When you gather all the necessary credit application information, you need to make a decision as to the viability of issuing credit to your customer.
You need to address three areas:
1) Customer assessment (covered in the previous section) Company Reports are available to help assess a customers' credit worthiness.
2) The terms & conditions you are willing to offer
3) The credit limit you are willing to allow
Your terms and conditions are the most important element of credit sales. There are many good books on contracts if you feel comfortable writing your own terms and conditions. You can start by looking at what other similar companies consider relevant for their business.
However, a solicitor is a must if you require terms and conditions outside of the basic 6, being:
1) Payment Period
2) Interest on Late Payment
3) Discounts
4) Notification of Queries and Complaints
5) Retention of Title
6) Law
IMPORTANT: THE FOLLOWING ARE ONLY EXAMPLES
(1) Payment Period
'Full payment of this invoice is due by…' (state date, not number of days).
‘Full payment of this invoice is due within 30 days of the date of this invoice.’
‘All invoices raised in the current month will be due for payment by the end of the following month’ (can be a long credit term).
‘All invoices raised in the current month will be due by the 15th of the following month’ (or whatever date, be sure of what you are offering).
'Full payment of due invoices to be paid within (30) days of the invoice date.'
There are many other payment terms not covered here, but the above will suffice most situations in the UK.
"We understand and will exercise our statutory right to claim interest and compensation for debt recovery costs under the late payment legislation if we are not paid according to agreed terms."
HELP! Late Payment Interest Calculator
The calculator works out the interest that you should charge on overdue amounts. The main figure you need is the daily rate of interest: as late payment interest is not 'compound interest' i.e. interest on interest, the daily rate never changes.
The base rate of interest is set by the Bank of England once a month (the rate that affects the mortgage rate) and this long with the statutory late payment rate (which is set by the government) is a guideline. You are advised to charge the minimum of the current base rate, and the maximum of the current base rate plus the statutory rate.
Example: If the base rate is set at 6% and the statutory rate is set at 8%, you are advised to charge a minimum rate of 6% and a maximum of 14% (6% + 8%).
NOTE: The base and statutory rates are guidelines, not hard and fast rules. Ultimately is it up to you how much interest you charge (if the rate is 'fair'), but always make it clear to the customer how much you will charge, before you charge by using Terms and Conditions of Sale.
If you have no sales contract, and the supplier has set no interest conditions, the statutory law automatically gives you the right to charge interest on amounts due after an initial 30 days.
The number of days outstanding is the amount of days the payment is overdue.
Example: You bill a client on the 1st of March, giving them 30 days to pay and they still have not paid by the end of April, the number of days outstanding is 30, not 60.
No VAT is charged or paid on overdue amount. Interest is charged on gross balance outstanding.
(3) Discounts
‘A two (2)% discount of the invoiced amount will be allowed if full payment is received within seven (7) days of the date of the invoice.
In the above example we have given a common discount figure and a less than average number of days to take the discount option. The figures you use must be:
affordable (to you the supplier)
profitable (after the discount is taken)
controlled (after the 7 days, no discount can be taken)
The supplier and the customer must both benefit from a discount.
supplier’s benefits: faster cash flow
can be used as a sales aid
reduced finance/bank charges
improved probability of receiving payment#
customer's benefits: genuine savings
improved margins
can off-set price increase
can negotiate higher discount rate for large orders
Some companies enter the amount of discount allowed, together with the discounted balance. The problem with this is that the customer in seeing the discounted invoice total after the allowed period is always tempted to send you the reduced payment.
It is not unusual for customers to take discounts even when paying 30, 40, 50 days late. You need to make your customer aware that you will not accept such action. Discounts are viable when you need fast cash flow, or have sufficient working capital, or your own financing is inexpensive. However, if you cannot afford discounts you must resist the temptation to do so, unless your customer wants a large order.
Some customers would never consider paying late, therefore, by offering a discount you are drastically reducing your profit for a small gain in days. You should use discounts as a strategic option, be that to increase sales or improve cash flow. Once you start offering discounts, trying to stop them will seem like a price increase to the customer. In fact, after a short period the customer will not even consider the discounted price as anything other than normal with the following statement not uncommon, "I've always paid you in time for the discount, and now we have a few cash flow problems you want me to pay the full amount", it happens, often.
The Basic Discount
If you get an invoice totalling £900 including vat, offering a 2% discount if settled in 20 days this means 2% from the vat inclusive figure (in the absence of any other comment).
£900 divided by 2 multiplied by 100 = £18.00 discount.
Invoice Discount or Delayed Payment
If you currently pay your supplier invoices at 60 days from invoice date, and your supplier is now offering a discount of 2% if you settle in 20 days from invoice date. You need to work out whether it is in your financial interest to take the discount, here's how to do this:
Discount offered 2%
divide by 100, less the discount amount (100 - 2 / 98) = 0.020 x 365 = 7.448
divided by the difference between your current payment period '60 days'
and, the number of days to qualify for the discount '20' (60 - 20) being 40 = 0.1862 being 18.6%
Not to confuse you, or me, further, the final figure of 18.6% means that if you can borrow money for less than this figure you should accept the discount, even if this means an overdraft at less than 18.6%.
If you borrow from your bank at 12% per annum and you give your customers a 2% discount if paid in 20 days, this cost of the discount equates to waiting 60 days for every invoice to be paid, but you will get your money 40 days quicker.
Article Index:
1 Introduction - Terms & Conditions of Sale & Service
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Introduction
