They may make all their sales on a cash basis. However, like it or not, we live in a credit-driven society and in many cases, this costs them sales and customers.
If a supplier needs to place a large order, they may not have the funds to pay for it all in full. Therefore, their order will go to a company that extends credit.
Thus, small businesses face a trade-off of balancing the costs of granting credit against the benefits of increased sales. If they: offer too little credit, they risk stifling their company’s revenue growth; offer too much credit, they may slow their company’s profit growth; offer credit haphazardly and it can be disastrous to their company’s ca$h flow.
Clearly, you should grant credit only if the positives of potentially having more customers and being able to charge higher prices outweigh the following negatives:
BAD DEBT POTENTIAL – If you make all of your sales on a cash basis, there is no risk of having bad debt. You also risk stifling your revenues. Conversely, if any portion of your sales are on credit, there exists the possibility of debts you may never collect. But you may have more customers and be able to charge higher prices.
SALES REVENUE EFFECTS – While granting your customer credit so they can delay paying you is a convenience to them and will probably garnish more business for you, it’s not so convenient for you or your bottom line (on an immediate basis anyhow).
INCREASE IN COSTS OF GOODS SOLD – When you extend credit, it means paying for a product or service in order for you to have it in stock yet not getting paid for it immediately when it’s purchased. While you will eventually get paid, your business has to have enough cash flow to compensate for the delayed payment and you lose any interest income you might have earned on that money.
FINANCING YOUR ACCOUNTS RECEIVABLE – If you offer credit to your customers, chances are you will have to take on debt to finance your accounts receivables in which case you will have to factor the cost of short-term borrowing in as part of your decision. You will also have to consider whether you have the time and resources to collect late payments.
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