buyer can sell the inventory before paying cash for it. Instead of lengthening the cash cycle, the buyer shortens it and increases profitability, all without a change in the number of days the inventory is actually held on hand. In other words, the buyer can greatly reduce his cash flow cycle without changing the number of days inventory is held. These deferred cash payments make the buyer appear rich in inventory to customers, but his cash flows aren't locked up until he pays the seller cash. With any luck, the customer will pay before the end of the trade credit term and none of the buyer's cash will be at risk.

From this scenario comes five powerful reasons to buy 'on account': 

  1. It requires no/low-cost financing
    • Buying on account is considered one of the cheapest forms of working capital financing. Ultimately, buying on account improves cash flow and increases profitability by lowering interest charges. It also gives you the ability to pay over several months.
  2. It provides discounts on early payments
    • The cost of financing depends on the terms you receive. For example, “3/30 net 60” means you get a 3% cash discount if you pay within 30 days. You can also forfeit the 3% and use the cash for another 30 days. This gives a 60 day free credit period. Make sure there are no late-payment or delinquency fees in the agreed upon terms.
  3. It improves internal controls
    • To take advantage of terms you have to have a good system of controls in place. Efficiency is key. Improvements should be made in processes like expense tracking and signature authority.
  4. It provides easily obtainable credit
    • There is no need to go through a rigorous application process for trade credit. Some companies require a credit check, but it's nothing like the application for a bank loan. Invoicing and trade credit are generally available for all B2B customers. 
  5. It's easy to maintain and has few regulatory constraints
    • While the initial process of setting up controls may seem tedious, it is generally a one-time process with lifelong cash flow benefits. That is, the maintenance of these processes is minimal. There are no credit meetings to schedule, covenants to worry about breaking or metrics to keep up with. 

Not all deferred payment accounts are favorable. If they don’t allow you to take advantage of the reasons listed above, you should negotiate better terms. 

In Summary

Business is made up of buyers and sellers. Together they create a marketplace. Too often managers concentrate on the sell, when it is the buyer that holds the power of the business model. 

There is something about the term efficiency that seems almost inhuman in our everyday personal lives, but a good business model is driven by efficiency. Those companies that aren’t negotiating the best terms on trade credit are leaving  profits on the table. Does it get any more efficient than a no cash purchase of inventory at 0% financing?

Buying on account is one of the only ways to drive efficiency in both inventory turnover and financial leverage. It is the type of option that is so beneficial that it may feel like a trick, and in some ways it is. It is an accounting optical illusion that has allowed large companies to finance themselves on the backs of smaller companies for decades. Buying on account makes the job of the efficient entrepreneur an easy one -- inventory and leverage offered up in one smooth little pill. All you need to do is sell.  

Want to offer your customers the perks of buying on credit without collections or waiting for payment? Contact us.

Posted in Finance, B2B Sales, Management