Pros and Cons of Selling on Credit on Working Capital.
There will be a mix in your sales. Some will pay cash while some will buy on credit. Selling on credit is almost inevitable in business. Some factors will necessitate that you sell on credit. You may need to sell on credit because you want to maintain a closer relationship with the customers or as a result of the increased competition. It may even be that competitors are giving out credits. So, if others are selling on credit and you don’t, you may possibly lose customers to competitors. Before you sell goods on credit, you need to evaluate the decision very well. Try to consider the trustworthiness of the customers involved. This can be achieved by carrying out background checks on his credit history.
There is nothing bad in establishing credit limits for your customers. Credit should not be open ended; customers should be informed of the normal credit period. A register containing accurate records of all transactions with credit customers and the amounts they are owing is equally necessary. You can invest in a software for keeping track of accounts receivable aging reports. The same customer could have multiple entries with different payment terms. This should be part of your strategies for working capital management. Selling on credit has advantages and disadvantages.
- You are going to enjoy quick turnover. Instead of goods becoming obsolete, you can quickly get them rid off from your shelve by selling them on credit.
- High volume of sales. Selling on cash basis will limit your sales but when you sell on credits, you will achieve higher sales and more market share.
- Increased profit margin. Since the customers are not paying immediately, you may choose to sell at prices that are slightly higher than normal prices.
- Customer’s loyalty. Selling goods on credits to customers make them to have a sort of affinity with you.
- It can lead to bad debts. There is no guarantee that the customers will pay back. Even though he plans to pay, any events can happen which may make the debt irrecoverable.
- Loss of income/capital. Bad debt is a loss of income as well as loss of capital you have invested in buying the goods. If you keep losing your capital, it will only take a short period before you will be out of business.
- Liquidity problems. Credit sales can lead to liquidity problems especially if you are not enjoying the same credits from your suppliers.
- Strained relationship. Some customers are very difficult when it comes to money matters. They buy on credits but they don’t want to be asked to pay their debts. Selling on credits to such individual can lead to a strained relationship. If you must sell on credit, do your background checks on the individuals
Since selling on credit is inevitable, you need to gear your efforts towards collecting your money on time as delay or default in payments will have adverse effect on your cash flow and ultimately on your bottom line.