Setting a payment policy for your business

invoiceA small business is not just about producing and selling products.  An ultimate aim is to make money so that the venture can continue and grow in a sustainable basis.

This means a small business owner must know how to handle money in an efficient way.  This implies more than just the need to set up bookkeeping and financial systems to keep track of money going out and money flowing in.

One aspect in financial management that many small businessmen tend to overlook is establishing payment and collection policy.

Setting payment terms covers deposits, progress payments, and extending credit.

Prior to delivering a product or providing a service, a small businessman must establish clear, written payment terms and ensure that clients and customers understand these.  Thus, these terms are best printed in estimate forms, included in formal contracts and job orders and printed on invoices and statement of accounts sent to customers.

Securing Deposits

To avoid exposure to bad debts, a small business must make it a point to ask clients for a deposit especially if it’s supplying a service.

How much is fair in deposits?  Some service businessmen charge 50 per cent of the value of the order, others lower.  But it would be safe to charge a deposit that covers the value of the materials you will use to perform the service.   If you’re supplying labor only, a fraction (say, one third or one-fourth) of the value of the contract may be charged.

Progress payments

Another insurance against undue financial risk is to ask for progress payments.

The key to successfully securing progress payments is to prearrange your contract and payment terms. Agree on the amount that will be due at various stages of the project. You can use percentages to calculate the progress payments, such as 25 percent deposit, 25 percent upon delivery of any materials, 25 percent upon substantial completion, and the balance at completion or within 30 days of substantial completion. Or you may arrange for more concrete progress payments based on indicators that are relevant to the specific scope of work, the job or the services provided. Regardless of the system you use, progress payments on larger jobs can dramatically lessen your exposure to financial risk.

Extending credit

Should you extend credit or not?

In most cases there’s no need to extend credit to consumers unless you deliver a service such as pest control that’s billed monthly or a major contract that is completed in stages. As a general rule, when a transaction is complete you should be paid in full.

However, in the case of business-to-business sales, such as when you sell to a big retailing chain, commercial clients will generally want some type of credit on a revolving-account basis, such as 30, 60, 90 or sometimes 120 days after delivery of the product or completion of the service. Ideally, you want to be paid as quickly as possible, so you might want to offer a 2-percent discount if invoices are paid within one week. And if you do extend credit, make sure to conduct a credit check first, especially when large sums of money are at stake.

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(For the related topic of collecting receivables, read this previous article.)