Many freelancers struggle with having to offer payment terms to commercial clients. Payment terms – also called trade credit – allow commercial clients net 30 to net 60 days to pay an invoice. Most large companies, your ideal clients, demand these terms as a condition of doing business.
However, offering terms can backfire if done incorrectly. For example, you could run out of money before your client pays you, resulting in serious consequences for your business. Or worse, your client could decide not to pay you, saddling your business with bad debt.
Offering credit to clients does have advantages. It can help you win contracts, especially if competitors aren’t able to wait for payments and offer credit. And, if used strategically, it can help grow your business.
Can you afford to offer credit?
You should offer credit only if you can afford it. Many freelancers mistakenly offer credit when they can’t afford to wait up to 60 days for payment. This miscalculation opens them to the risk of running out of money before the client pays – impacting their ability to pay vendors, employees, subcontractors, or even their own salaries.
Don’t offer credit until you have built a financial reserve sufficient to cover expenses for two to three months. This reserve should allow you to operate your business without interruption while waiting for payment. By the way, plan your reserve conservatively and assume that some clients may pay late.
Does the client deserve credit?
You should provide payment terms only to commercial clients with good credit. Most solopreneurs, especially new ones, are so excited to get their first client that they offer payment terms without considering the client’s creditworthiness. This decision can often lead to problems, as a dream client can easily turn into a nightmare of bad debt if you are not careful.
The easiest way to determine commercial creditworthiness is to purchase a commercial report from one of the major providers. These reports offer a wealth of information. Most reports include a commercial credit score, along with information on how to interpret it. They also provide your client’s payment history – valuable information, since you can assume that your client will pay you as well as they pay other vendors.
Lastly, the reports provide a suggested credit line. Take these suggestions with a grain of salt since they can be very generous. A good rule of thumb is to offer no more than the average of all open credit lines. However, there is room for flexibility with this decision.
Do you have the time to handle invoicing and collections?
Consider that, by offering credit, you also increase your client management workload. Unfortunately, it’s not as easy as creating an invoice, mailing it, and hoping that it gets paid in 30 days. Instead, you need to track all payments and handle collections calls when invoices become past due. Handling collections can be time-consuming, and, often, very frustrating.
Avoiding potential cash flow problems
Offering terms opens you to potential cash flow problems, even if your clients have good credit. Late payments are common. It’s not unusual for entrepreneurs to face unexpected problems, especially if their companies are new and growing quickly. One way to handle these problems is to use financing.
One great source of funding that is often overlooked by small business owners, especially self-employed individuals, is the Small Business Administration (SBA). The SBA offers a Microloan program for small businesses. Microloans are usually for less than $30,000 and have easier qualification requirements than conventional business loans. If a loan does not work for you, consider invoice factoring financing. Though more expensive than conventional financing, these lines offer flexible financing to growing companies.
One last point: evaluate your financial options before you run into problems. The worst time to look for financing is when you are in the middle of a cash flow crisis. Instead, plan ahead so that you can be prepared before problems arise.
Marco Terry is the managing director of Commercial Capital LLC, a firm that provides invoice factoring financing to freelancers and entrepreneurs. You can connect with him through LinkedIn, Twitter, or Google+.