How and When To Finance Your Customers: 5 Basic RulesBy Fernando Padilla | Tue, 09/14/2021 - 08:58
Seventy percent of the financing in Mexico is between supplier and client. This has created two cultures opposed by nature. Entrepreneurs always have doubts about when, how and whether or not they should provide financing to their clients. They wonder what might happen if they provide financing but then do not get paid; if they do not provide financing, they wonder if customers will not buy their product or service; should they also provide financing if the competition does; and how should they document the financing? Is an agreement by mail enough?
Currently, 75 percent of companies grant some type of financing, mostly without knowing how. This usually causes problems, including overdue and irrecoverable accounts receivable and, most importantly, loss of customers. But it is possible to have a good result if the process is orderly, structured and implemented with a little knowledge.
The basic rules that every company must follow to create its own financing structure are:
All financing has a cost
Financing costs money in time and opportunity cost. Every day that passes that we have no money is costing us: from the financing lines to the accounting record. If we can't use that money either to buy or invest, we're failing to earn and failing to earn comes at a cost. That's why it's important to make it clear that all funding has a cost. Not contemplating the cost of financing reduces profitability and puts liquidity at risk. So, if your company is going to provide financing, it should increase costs, but how do you do that? How do you set the cost of money? The simplest method is to take as a basis the governmental role that is determined directly by Mexican Federal Treasury Certificates (CETES). If the CETES provide an approximate rate of 4.5 percent annually, we must divide that by 365 days to get a basic cost per day. This exercise helps provide a floor reference but the reality is that it costs much more.
Other examples in Mexico of the costs of annualized money:
- Banks range from 10 percent to 60 percent per year
- SOFOMES from 12 percent to 80 percent per year
- Fintech-online lenders range from 30 percent to 100 percent per year
- Pawnshops range from 80 percent to 300 percent per year
- Financing of transnational companies, 1 to 4 percent for every 30 days.
Funding always has to be documented
Under all circumstances, there must always be a financing contract, a promissory note or at least post-dated checks because these documents support us when customers fall behind or stop making their payments. This type of situation generates expenses: calls, lawyers, lawsuits. With our contracts, we can legally demand repayment of the financing we have granted.
We must always stipulate what the dates of payment are, the exact amounts, the method of payment (transfer, cash, check), the conditions and what will happen if they are not met. This is where sanctions, costs and the interest rate come in, so that both sides are aware and it is easier to get through a crisis.
You have to document even the loans you make to your family and friends. Do not feel bad; this process helps those involved to be calmer and in case of conflict, maintaining friendships.
Know the cycle of your business
Knowing perfectly all the processes of your business is essential to be able to make the decision whether or not to finance a client. The rule of thumb is that they have to pay their bill at least at the same time that your company must pay its bills.
The main factor is to know perfectly the cycles of money in your business, how many days elapse between when you pay and when you get paid. On paper, it is theoretical. The reality is that the client always takes a little time to pay, which when a revolving line helps.
By wanting to follow customs when selling to a client and not setting clear parameters, it puts you in an unnecessary situation of stressing your company’s liquidity.
For example, you close a sales contract with Walmart, but in the conditions of sale, they tell you that the payment delivery is in 120 days. Because of your excitement at getting that sale, you accept, but on the other hand, your production process takes 30 days. Obviously, you have to pay your payroll every two weeks and your raw material supplier gives you only 30 days of payment. Naturally, you have to finance your operations, from 60 to 120 days, which will mean that the more you sell, the more financing you will need to do, causing stress on your liquidity. If you do not have a strategy to deal with it, selling to Walmart will become your worst nightmare.
Preventing such a situation requires Rule #2, and including the cost of money over time, which can be done with the support of a financial institution that helps you by financing these periods or, the most expensive and inefficient path, with the capital and profits of your company (the latter is the least recommended).
One tool you can use to make the financing you are going to grant to your clients more institutional and better structured is through a revolving line through a banking or nonbank financial institution. The easiest way to achieve a line of this type is with a SOFOM, which can create an arm to be able to finance your customers and be able to fill the gaps in the time you need to pay your supplier.
Never leave the collection of financing in the background
One of the main reasons why customers do not pay — and it will sound ridiculous — is because companies do not charge.
You must have an area or a person who maintains order on the invoices, a good collection structure and control of what you finance. One of the main causes of late payments from customers is often the fault of the companies that offer the financing.
Very organized companies know when they have to pay their bills, they have their system and they even pay without being notified, but the reality is that they are the minority.
You must collect before the invoice due date arrives, call the day of billing, send emails or send a notification in any way you can. In case there is no payment, take specific actions in a timely manner.
If a customer starts to fall behind, don't stop acting
The moment a customer starts to show some arrears, or already has at least two unpaid payments, do not settle for the telephone or email explanation. Visit your client to know the reasons for the arrears, evaluate and negotiate. Either you extend your term (remember more term equals more costs) or suggest another form of payment (for example in kind). The important thing is that you do not let time pass and if you notice that your client is still unable to pay or comply, get the advice of a lawyer to plan your recovery strategy. In these situations, the result is better for the one who acts fastest.
EXTRAS: Tips for Granting Funding
- What can I do to sell more through financing?
It is best to approach a financial institution to help you create financing programs. This works well when your product or service is expensive or you have durable goods. The financial institution values your clients as their own possible borrowers, since it is the one that grants the financing directly. You can say that you are selling cash because the entity that is going to pay you is the financial institution. You can also maintain the relationship with your customer because you are dedicated to sell and deliver, not to charge, which is always very friendly. That's how it works with car dealerships, which really just focus on selling. They partner with financial institutions that actually give you the financing or lease for the purchase of a vehicle.
- Consider the nonbanking financial sector
This is a great opportunity because there are many nonbanking financial institutions — SOFOMES — that can help you create personalized and flexible products to be able to open a range of customers (to connect with the main SOFOMES, go to www.asofom.mx, the association of SOFOMES of Mexico). You will be able to establish quick processes, since speed is key for companies. You could also work with a bank; the only disadvantage is that they are slow and rigid in their authorization processes.
- Experience the use of fintech (technology + finance)
There are many companies that are not banks but offer financial solutions for your business and your customers, such as crowdfunding platforms or collective funding, which offer an alternative and innovative way to finance assets, such as lendera.mx, with simple and cheap points of sale terminals that you can consult through your mobile devices, such as clip or billpocket. In addition to the fact that these allow you to easily accept credit card payments at a low cost, you can offer monthly interest-free options to your customers